House prices increase by 0.5% in March

House prices increased by 0.5% in March, reveals the latest Nationwide House Price Index.

Related topics:  Mortgages
Millie Dyson
31st March 2011
Mortgages
Robert Gardner, Nationwide's Chief Economist, said:

“House prices increased by 0.5% in March, leaving them 0.1% higher than March 2010. Prices have now increased, albeit modestly, in three of the past four months.

“The three month on three month measure of house prices, a better measure of the underlying trend, showed a modest rise of 0.6% in March. The outlook remains uncertain, but all things considered, this is unlikely to mark the beginning of a strong upturn in prices.

“The economy entered a soft patch at the back end of 2010, and there have been few signs of a strong bounce-back. The jobs market remains challenging and Nationwide’s Consumer Confidence Index suggests that sentiment has fallen to an all time low in recent months.

“While demand is likely to remain fairly soft, a rapid increase in the supply of properties also appears unlikely. Low interest rates and a stabilisation in labour market conditions have prevented a rise in forced selling, and the subdued market outlook is deterring many sellers from entering the market.

“With the economic recovery expected to remain sluggish, the most likely outcome is that the property market will follow suit, with low transaction levels and prices moving sideways or modestly lower through 2011.”

Interest rate increases – how much of a hit?

The Bank of England is likely to start the process of returning interest rates to more normal levels at some point in 2011. However, rate increases may exert more of a drag on the household sector than would have been the case before the recession.

Households more sensitive to rate increases

Mortgages account for around 85% of household debt and since 2008 the proportion of mortgages on variable interest rates has risen sharply, from 48% to 62%.

This trend has largely been driven by a rise in the number of people on lenders’ standard variable rates (SVR), where borrowers automatically rolled onto SVR as their fixed rate deals expired. Around a quarter of mortgage balances are currently on SVR.

Many people have chosen to remain on these rates due to the low base rate environment, where SVR rates are often lower than those on offer for new fixed rate deals.

How much of a squeeze on borrowers?

For those with a capital repayment mortgage, a typical mortgage payment is currently around £455, equivalent to 23% of individual take home pay. A one percentage point rise in interest rates would see this rise to £494 - 25% of current take home pay.

In the five years before the crisis, the Bank Rate averaged 4.5%. A rise to this level would see typical payments rise to £621 if rate increases were fully passed on to borrowers.

If the Bank of England were to increase interest rates to 4.5% by the end of 2013 and wages keep rising at the current pace of 2.3% a year, this would take typical payments on repayment mortgages to 29% of take home pay.

Can the economy and housing market cope?

Ultimately, the key factor determining the impact of higher interest rates on households is the economic backdrop against which it takes place.

If the rise in interest rates is gradual and occurs when the economy is recovering strongly and the labour market is strengthening, then the impact on households and the housing market should be fairly modest.

However, still high levels of debt and the increased share of variable rate mortgages suggests increased grounds for caution, since the household sector is likely to be more sensitive to interest rate increases. This is an important consideration - after all, households account for over 60% of spending in the economy, and the recovery remains fragile.

More households may choose to switch to fixed rate mortgages in the quarters ahead, reducing the sensitivity to rate rises. But the incentive is blunted by the fact that the rates on fixed rate deals are often higher than the variable rate people are currently on.

This is because the cost of fixed rate mortgages is linked to longer-term interest rates, which are higher than the Bank Rate. Moreover, the differential may widen further in the months ahead - long-term interest rates may move up more sharply than the Bank Rate as investors anticipate further interest rate increases ahead.

Nicholas Ayre, a director of UK buying agents, Home Fusion, said:

"Never has a monthly price rise been less representative of the state of the property market. Given the state of demand, the recent trend of price rises the Nationwide has observed is likely to be short-lived.   

"In a climate of rising unemployment, rising living costs and, sooner rather than later, rising interest rates, the demand for property is understandably suffering. The only thing that seems to be falling, and sharply, is consumer confidence.

"Is now the time to commit to potentially the biggest financial outlay of your life? For many prospective buyers, the answer is no. At the higher end of the market, there is still movement and sought-after properties are still commanding good prices. At the lower end, prices are under a lot more pressure.

"The Nationwide is right that the timing and management of interest rate rises will  be pivotal. Too many rises too soon and the market is likely to come under extreme pressure."
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