The UK economy ground to a halt at the end of 2001 with gross domestic product (GDP) unchanged between the third and fourth quarters. This represented a sharp slowdown compared to a rise of 0.5% in each of the two preceding quarters and marked the third successive quarter of GDP growth below the UK’s long-term average of 0.6% per quarter.
Recent data continues to highlight the massive imbalances that exist within the economy. Manufacturing output fell by 1.7% in the fourth quarter, marking the fourth successive quarterly decline and confirming that the sector remains stuck in recession. The sector’s difficulties are spread widely across the various industries. However, the contrast with the service and consumer sectors could not be any starker as consumer credit and mortgage lending shows record growth.
Total lending to individuals (incl-uding credit cards and mortgages) is currently growing at nearly 11% year-on-year and consumer credit is running at around 14%. Service sector activity increased by 0.7% between the third and fourth quarters and was 4.0% higher than the previous year.
The marked slowdown in the global economy, the sharp falls in the stock market over the past two years and the remaining effects of the foot-and-mouth outbreak are likely to ensure that the UK’s economic growth remains sluggish over the next 12 months. There are, however, good reasons not to be gloomy about the UK’s economic prospects.
The economy has weathered these adverse factors well so far, holding up better than our main international competitors. Moreover, we expect recent fiscal and monetary policy decisions to support activity and therefore prevent a protracted and deep slowdown.
Significant increases in government consumption and investment are beginning to be implemented, which together with the quick response by the Bank of England in lowering interest rates in the face of the deteriorating global environment, should also help to underpin demand. Nevertheless, our forecast for UK economic growth is a relatively modest 1.5% this year before returning to above trend growth of 2.7% in 2003.
The Bank of England has left base rates unchanged at 4% since cutting rates by 50 basis points in early November. In the subsequent four months, speculation that the next move in interest rates will be upwards has mounted. Indeed, some have argued the bank will act early in order to curb the ongoing strength of consumer demand and borrowing, in order to safeguard against the potential build-up in inflationary pressures this could cause.
However, the minutes of the Monetary Policy Committee’s (MPC) February meeting, showed there was a seven-two majority in favour of keeping rates on hold, with the two dissenters voting for a further rate cut.
The minutes also reveal that much of the discussion was centred on the pros and cons of reducing rates, with little mention of any arguments for increasing interest rates in the immediate future.
The MPC’s lack of focus on any arguments in favour of raising rates in the short term surprised the money markets. This, coupled with an unexpected fall in retail in January and a warning from Bank of England governor Sir Edward George that the markets were looking for too aggressive a tightening in monetary policy this year, contributed to a shift in market sentiment.
As a result, the markets have scaled back their expectations regarding the extent to which they expect rates to rise this year. Nevertheless, the markets continue to look for base rates to end the year at 5.0% ‘ a full percentage point above their current level.
We regard talk of interest rate rises to be highly premature. Although it looks most likely that interest rates have now reached the bottom of the cycle, a further cut cannot be ruled out. A rapid downturn in consumer spending growth, ahead of a firm recovery in the global economy would be the most likely development to trigger a further easing in monetary policy.
Despite this uncertainty regarding the short-term prospects for rates, we expect sustained strong growth (albeit slowing) in household borrowing and spending is likely to mean interest rates will need to rise during the second half of 2002 as world economic conditions begin to improve. Overall, we expect interest rates to head back to 4.5% by the end of this year and up to 5.0% by early 2003.
So what does this mean for the housing market? House prices paused in September and October, remaining broadly unchanged in those two months, as household confidence was damaged in the wake of the terrorist attacks in the US on 11 September. The one point reduction in interest rates in the two months following the atrocities has outweighed this negative impact on the market, by causing mortgage payments to fall to their lowest proportion of gross average earnings since 1983.
This favourable impact on affordability has stimulated renewed buoyancy in housing demand, leading house prices to rise strongly during November to February, with prices increasing by 8.4% over the four months (27% on an annualised basis).
As a result, the annual rate of house price inflation has accelerated from 9.4% in October to 16.9% in February, marking the highest annual rate since July 1989, and causing the average price to break through the £100,000 barrier. A shortage of properties for sale on the market has also helped to push up prices in recent months. This is borne out by figures from the Royal Institute of Chartered Surveyors, which show the ratio of completed sales to stocks rose to 51% in January ‘ its highest since the peak of the late 1980s boom in October 1988.
In contrast to the strength in house prices, housing transactions in England and Wales fell in both December and January in seasonally adjusted terms. These figures from the Inland Revenue are, however, a lagging indicator of the market, measuring house sales that occurred some months before.
A sensitive market
These weak figures at the end of 2001 and early 2002 largely reflect the frailty of the housing market in the immediate aftermath of 11 September. Nonetheless, transactions as a whole in 2001 were unchanged compared with 2000, notwithstanding the high level of housing demand that prevailed during much of the year. This is very low compared to the record 2.1 million transactions in 1988 at the peak of the last house price boom.
While there is little sign of a slackening in housing demand in the near future, we do expect the market to slow later this year. The slowdown will mainly occur in response to the softening in the wider economy and a rise in unemployment, combined with the modest increase in interest rates in the second half of the year. In addition, mounting difficulties for first-time buyers entering the market in southern England as a result of the sharp rise in prices over the past few years, will also curb demand.
Overall, we expect house prices to continue rising over the coming 12 months, albeit at a more modest pace than over the past year. House price inflation is predicted to ease to 7% in the fourth quarter of 2002. The level of property transactions in England and Wales is forecast to decline from 1.44 million in 2001 to 1.42 million this year.
The strong South
Regionally, the South of England is likely to bear the brunt of the expected housing market slowdown this year. The ratio of prices to earnings is above its historical average in Greater London, the South East, the South West and East Anglia, suggesting significant numbers of potential first-time buyers are finding it difficult to enter the market in these parts of the country. Greater difficulty in being able to purchase a property is likely to lower demand and constrain house price growth in southern England during 2002.
Reduced City-of-London bonuses and the adverse effects of the sharp fall in equity prices are also likely to contribute to a marked slowdown in house price inflation in Greater London, where prices are expected to rise by only 2% in 2002.
The continuing problems that the manufacturing sector is likely to face during much of this year, as a result of the global economic slowdown, will further constrain economic activity outside the South. This is likely to prevent any significant pick-up in house price inflation in these regions ‘ despite their more favourable housing affordability positions.
While we expect prices to rise by more in the North compared to the South over the coming 12 months, we are not predicting a marked acceleration in house price inflation in the North.
Martin Ellis is group economist at Halifax
The downturn in the global economy, falling share prices and the ongoing effects of foot and mouth means economic growth is likely to be sluggish over the next year.
Interest rates are expected to reach 4.5% by the end of the year, reaching 5% early in 2003.
Nationally, house price inflation will ease to7% in the fourth quarter of the year, but drop to 2% in London.