(Bloomberg Opinion) -- The U.K. property market appears in great shape. The Nationwide House Price Index has gained 14% over the past year and rents are rising fast. Supply is tight and borrowing costs remain low despite recent rate increases by the Bank of England. Something, though, is not quite right — and people in a position to know are already pulling their horns in.
The BOE's latest credit-conditions survey indicated that mortgage providers were planning to reduce the supply of home loans at the fastest rate since the early months of the pandemic in 2020. Back then, lenders withdrew many of their most attractive deals the moment it became clear that lockdown would last considerably longer than initially anticipated. This caused average mortgage rates to rise even as the BOE cut its base rate, first from 0.75% to 0.25% and then to a record low 0.1% in March 2020.
Some lenders later went further. Barclays Plc suddenly reduced its maximum loan-to-income ratio from 5.5 times to 4.49 times. The new policy applied even to mortgages that had been “agreed in principle.” Many property transactions collapsed with buyers unable to complete their purchases, often losing money already spent on surveys and legal fees. In the event, thanks to furlough, mortgage default rates remained low, and confidence soon returned to the market.
Today, though, lenders are again turning cautious and this time there's no furlough scheme to protect consumers squeezed by the cost-of-living crisis. U.K. inflation accelerated to 7% in March and is set to rise further after a regulatory cap on household energy bills recently jumped 54%.
Banks appear to be pricing in the risk of recession. That's not just apparent in the forecast supply of home loans. Mortgage rates are also flagging difficulties ahead. It's rare for fixed five-year mortgage rates to drop below average two-year rates, but when they do, it can auger trouble. It happened in the late 1990s and in 2008, and it is happening again right now.
In 1997, a financial crisis gripped much of eastern Asia. The following year Russia defaulted and hedge fund Long-Term Capital Management collapsed. Fearing for the stability of the financial system, policymakers cut rates. But after the protracted economic contraction of the early 1990s, U.K. house prices were still more than 30% below 1989's peak in real terms. By no stretch was the market considered overextended and consequently it came to little harm.
In 2008 though, the situation was very different. The Global Financial Crisis was characterized by reckless lending on both sides of the Atlantic. House-price inflation spent most of 2007 in double digits. The Nationwide House Price Index rose by almost 160% in real terms between 1998 and 2007 to an historic high.
Fortunately it appears that the current situation in U.K. property more closely resembles 1997 than 2008. Adjusting for inflation, house prices are still 8% below that 2007 peak.
Lenders are considerably more cautious. Strict affordability guidelines for borrowers have been in place for several years. Retail banks compete on price, not the slackness of their credit controls. In 2014, the BOE forbid mortgage lenders from extending more than 15% of their new residential mortgages at loan-to-income ratios of 4.5 or more — the rule that prompted the Barclays pullback in 2020.
The housing market is also less immediately sensitive to the cost of home loans. The English Housing Survey shows that homeowners who have never had a mortgage, or have repaid it, outnumber those with mortgages and have done so for nearly a decade. Some 74% of residential mortgages have fixed interest rates, rising to 96% for new borrowers since 2019, according to trade body UK Finance.
So while banks have every reason to be concerned about the economic outlook, their existing borrowers are less of a worry. An economic slowdown should see fewer forced sellers of property. Expect the U.K. property market to experience a marked slowdown in activity — but not a substantial fall in prices.
The issue that nobody has addressed, however, is that the housing market has become safer precisely because it now excludes so many of those seeking to make a start in life but lacking the income to do so. Instead of former Prime Minister Margaret Thatcher's ideal of a “property-owning democracy”, U.K. housing just becomes an ever-more exclusive club of those not requiring mortgages and those sufficiently creditworthy to be mortgageable.
That is where the real unsustainability in U.K. property lies. The market may dodge a crash, but it is still in a state of crisis.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Stuart Trow is an investment strategist, most recently at the European Bank for Reconstruction & Development. He is a financial coach, co-host of “Money, Money, Money” on Switch Radio and author of “The Bluffer's Guide to Economics.”
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