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Interesting Article In Financial Adviser 11/8/05

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MPC is the last line of defence

11th August 2005

Rising mortgage approval rates cannot halt the market’s decline on their own

THE property market can sometimes appear a little confusing, perhaps because we are living through a bubble in housing market indicators – one that certainly shows no sign of bursting.

As far as we are aware there are eight house price indices out there, a figure that includes the new FT House Price index that was launched a few weeks ago.

The Nationwide and Halifax indices, and the new FT index, indicate that house price inflation is anywhere be- tween 6 per cent and 3 per cent, while the Rightmove and Hometrack surveys indicate a much lower figure of somewhere be- tween zero and -3 per cent.

Although these values vary quite substantially, their rate of decline over the past 12 months is virtually identical. Furthermore, none of the indices show any sign of turning up at the moment. At the current rate of decline, house price inflation, based on an average of these indices, is likely to be around -5 per cent by the end of this year.

There is also a plethora of housing market activity measures. According to the Royal Institution of Chartered Surveyors, first-time buyer inquiries have fallen recently and the average sales for each surveyor is now as low as at any time since 1992. The surveyors have also recently reported that new buyer inquiries have fallen again. Meanwhile, the Council of Mortgage Lenders estimates that first-time buyers still make up only a small proportion of total sales at around 30 per cent. These, and other measures of activity, all indicate that the market is weak and that it is likely to weaken further.

But perhaps there is one ray of hope in this morass of data. Mortgage approvals, normally an excellent indicator of future housing market activity, increased last month for the sixth time in a row. Which is surely good news. Well maybe it is, but before we get too excited about a forthcoming upturn in housing market activity take a look at this week’s chart.

The blue line represents monthly mortgage approvals, where we have set the zero line on the x axis at the point at which mortgage approvals peaked back in November/December 2003. Each point on the x axis represents the number of months before and after the peak in approvals. In late 2003, at their peak mortgage ap- provals were running at an astounding 130,000 a month. Today, just 18 months later, mortgage approvals have fallen to just more than 90,000 a month.

The chart shows that the recent trough in approvals was 77,000 recorded 12 months after the November/ December 2003 peak.

The red line on the chart represents mortgage approvals over the late 1980s and early 1990s, where we have aligned the peak in mortgage approvals back then of 145,000 that occurred around April 1988, with the more recent peak in November/December 2003.

The red line shows the extent of the collapse in housing market activity in the four to five years following the peak in approvals in the spring of 1988.

What is particularly interesting about this chart is the recovery in approvals which occurred on each occasion 12 months after their respective peaks. Back in 1989 this proved to be “a dead cat bounce” rather then the start of a recovery in housing market activity. Is the pick up in approvals data over the last six months just another dead cat bounce, or is it an indication that we are in for a soft rather than a hard landing?

Before attempting to answer this question, we should point out that there are two key differences be- tween then and now. Back in the late 1980s, the Treasury began to increase interest rates sharply as it clung to the rapidly fading hope that it could keep sterling in the exchange rate mechanism. This time around, the Monetary Policy Committee is cutting rates. This suggests that the pick up in approvals will continue this time around rather than fade as they did in the early 1990s.

On the other hand, measures of property market ‘stress’ indicate that the market is more overstretched today than it was 15 years ago. For example, household secured and unsecured debt as a proportion of disposable income currently stands at 120 per cent and 24 per cent respectively, compared with only 80 per cent and 13 per cent respectively back in 1990. Mortgage equity withdrawal, a key support for consumption, has fallen far more rapidly this time around than it did in the early 1990s, and it is still falling. Furthermore, the house price to earnings ratio peaked at five in the late 1980s. Today, the ratio stands at six. Retail banks have already begun to respond to this by increasing loan loss provisions this year.

In our view then, welcome as the upturn in mortgage approvals is, at best it will only help to soften the inevitable housing market landing. At worst, it will not translate into increased activity.

In the end, only the MPC stands between a soft and hard property market landing. Last week’s rate cut will help to soften the landing, but in our view more rate cuts will be needed before the end of the year, if they are to prevent the deflation of the property market damaging the UK economy.

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Interesting article, only bit I have a problem with is where they say that the BOE is cutting rates this time around. No it isn't! Rates are past their trough and are set to start rising.

The difference this time around is that due to the insane levels of gearing it will take a much smaller rise in IR to cause the market to collapse. And that since the last time around we have lost what remained of our manufacturing base leaving us with an economy based soley upon personal debt and government spending, both of which are about to stop.

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