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Clare Francis: Just when you thought it couldn't get any worse it did. The collapse of US investment bank Lehman Brothers has sent share prices around the world plummeting. Here in the UK banking stocks have been particularly badly hit and we may now see a merger between Lloyds TSB and Halifax Bank of Scotland. But what does all this mean for the economy and house prices? I'm with Fionnuala Earley, chief economist at Nationwide Building Society to find out.
Q1: So Fionnuala, this was the week that the financial crisis really took on a new dimension, the collapse of Lehman Brothers has had a tumultuous effect on the global stock markets. But what does it mean for the UK economy? Is a recession now more likely?
Fionnuala Earley: I think the first thing it does is add a great deal of uncertainty on top of what we already had, and we've already seen the financial markets reacting and LIBOR rates have gone up as a result of this. People are feeling a little bit more cautious about lending to each other, the banks, at this moment.
What this means for the overall economy will of course depend on what the Bank of England decides to do to try to correct that in the UK, and it looks increasingly likely that they're more in favour of reducing rates more quickly than they have done.
Q2: I was just going to ask that, because what room for manoeuvre does the Bank have at the moment? On the one hand we've obviously had rapid deterioration in the state of the economy but we've also had new inflation figures out showing inflation rose to 4.7% last month, and Mervyn King, the Governor of the Bank of England has warned it is likely to hit 5%. So is the Bank in a position where it can reduce rates or are they stuck?
FE: I think they probably can begin to think about reducing rates, and we're expecting them to do that this year now, and the reason for that is that they look at inflation rates two years ahead. So if they think that the economy is going to slow very rapidly and perhaps go into recession, then they will think that this will slow things down.
And we've already seen that the arch-hawk of the Monetary Policy Committee, Tim Beasley, didn't vote for a hike this time, so it looks like this tone, the sentiment is changing at the MPC.
Q3: How far do you think rates might fall?
FE: Well we do think that the economy is slowing down very rapidly, so we think that rates will begin to be cut this year, and we think that they'll be cut relatively rapidly next year. So we think they're going to end up at the end of 2009 around 3.5%.
CF: Gosh, so that's a lot lower than the 5% they are at the moment?
FE: That's right, yes.
Q4: What impact is all of this having on the housing market? Obviously house prices are falling much more rapidly than analysts were expecting at the beginning of the year. Nationwide was forecasting zero growth at the beginning of the year but that's obviously since been revised downwards and Graham Beale, your CEO, warned last week that prices could fall by up to 25%. Why is it so much worse than anyone was expecting?
FE: Even when we made our forecast we were very well aware of the risks, and we always try to do that - to present a central forecast on where the risks are going. At that time we'd just had the credit crunch had just started, Northern Rock had had it's troubles, and we thought at that time that it would all be over in perhaps 3 or 4 months and everything would get back to normal, but perhaps with you know affordability still being an issue in the housing market in particular.
But clearly we're in a very different position now from where we thought we would be, and we've had as you'd mentioned the collapse of Lehman, Northern Rock going on for a bit longer, and that's really affecting sentiment in the market. So one we've had sentiment changing significantly, people expecting prices to fall and that means they don't transact in the market, and that makes the market stickier. Availability of finance is also being matched by lenders traditional risk attitudes, so not wanting to lend such high loan-to-value (LTV) ratios when house prices are falling or when they think people might not be able to afford that, and that's a rational thing, both for the lender and the borrower.
Q5: And how much is consumer confidence key to the market?
FE: I think expectations about where house prices are going to go are a big factor in the UK, sentiment does move very quickly though, so that could change very rapidly, but it's definitely true, we do try to measure what people think is going to happen to house prices, and we saw a big change, almost to the day when Northern Rock had its troubles, and we've seen people expecting prices now to fall, and they're expecting them to fall by about 10-12% over the year.
Q6: And which parts of the country are worst effected? Are some areas proving more resilient than others?
FE: Well Scotland has been the star really in that sense, and theres good reasons for that. Affordability in Scotland has been much more resilient than anywhere else in the UK, but that said it's not going to be immune from what's going on at the moment with the slowdown in the economy, and we did see on the quarter a small fall in Scottish house prices, but year-on-year they are still growing.
Northern Ireland on the other end of the scale, we are seeing an enormous correction there, and again in a way that's not surprising because prices increased by almost 60% year-on-year in one quarter last year, and now they are falling at around 20%, so a big deal of correction there. But affordability had become so difficult in that area, so far out of line with earnings, that's not unexpected.
Q7: What about London and the South East, because obviously that has been expected to out-perform the national average because of the money and wealth that's tied up within the region. But if the financial crisis continues and we see thousands of City workers lose their jobs, could the situation be very different and the market in this region be a lot weaker?
FE: Well, possibly. At the moment London and the immediate surrounding area, the outer metropolitan area, is still performing better - prices are falling but performing better than other parts of the UK - everywhere else is bunched around about the UK average. But it would be silly to not think this will have an impact on sentiment in London.
But that said there is a big population this year in London and the South East, and that is something that is quite supportive and there is still that rental accommodation - buy-to-let landlords might still be entering into the market, and also remember we've got the Olympics and people who need to have homes to live in while they're building the infrastructure for that.
Q8: What's the long term outlook for the property market? Obviously over the last decade we saw prices boom and people's perception of risk was almost that there was no risk in bricks and mortar and if you bought a house, it would go up in value. But obviously for those who bought in the last year or two and didn't have much of a deposit to put down, many of them will now have mortgages that are for a greater value than the value of their property - what would you say to them? Are prices going to recover?
FE: Well the long-run real rate of house price growth is about 2.8% a year, and there's no reason to think why that would really change, given our economy. What we're seeing at the moment is volatility around that trend. So if we think about somebody who's perhaps bought in the last year or so, I don't expect they would have thought 'I'm buying this house now and I'm going to move next year', they'll probably be thinking 'I'm staying in this house for the next 5 or 6 years' - by which time the market will have come around and we'll have seen that trend coming back to trend and that volatility erasing itself if you like.
Q9: What about people who are thinking of buying at the moment or perhaps not thinking about buying because of the state of the market - is it worth holding off for a few months, or, should they just carry on regardless?
FE: Well I'm often asked that question and it's a really strange one, and it sounds like I'm ducking it but I'm not! I think it's such a personal decision buying a house and there are so many other factors apart from just the cost of it, and whether you can afford it just at the moment - it's about whether your family's growing, it's about whether it's the right location for the school that you want your kids to go to and all of those other things.
But the important thing is whether you can afford it. Some people, if for example the stamp duty issue, it's unlikely it will have a big impact on most people, but those who are thinking about moving around about this time will probably take advantage of that, but for others, is it that much of a difference to that affordability? £1,750? Then perhaps they're not in the right financial position to be able to afford now, so it's probably better for those sorts of people to hold on a bit longer and save up a bit more.
CF: Thanks very much Fionnuala.
FE: It's a pleasure!
