The cracks be­gin to ap­pear

Financial Mirror (Cyprus) - - FRONT PAGE - By Nick An­drews

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



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.

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