Leaving the EU might just end up being business as usual or, perhaps, the early stages of new market dynamics for the UK housing sector. In either case, we’ll all have to keep our eyes on the ball
Diego Iribarren is an Assistant Director in EY’s Economic Advisory Practice
12 December 2016
The UK economy seems to be taking Brexit the vote to leave the EU in its stride. It expanded by 2.2% in the third quarter of 2016, despite a 17% decline in the pound’s value against the dollar since the referendum and a temporary dip in consumer confidence over the summer. The initial post-Brexit shockwave seems to be giving way to an understanding of the challenges that lie ahead.
The global economy, however, continues to operate with a heightened level of uncertainty, with the recent election of Donald Trump as President of the USA – a staunch critic of international trade – doing little to improve this.
The EY Item Club’s latest issue (Autumn 2016) addresses this point. At the moment, economic growth is being driven almost entirely by consumer expenditure as investment came to a near halt during the first half of 2016 (an average growth rate of 0.6%). In this sense, the rebound in industrial production during quarter two was not enough to boost economic growth as household savings also declined by 12% during the first half of 2016. Going forward, short-term economic growth will depend on a combination of consumer expectations (a notoriously volatile indicator) and the continuation of cheap credit.
In consequence, the EY Item Club is forecasting a rather weak 2017: a dip in economic growth to 0.7%, an important deceleration in consumer expending to 0.6%, and contractions in domestic demand and investment of -0.1% and -2.1%, respectively.
Concerns for the economy
The two bigger immediate concerns for the economy are, however, inflation and business confidence. The sustained devaluation of the pound – while providing a major boost to our exports (that should translate into a higher export growth of 3.4% in 2017) – also creates pricier imported goods and services. This includes both final consumption goods as well as intermediate inputs, such as construction material and raw materials.
In most economies, a currency devaluation takes around three to six months to be engrained into domestic inflation dynamics. In our case, however, the pound’s devaluation had an immediate impact on producer inflation, as the producer price index spiked by 1.5% in quarter three, the highest increase since the end of 2011.
Ultimately, higher inflation erodes both purchasing power and business confidence – two key drivers of economic growth.
GDP growth and housing starts (1981–2015)
The impact on housing
Historically, housing starts have, on average, expanded by around 7% with every 1% increase in quarterly GDP (see graph above). This time around, however, the UK housing market is facing the prospects of a declining economy and, concurrently, a possible shift in the fundamentals of demand for housing space, both of them directly related to Brexit. Indeed, Brexit stands to have a direct short- to medium-term impact as growth of both the UK’s resident population and income declines.
Furthermore, the (very real) possibility of interest rate increases over the next two years as the Bank of England begins to normalise monetary policy provides the right context for a deceleration of the rental cycle across the country.
Interestingly, Brexit also stands to deepen the schism between city centres and other markets, particularly in London. The pound’s devaluation will create an added incentive for foreign investors seeking AAA price assets, resulting in additional upward pressures on rental values, thus keeping yields compressed. In contrast, those markets dependent on domestic dynamic alone might end up facing the perils of slower demand growth.
Whatever the case, investors will have to pay close attention to housing fundamentals over the coming months and, in particular, to the details engraved in the manner in which Brexit unfolds.
It might just end up being business as usual or, perhaps, the early stages of new market dynamics for the UK housing sector. In either case, we will all have to keep our eyes on the ball.
In the spirit of keeping our eyes on the ball, the National Housing Federation has been actively working to secure the best possible policy environment for housing associations outside the EU.
We’re publishing a new briefing for boards on risk, we’re at the heart of influencing government through exit, and we’re holding conversations in January 2017 between industry stakeholders, subject experts and housing associations to consider the housing association offer for the future of investment, care and construction outside the EU.
To hear more about this Brexit and Beyond work, get in touch with Lucy Pedrick, Policy Officer.