UK economic growth was weaker than expected in the first quarter at 0.3%, with the annual growth rate falling to 2.5%. The principal factor behind the reduction in growth was a substantial fall in North Sea oil and gas production due to numerous technical difficulties. Second quarter energy output has been affected by the Grangemouth dispute. As a result of the reduction in UK oil and gas output, we have fractionally reduced our forecast of UK growth this year by 0.1% to 1.7%. The growth data adds to the negative gloom that is pervading the UK housing market. In the real economy, the outlook is somewhat more positive. The key factor remains the stability of the labour market. We suspect that the downturn in economic growth will be short lived given the relatively positive response of the Bank of England to the international credit crunch via major liquidity injections. We believe that the trough in the economy will be reached in the summer months, after which the normal time lags associated with monetary policy easing should produce a very gradual recovery in economic outlook. Next year, we predict that UK growth will average 2.2%, marginally below the long term average rate of growth of the UK economy (2.4%).
The sharp increase in inflation last month resulted in CPI rising to 3%, the top of the Government’s target range. Given the recent upturn in oil prices, CPI may well be above target next month, and remain so until the UK currency rises to a level that places downward pressure on inflation. The prime reason for the significant increase in inflation in recent months has been the depreciation of sterling. The trade weighted index has fallen by 12% since early September. Given the time lags associated with monetary policy, the MPC tends to focus on the 1-2 year inflationary view, which is more positive than the current scenario. We believe that one further base rate cut is necessary to sustain a degree of confidence in the consumer sector, and prevent UK growth heading towards 1% per annum level. Whilst the MPC face a very difficult balancing act, we believe that base rate should be reduced to 4.75% next month, accompanied by a statement that there will be no further base rate cuts in the current inflationary environment. From a housing market viewpoint, it is more important for the Bank of England to make further significant liquidity injections into the UK financial market, thus increasing the availability of funds for mortgage lending.
The full impact of the international credit crunch is being felt by the UK mortgage market. Mortgage approvals in March fell to £24 billion (seasonally adjusted) versus a 2007 average of £30 billion per month. Net advances fell to £6.9bn in March and we expect both net approvals and advances to reach a low in the region of £6 billion (seasonally adjusted) in mid summer. Thereafter, the cumulative impact of liquidity injections by the Bank of England should increase the supply of mortgage credit. We continue to predict that net advances this year will average circa £7 billion per month (£85 billion for the year) rising to an average of £8 billion per month in 2009. Our gross advance forecast has been shaved by £10 billion to £320 billion. There remains very substantial potential for re-finance business in most sectors of the market. In respect of future business, our perception remains that there is growing first time borrower demand for mortgage funds, which will provide a solid backbone to mortgage demand as the liquidity situation slowly improves during the second half of the year.
The annual rate of house price inflation has entered negative territory for the first time since February 1996 (based on the Halifax and Nationwide house price indices). This reflects the combination of the slowing economy, the rising cost of mortgages and the limited availability of mortgage credit. Given the very high level of house price inflation in third quarter 2008, we expect the annual rate of house price inflation to reach a trough in the region of minus 5% in the third quarter, recovering to minus 3% in the fourth quarter 2008 and to 0% in winter 2008/09. Next year, we continue to predict that the annual rate of house price inflation will be plus 2%. This reflects the prospect of a recovery in wholesale market liquidity, which should lead to a significant increase in the supply of mortgage funds next year. In addition, the likely upturn in UK inflation will renew interest in housing as an inflation hedge. Any long term view of the housing market must be qualified by the significant sector and regional variations. There are areas the market, notably flats in a number of areas, where the fall in property prices has been far greater than the national average reduction. Other areas of the market have shown relative outperformance, reflecting factors such as the quality of building and location.
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