When British voters decided in June 2016, by a narrow margin, that they wanted nothing further to do with the European Union, did that worsen the fundamentals? Or has it merely depressed sentiment?
How will Brexit affect the UK housing market?
That sinking feeling
Two principal factors affect the outlook for prices in a free market: the fundamentals and sentiment. The fundamentals determine value: what is the asset actually worth? Sentiment sets the price: what are people willing to pay for it?
When British voters decided in June 2016, by a narrow margin, that they wanted nothing further to do with the European Union, did that worsen the fundamentals? Or has it merely depressed sentiment? Certainly, the UK housing market has come under pressure, especially over the past six months or so.
It’s not so much that prices have fallen, although that has clearly happened, but that the market has stalled because of the uncertainty created by Brexit. That’s sentiment. But there are also fundamental grounds for concern.
The British government’s own research, published a year ago, claims the UK will be worse off under any version of Brexit, deal or no deal. Specifically, the analysis states economic growth could be diminished by a total of between two and eight percentage points, depending on the type of withdrawal, over the 15 years following Brexit.
The forecast is credible and its implications are seriously worrying for Britain as a whole. However, Brexit is not the only element to be weighed.
A very British crisis
The most important other consideration is the underlying state of supply and demand, in which the UK’s chronic shortage of housing is the most constant factor. Research published by Edinburgh’s Heriot-Watt University in May 2018 calculated that the nation needs to build an additional 3.9 million new homes by 2031 to meet rising demand.
That equates to 340,000 new homes annually, compared with the government target of just 300,000 completions by 2022. Other analysts put the figure somewhat lower, but still forecast demand for 250,000 new homes annually.
In 2017, however, just 217,000 were registered. While that was a new record, Knight Frank, a leading estate agent, forecasts a 50,000 annual shortfall, at least, on the government’s 2022 target. Observers have described the situation as “a crisis”.
One of the government’s most popular responses has been the Help to Buy scheme, introduced in 2013 and since extended until 2023. It is mainly, but not exclusively, aimed at first-time buyers, offering them cheap finance for up to 20% of the cost of a home. It must be newly-built and cost no more than £600,000.
As at end-March 2018, after five years in operation, the scheme was used by nearly 160,000 home-buyers, over 80% of them first-timers. That makes it a significant factor underpinning UK property values, one that will persist for the next four years.
Spend, spend, spend
A much more important support has been quantitative easing (QE), introduced in 2009 in response to the Great Financial Crisis (GFC, 2007-08). Under the scheme, over the ensuing three years, the UK government pumped £435 billion into buying its own bonds, popularly known as ‘gilts’.
This pushed down yields, i.e., the annual returns represented by the interest paid to gilts investors, thereby also depressing yields on other financial assets, especially including deposits and savings accounts. In turn, that encouraged savers to spend in support of an ailing economy. This they did enthusiastically and savings fell to a fraction of their 2010 peak.
Of course, the drop in interest rates also reduced borrowing costs, so that savers were encouraged to take out mortgages, thereby further supporting property values.
So much for the fundamental elements that have driven the UK housing market since the GFC. Will they remain as supportive in coming years?
Clearly, the shortage of homes isn’t going to change much; it might even get worse if Brexit uncertainties depress the confidence of the building industry and cause it to pause or reduce its investment in new developments. Additionally, the Help to Buy scheme, as already noted, will continue to support prices for another four years.
Buddy, can you spare a dime?
The outlook for interest rates is more contentious. Rates began to rise in 2018 for the first time since the GFC, as the UK economy at last responded positively to QE.
While the increase, from 0.25% to 0.75%, has been minuscule in absolute terms, it nonetheless represents a threefold rise in the underlying benchmark for all UK borrowing, especially including mortgages. Were it not for Brexit, the economy would, most likely, have continued to strengthen and, thereby, cause rates to rise further than they have done already.
However, since the Bank of England last increased its base rate, in August 2018, the increasing threat of a no-deal Brexit has put much of the UK’s economic activity on hold, in addition to reversing the uptrend in house prices.
More importantly, Mark Carney, governor of the Bank, has made it plain that the course of interest rates in 2019 will be crucially dependent on the Brexit outcome. While a smooth exit, accompanied by a withdrawal agreement, would restore confidence and restart the economy, it would also be likely to cause further rises in the Bank’s base rate.
On the other hand, a no-deal departure would undoubtedly cause significant disruption, possibly leading to a recession; technically, that’s two consecutive quarters of economic decline. In those circumstances, interest rates would certainly go down also.
A world of worries
However, none of these concerns is solely the result of Brexit worries. The entire developed world, not just the UK, is facing an economic slowdown this year. The International Monetary Fund, anxious about rising US interest rates and growing international trade tensions, has cut its forecast for worldwide growth in 2019, from 3.7% to 3.5%. Growth in the Eurozone (the 19 European countries that use the euro) is expected to fall from 1.8% to 1.6%.
It’s against this gloomier backdrop, not just Brexit concerns, that the Bank of England announced this February that it was cutting its 2019 forecast for UK economic growth sharply, from 1.7% to just 1.2%.
It has been said that, if one laid all of the world’s economists end-to-end, they would never reach a conclusion. That’s pretty much how the foregoing predictions appear. Nonetheless, whatever kind of Brexit eventuates, it’s clear the UK economy is slowing and, so, rising interest rates should not be a concern for UK house prices.
How does it feel?
Which brings us back to sentiment, for which facts and forecasts matter much less than opinions and feelings. The chart measures it in terms of UK consumers’ level of optimism about the economic outlook over the next 12 months.
Despite cheap loans, Help to Buy, and continuing (if slower) economic growth, Mr and Mrs Average are glummer than they’ve been at any time for the past five years. However, they are not despondent. The latest reading for this survey is -13, compared with an all-time low of -39 (GFC, July 2008) and a record high of +10 (booming economy, June 1987).
While one may justifiably be concerned that this moderate level of current anxiety fails to allow for a no-deal Brexit, it’s more important to note that sentiment is almost invariably wrong. For proof, note that British consumers felt gloomiest just eight months before the world began to recover from the GFC, while they felt brightest barely three months before the October 1987 stock-market crash.
Seek truth from facts
Yogi Berra, US baseball hero and folk-philosopher, supposedly noted: “It’s tough to make predictions, especially about the future”. Where Brexit is concerned, his observation is especially true.
It’s clear that, whatever form it takes, Brexit will drag down the UK economy and will do so for an indeterminate period. Consumers seem to recognise this. Even so, their pessimism is unlikely to have reached bottom yet and probably won’t do so until Brexit has happened and its immediate effects, at least, are known.
When it does, however, sentiment will then be at its probable worst. That will mark the turning-point at which the positive long-term fundamentals supporting the UK housing market will reassert themselves.