The cracks begin to appear

Backward-looking data has held up surprisingly well in the UK since June’s Brexit vote. It is not that second quarter GDP growth came in ahead of expectations at 0.6% QoQ; only one week of 2Q fell after the referendum.

However, despite dire warnings of the damage June’s “Leave” vote would inflict on the UK’s all-important property market, home prices proved remarkably resilient in July. The Nationwide house price index rose 0.5% MoM, an acceleration from June’s figure.

But before anyone dismisses the Brexit vote as an economic non-event, forwardlooking surveys are painting an altogether darker picture. Consumer and business confidence recorded their steepest falls in years in July, while Markit’s flash PMI slumped below 50. Perhaps even more ominous, the Royal Institute of Chartered Surveyors warned that house prices were already set to head lower even before the referendum.

In an attempt to support the economy— which necessarily means supporting the housing market and related consumption and investment—the Bank of England is likely to cut its benchmark short term interest rate from 0.5% to 0.25% next Thursday. However, there are good reasons to believe BoE rate cuts will do little to arrest the slide:

- The BoE’s direct influence on household spending is much less than in 2007-2009. In the financial crisis it was able to cut rates by 525bp, which greatly reduced mortgage service costs, raising households’ discretionary income. However, according to the Office of National Statistics, the proportion of homeowners with a mortgage has fallen to fewer than half in recent years, and only around half those are on variable rate loans. With the Bank already close to the zero rate bound, and its scope to cut rates greatly reduced, a reduction now will have a much smaller spending.

- The run-up in house prices over recent years has been driven partly by leveraged buy-to-let purchasers. In 1Q16, BTL loans made up 21% of all new mortgage lending, up from 12% three years earlier. The high 1Q proportion of BTL lending represented a rush of buyers ahead of an increase of stamp duty, which added 3pp to the standard rate for BTL purchasers. Since the new duty came into force in April, however, BTL lending has

impact

on

household fallen 40% relative to 2H15, which will remove much of the support responsible for driving prices up so fast, especially in London.

- Unlike owner-occupiers, BTL landlords typically depend on rental income to pay their mortgage costs. If a downturn in the UK economy now leads to rising unemployment and the transfer of jobs away from London, rents are likely to fall. That is likely to lead to forced sales among more highly-leveraged BTL landlords, adding to the downward momentum on prices and exacerbating the negative wealth effect.

- Pain in the commercial property sector will also hurt the real economy. In the runup to the Brexit vote, transactions fell by a third QoQ, and by half in London, as foreign investors, responsible for 45% of deals by value since the crisis, held back. If the financial sector now loses EU passporting rights as a result of Brexit, the pain will get worse.

Stress tests indicate the UK banking sector should withstand a 30% slump in commercial property prices. However, with 75% of small business lending secured by commercial real estate, the BoE estimates that every 10% fall in prices reduces investment in the UK economy by 1%.

In conclusion, there is little that interest rate cuts can do to mitigate a postreferendum slowdown in the UK economy that will only be deepened by an already overdue downturn in both the residential and commercial property sectors.