The Growth Series

Economic volatility - crisis or opportunity?


by Jeremy Duncombe, MD of Accord Mortgages

Context and perspective are the two words I’ve been using a lot recently. At any snapshot in time, there will be a statistic that allows you to create a positive or negative narrative around the same fact.

A 3.5% drop in house prices can be positioned as a crash if taken in isolation, but against the context of a 20% increase over two years can also be reported as a 16.5% increase. That’s why you can see the current market volatility as either a crisis or an opportunity.

We know that the only certain thing at the moment is…   uncertainty.

That has never been truer than in the last few weeks, with the cascade of developments we’ve seen within the mortgage market. Firstly, increasing Swap rates due to better than expected economic news, then the Bank of England raising its base interest rate by 0.5%, double what many were predicting, and then the announcement of a Mortgage Charter to be supported by almost all lenders including YBS & Accord.

The base rate decision was triggered principally by June’s Office for National Statistics (ONS) figures, which showed inflation had stubbornly refused to budge below May’s 8.7%  - well above the Government’s 2% target, and it’s stated aim to halve the current figure by the year-end. Of course, we all know, first-hand, why this is happening – the high cost of living, evident in everything from food and basic household supplies to energy and fuel, is causing us all considerable pain, and the Government believes the base rate is a key lever for countering this.

In reality, mortgage rate increases affect a very small cohort of people immediately, due to the majority being on fixed-rate mortgages.  But borrowers coming off the historically low fixed rates they’ve enjoyed for years now are seeing their monthly mortgage payments rise by typically hundreds of pounds, compounding the impact of the other increased costs they are already juggling. Indications are that many are making tough decisions,  living more frugally in a bid to prioritise their mortgage payments. That’s why we’ve been pleased to sign up to the new Mortgage Charter, signalling our commitment to offer borrowers all the support we can during these difficult times.

Higher rates and monthly mortgage payments are making it harder for those looking to buy a house to qualify for their loan, due to the impact on affordability which, as we saw after the mini budget, will prompt some to sit tight amidst such market uncertainty, slowing the market, reducing the supply of homes available and, in turn, putting pressure on house prices.

Sunny side up

As the saying goes though, there are two sides to every coin and, while no doubt keeping brokers pretty busy, the current period of economic volatility also marks a unique opportunity for you to demonstrate your worth.

Given the complexity of today’s market, borrowers have never needed your expert guidance as much as they do now.

Common questions like ‘how much can I borrow?, ‘should I choose a fixed or variable rate?’ and ‘what term length should I choose?’ have been superseded by queries like ‘what is the long-term direction of interest rates?’, ‘is now the right time to buy?’, ‘what is the maximum mortgage term I can have?’ and ‘is this another credit crunch?’. And, while offering borrowers the kinds of precision answers they might want would require the kind of crystal ball-gazing none of us can offer, beefing up your personal knowledge around the market dynamics impacting mortgage rates and criteria will help you provide borrowers with more clarity. There’s another famous saying that ‘knowledge is power’, at least understanding what’s going on helps borrowers make the right choices for their circumstances at present.

Sitting and waiting for any future interest rate falls that might or might not happen, or effectively betting on future trends in the economy, is a dangerous game. Borrowers need to decide what’s best for them based on their current earnings, outgoings and budget. In addition, they need to consider the tangible level of interest rates, what lenders are currently able to offer and what their pockets will realistically stretch to month-on-month, with your help.

But how on earth do you fulfil this white knight role when you’re no doubt feeling you have new and confusing developments coming at you from all sides, not least keeping up-to-speed with the latest moves lenders are having to make on product pricing and criteria, to reflect market conditions?

Well, taking every possible opportunity to increase your own understanding - not just of the ‘outputs’ of market developments, but the underlying factors causing them to happen, will enable you to provide the truly expert advice borrowers desperately need right now, and so stand out from your competitors – not to mention building long-term loyalty among the clients you support in finding a positive path through the volatility.

And we’re here to help!

Below you’ll find a summary of our latest take on the economic factors influencing the mortgage market – to give you ammunition for the kinds of conversations you’ll need to have; but also, hopefully, some much-needed reassurance, because things are far from all bad. We are hopeful that the current volatility in the market is effectively the equivalent of intermittent aeroplane turbulence along the route to medium-term recovery and stability, as opposed to the smooth glide path some were expecting.
Keeping our heads amidst hyperbole and panic is part of our responsibility to borrowers, and recent developments like a 3.5% drop in house prices need to be seen in the context of the 20% increase over the past two years. It’s also important to remember that, historically, interest rates have averaged around 5%. Although their impact is currently exacerbated by higher house prices than in previous higher-rate environments, what we’re seeing represents the return to more normal levels, which was always inevitable.

So, here are our key ‘need to knows’ about present market dynamics, to help you explain things to your clients:

  • At the time of writing, an increasing number of forecasters have adopted a more positive view of the UK’s economic prospects – with the Organisation for Economic Co-operation and Development (OECD), the Office of Budget Responsibility (OBR) and the International Monetary Fund (IMF) echoing the Bank of England in suggesting the biggest drag on real activity from higher inflation is in the past and the economy appeared to be coping with the rise in interest rates from 0.10% to 4.50%.
  • The recession many of these organisations predicted last autumn has not materialised, and a 0.2% month-on-month (m/m) rise in real Gross Domestic Product (GDP) in April, following March’s 0.3% m/m contraction, further raises hopes that the country will escape a recession this year. In the past four quarters, GDP has fluctuated within a narrow range, from marginal growth of 0.1% to a slight contraction of -0.1%. The only quarter with negative growth was Q3 of last year, which is less than what is required to classify as a technical recession – two consecutive quarters of contraction. The latest forecast from the Bank of England anticipates a flat performance for the UK economy during the first half of 2023 and an improvement in the latter half, with projected growth of 0.25% for the year as a whole. While growth across other G7 economies has also been slowing thus far in 2023, the UK continues to lag behind and is just 0.4% larger than its pre-pandemic size.
  • Despite the thirteen rate hikes since December 2021, Office for National Statistics (ONS) data shows homeowners are still only devoting 3.7% of their incomes to interest payments in Q4 2022. That’s not much higher than the 3.4% in Q3 2021, when the base rate was at 0.10%. One reason for this apparent resilience amidst the current cost-of-living challenges, is the strength of the jobs market. Unemployment is still very low, in fact the ONS reported a fall in April, so demand for workers remains strong and supply low. As a result, pay growth remains very strong, with annual nominal earnings growth in the three months to April 2023 reaching 7.2% –the fastest growth rate seen outside of the pandemic period, fuelled by labour shortages in some parts of the market and April’s increase in the National Living Wage of around 9%. Annual private sector pay growth was also up by 8.2% in April, from 6.4% in March. It’s worth bearing in mind, though, that after adjusting for inflation, real pay is still falling by 1.3%, albeit this is slowing from the 2.3% annual fall recorded in January.

The acceleration in private sector pay growth will be one of the things keeping the Bank’s Monetary Policy Committee (MPC) members awake at night, because higher wage costs allow firms to pass on higher prices for consumers, making this a key contributor to higher inflation, which is why financial markets now believe more interest rate hikes are needed to cool consumer demand, and, in turn, ease price pressures. If mortgage rates surge as expected, however, this would almost certainly tip the economy into a recession and potentially spark a housing downturn. Interest rate fluctuations typically take up to two years to impact the economy.

Since last June, the Bank of England base rate has increased from 1% to 5%, an overall increase of 4%, so we expect the full impact of this to hit households and firms later this year. However, because more people than before – around 80% –  are now on fixed-rate mortgages, the impact of these rises in interest rates is likely to take longer to feed through into the economy than with previous such measures, delaying the impact on mortgage holders. UK Finance, the trade body for UK retail lenders, suggests 1.81 million people will be refinancing their home loans at some point this year onto considerably higher rates, which will likely squeeze household take-home pay even further, start to dampen demand and bring inflation down.

  • In terms of other costs driving high inflation, there are also grounds for optimism. One reason why UK inflation has been higher than elsewhere is that the recent fall in wholesale gas prices has taken longer to feed into utility prices. If the Ofgem price cap is cut from £2,500 now to about £1,500, as some are forecasting, the fall in UK energy price inflation later this year would help bring Customer Price Index (CPI) inflation down, which would be a further step in the right direction. Food price inflation is also expected to fall more sharply in the UK, from 19.2% in April to perhaps 9% by December. Added to this, a phenomenon known as base effects – which benchmarks high prices against a year earlier to calculate how far they have risen – will also help lower inflation, as the differential gets smaller and starts to show a downward trend.
  • Given the above point, you could argue it’s questionable whether the base rate needs to rise to as high as 5.75% later this year, as financial markets are expecting. Our view initially, and that of some economists, was that it may not need to go any higher than the 5% we’re now seeing. But following the Monetary Policy Committee’s decision to rise to this level in June, it’s realistic to assume they are not quite finished yet – albeit we still don’t think it should reach the heights the financial markets are predicting.
  • Homeowners who took out a 75% LTV mortgage of £180,000 on an average-priced house of £240,000 in June 2021, will see their mortgage payments increase from around £700 to £1000 when they refinance this month. If mortgage rates bed in at 5.5%-6.0%, the largest jump in mortgage costs will come in early 2024, when a similar borrower could see their monthly payment rise by £380.
  • In contrast to previous economic cycles, mortgage affordability pressures, rather than unemployment, seem to be the main drivers of arrears, while arrears and repossessions remain low, largely due to the low level of unemployment. However, this could also be partly due to the fact fixed mortgage rates have delayed and reduced the impact of higher interest rates on spending in the economy. Indeed, only a third of mortgaged households have had their mortgage rate rise to above 3% so far. 

All-in-all, there’s a chance that the financial markets have overreacted to higher-than-expected inflation. The question that remains is whether the Bank should follow the markets and raise rates again, or take a step back and wait for the substantial increases since last July to work through. Whatever it decides, it will be vital that we stay close enough to the situation to be able to allay the borrower fears that will undoubtedly follow.

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