Column: Housing storm leaves UK exposed, skews policy
If financial markets bore the brunt of this year’s interest rate shock, housing now stands in the firing line.
And a residential real estate quake would hurt many economies far more, amplifying the bond market ructions of the past 12 months if inflation can’t be contained quickly enough to allow central banks to stop tightening in 2023.
Overall housing activity – construction, sales and the related demand for goods and services that goes with housing churn – contributes an estimated 16-18% of gross domestic product annually in the United States and Britain. That’s well over $4 trillion for the former and half a trillion in the UK.
With long-term U.S. fixed mortgage rates above 7% for the first time in 20 years, and more than double January rates, U.S. housing sales and starts are already feeling the heat.
And as property has ridden the bond bull market of low inflation and interest rates for much those intervening decades – the sub-prime mortgage crash of 2007-2008 apart – any risk of a paradigm shift in that whole picture is a mega concern.
Twenty years ago, after the dot.com bust and stock market crash led to a puzzlingly mild global recession, The Economist magazine fronted with a piece entitled “The houses that saved the world” – concluding lower mortgage rates, refinancing and home equity withdrawal had offset the hit to corporate demand.
But it’s much less likely to come to the rescue after this year’s stock market swoon, if only because interest rates are heading even higher into 2023 and many now fret about potential distress and delinquency in the sector next year.
Some 10% of global fund managers polled by Bank of America this month think real estate in developed economies is the most likely source of another systemic credit event going forward.
And Britain, which even the Bank of England assumes has already entered recession, is particularly vulnerable.
UK homeowners outsize exposure to floating rate mortgages and greater vulnerability to rising unemployment leaves the British market a potential outlier amid the twin hits of rising Bank of England rates and this week’s expected fiscal squeeze.
Indeed, many feel the extent of finance minister Jeremy Hunt’s dramatic fiscal U-turn away from September’s botched giveaway budget is precisely to avoid the sort of brutal BoE rate hit to the housing market that had threatened initially.
British think-tank the National Institute of Economic and Social Research reckons some 2.5 million UK households on variable rate mortgages – about 10% of the total – would be hit hard by further BoE rate rises next year, pushing mortgage costs for about 30,000 beyond monthly incomes if rates hit 5%.
That partly explains why even though money markets still see BoE rates peaking as high as 4.5%, from 3% at present, high-street clearing banks Barclays and HSBC forecast the central bank’s terminal rate as low as 3.5% and 3.75% respectively.
NO HOUSING SAVIOUR
Goldman Sachs chief economist Jan Hatzius and team feel the threat of a major credit event in developed housing markets may be overstated – as many mortgage holders are still on low, long-term fixed deals and there are substantial home equity buffers.
But they said Britain stands out nonetheless.
“We see a relatively greater risk of a meaningful rise in mortgage delinquency rates in the UK,” Goldman said this month. “This reflects the shorter duration of UK mortgages, our more negative economic outlook, and the greater sensitivity of default rates to downturns.”
While Australia and New Zealand have higher variable mortgage rates, British mortgage holders also have a higher vulnerability to rising joblessness.
Goldman estimates that a one percentage point rise in unemployment tends to boost mortgage delinquency rates by more than 20 basis points after one year in Britain – twice as much as the 10bp impact from a similar scenario in the United States.
All of which bodes ill for UK house prices – although forecasts are still far from apocalyptic.
UK estate agent Knight Frank expects nationwide house prices to drop 5% next year and again in 2024, a cumulative decline of almost 10% but one that only takes average prices back to where they were in the middle of 2021. Further out they see stagnation persisting – with just a 1.5% cumulative gain in the five years to 2026 and London prices basically flat over all that period.
NIESR economist Urvish Patel concurred with the thrust of that – expecting lower house prices over the next couple of years but adding “fears of a house price and housing market collapse because of higher mortgage rates are unlikely to be proved correct”.
Offsetting factors are that a majority will be on fixed rates, supply remains tight and stamp duty taxes are due to be cut again, he said.
But he did point to Bank of England research from 2019 that studied more than 30 years of data and showed that a 1% sustained increase in index‑linked UK government bond yields could ultimately result in a fall in real house prices of just under 20%.
Ominously perhaps, 10- and 30-year index-linked gilt yields were at the epicentre of the September budget shock. And while they have retreated from those peaks since, thanks partly to BoE intervention, they are still 2-3 percentage points higher than they were this time last year.