Finding myself marooned at an airport recently, I purchased a copy of Malcolm Gladwell’s book The Tipping Point: How little things can make a big difference to relieve the boredom.
The book explains how markets and social trends reach a point at which small changes in social behaviour can cause dramatic and rapid change. On reflection, I think this has some relevance to the state of the mortgage market, which has experienced a benign state of low interest rates, high property price inflation and constant increases in volume for some time. There are indications of it reaching a critical tipping point.
Inflation has just reached an 11-year high with the Consumer Price Index at 3% and the more realistic Retail Price Index (which includes housing costs) at 4.4%. As a result, interest rates recently rose a further 25 basis points and now stand at 5.25%, with most pundits predicting at least another 25 basis point increase in the next few months.
Added to this, arrears and repossessions are on the rise, with 8,000 repossessions in the first six months of 2006 and 61,470 cases in arrears between three and six months over the same period.
But the economy remains strong, with company profits up and consumer spending holding up well – perhaps too well for the Bank of England which is trying to take the heat out of the economy and hold wage pressures down.
More significantly, if we look at historical data on arrears and repossessions it shows that levels are still good. In the first half of 1994 repossessions stood at 25,020, with three to six-month arrears at 189,250. The market was then moving out of a housing recession. But the critical factor then was interest rates. In December 1994 interest rates stood at 6.25% and in February 1995 they went up to 6.75%. They remained between 6.75% and 6% until January 1999 after which they started to fall.
As a result, mortgage volumes and house prices rocketed to where we are today. Hindsight is a wonderful thing – looking back it could be argued that interest rates dropped too low at 3.5% in July 2003 and that the 25 basis point cut in August 2005 was unnecessary, stoking further inflationary pressure.
What these numbers indicate is that if interest rates continue to rise we will reach a tipping point at which we start to see an adverse effect on consumers’ behaviour. This will lead to a dramatic drop in volumes, increased arrears and a stabilisation of house prices.
I must stress I am not saying that this will lead to a house price recession. The buy-to-let market has matured and any fall in prices would result in buy-to-let professional investors seeing the opportunities for better returns on rental incomes. This should keep the market liquid.
So what will be the tipping point for UK interest rates? Some pundits are predicting rates could go as high as 6% in this cycle. Looking at the historical data I would suggest that interest rates of over 6% would put too much of a strain on consumers. But interest rates may not be the only factor involved.