June’s larger-than-expected half percentage point interest rate rise has pushed the FTSE 100 index back into negative territory for the year and triggered fears of recession among investors and market observers.

Moreover, there seems little doubt the UK central bank will raise rates again at its August meeting, the only question being by how much.

‘It now appears that interest rates may go higher than were forecast and stay there for longer, in the context of stickier inflation and labour data strength. All of which suggest that a recession in the UK is now inevitable. All that remains to be seen is how deep this recession will be,’ says Colleen McHugh, chief investment officer of Wealthify.

Yet, for all the gloomy commentary, consumer confidence appears to be holding up, bolstered by the tight labour market, and it may be this which decides the direction of the housing market over the months and years to come.

HOUSEHOLDS UNDER PRESSURE

The number one concern for most people at the moment is the cost of living, with Kantar reporting 70% of shoppers it surveyed recently describing themselves as either ‘very’ or ‘extremely’ concerned about rising prices.

While the official inflation rate was steady at 8.7% in May, key items such as housing, electricity and gas prices are up by over 10% while food and drink prices are still rising at close to 20% on last year.

Even though price rises may slow in the next few months as we lap double-digit increases in the second half of last year, we’re still looking at prices going up rather than going down.

Now, mortgage costs are rising with the banks repricing their offers almost on a weekly basis as they rush to keep up with higher funding costs.

Last week, Barclays (BARC), NatWest (NWG) and Virgin Money (VMUK) told brokers that rates on many of their mortgages would rise on Friday, meaning June could have seen the steepest one-month rise in borrowing costs since May 1989, excluding last autumn’s disastrous mini-Budget.

Although mortgage rates were much higher in the late 1980s, the loan-to-income ratio today is almost double what it was then so a cost of 6% represents a similar financial burden to 13% in 1989.

THE HOUSING MARKET HAS SLOWED SHARPLY

Provisional government figures show residential housing transactions fell 15% during the first quarter of this year, although that figure was flattered by a strong performance in March which was the final month for buyers to complete before the end of the Help To Buy equity loan scheme.

Without Help to Buy, April’s level of transactions was down 32% on last year and down 29% from March on a seasonally unadjusted basis to just 67,000, a decline which as the government’s own statisticians say seems ‘particularly large’.

On a more positive note, the RICS UK residential market survey, widely seen as a lead indicator of future house prices and activity, has turned less negative in the last couple of months, with enquiries, prices and sales all showing an improvement since March.

The level of new buyer enquiries in May was the best – or as the survey says the least negative – in 12 months, while the net balance of house prices, while still negative, showed a marked improvement from the first quarter, and agreed sales and expected sales indicators were also pointing up.

We should caveat this with the fact the May survey was conducted before the latest inflation figures and subsequent rate hike, and the June survey – which is likely to be less positive – is due out within days.

Figures for mortgage lending, which are compiled by the Bank of England and always lag by a couple of months, seem to be following the downward trend in transactions, however.

April saw net repayments of £1.5 billion, which at the time was the lowest level of net borrowing since 1993 if the pandemic is excluded, while net mortgage approvals, which are an indicator of future borrowing, continued the decline seen since the start of 2021. In May there £0.1 billion of net repayments on mortgage debt.

It seems consumers have been drawing down their cash savings. In May, there was £4.6 billion more withdrawn than paid into bank or building society accounts – the highest level since records began 26 years ago.

Moreover, mortgage rates have risen sharply following June’s half percentage point interest rate hike meaning house buyers face even greater costs.

‘This has caused a significant deterioration in mortgage affordability and is likely to keep housing activity at very low levels. Given the poor outlook for approvals, very low, or even negative net lending is likely to be the norm for the summer,’ says Martin Beck, chief economic advisor to the EY ITEM Club.

It is hard to get a clear picture of the sales market from the listed estate agents such as Savills (SVS) and Winkworth (WINK:AIM), due to the fact that rentals and property management fees make a large proportion of their income, but comments by Winkworth’s chief executive Dominic Agace are worth flagging.

Speaking in April, Agace described the residential market as ‘remarkably resilient’ until the mini-Budget in October 2022, when confidence was upset. He noted the ongoing reversal of the Covid-induced race for space, with a reversion to office working and city life returning to business as usual, which translated into fewer home sales.

NEW-BUILD SALES STRUGGLING

Even if the housing market as a whole seems to be less bad than at the start of the year, the new-build market is under huge pressure.

Newcastle-based developer Bellway (BWY) reported a 25% drop in reservations in the first five months of the year, reducing its forward order book to 6,172 homes with a value of £1.7 billion, 29% lower than at the same point last year.

‘Given the profile of completions in the coming months and prevailing reservation rates, a further decrease in the order book is likely by 31 July 2023 and, as previously guided, volume output is expected to moderate in the next financial year,’ the firm cautioned.

Rival Berkeley (BKG) revealed current-year reservations were down around 15% and said it was ‘adopting a more considered approach to new sales launches and being more cautious on the pace of investment in our ongoing sites.’

It added: ‘In this type of market there is a lack of urgency and transactions typically stem from owner-occupiers with a current motivation to move or investors with immediately available funds, with demand therefore weighted to “product” which is closer to delivery, as opposed to off-plan sales that do not complete for two to four years.’

In response, Berkeley is cutting its output and guided that unit sales this year will be around 20% lower than last year.

That in turn is feeding through to suppliers, with Travis Perkins (TPK), the UK’s largest provider of building materials, lowering its operating profit guidance last month as demand from new-build housing and the repair, maintenance and improvement market dwindled due to ‘higher interest rates and weaker consumer confidence driven by persistent, higher than anticipated consumer price inflation.’

WHAT COMES NEXT?

Morgan Stanley’s UK economist Bruno Skarica sees two further quarter percentage point rate rises, in August and September, by which time the economy will be ‘flatlining at best’, with the jobless rate creeping higher.

Which raises an interesting question – could the direction of the housing sector depend less on how high interest rates go and more on how confident people are in the economy and how comfortable they feel in their jobs?

Somewhat surprisingly, last month’s GfK consumer confidence survey suggests people are growing more optimistic regarding both the general economic situation and their own personal finances over the next 12 months.

‘Despite the fierce economic headwinds of the cost-of-living crisis, double-digit grocery price increases, and the mortgage squeeze severely impacting both homeowners and renters alike, the UK Consumer Confidence Index has improved by another three points in June, the fifth monthly improvement in a row,’ observes GfK’s client strategy director Joe Staton.

‘This is the best showing for the overall index score for the past 17 months and, if consumers continue to weather the current economic storm, then this will provide a firm foundation for getting back to growth.’

This confidence probably stems from the fact the number of people in work increased to a record high last quarter and now exceeds pre-pandemic levels, with a rise in both the number of employees and the self-employed according to estimates from the Office for National Statistics.

The number of full-time employees increased during the latest quarter and is above pre-pandemic levels, while part-time employees also increased during the latest quarter but remain below pre-pandemic levels.

While the number of vacancies continues to drift lower, reflecting uncertainty in some parts of the economy, there were still over one million unfilled posts in May, while average pay excluding bonuses rose by 7.3%, the highest growth seen outside of the pandemic.

Finally, the redundancy rate fell to 3.3 per thousand employees which takes it back below pre-pandemic levels and continues the downward trend which has been in place for the last decade.

So, our overall impression is that even if higher interest rates push the economy into recession later this year or early next year, which is defined as two consecutive quarters of negative growth,    as long as it doesn’t nose-dive, causing mass layoffs in the process, consumer confidence should hold up which in turn should support the housing market.

THREE STOCKS TO BUY

GRAINGER (GRI)

Higher interest rates and a shortage of housing are tailwinds for professional landlord Grainger, which has a portfolio of 9,700 homes and an occupancy rate of almost 99%, a company record.

‘Momentum in the business is continuing as we move into the peak summer lettings season,’ says chief executive Helen Gordon.

MJ GLEESON (GLE)

Sheffield-based MJ Gleeson specialises in affordable homes, with an average selling price of £186,000 in the six months to December 2022 against a UK average house price of close to £300,000.

That doesn’t make it immune to the weak market, but it may attract buyers who are lowering their sights in terms of affordability.

THE PROPERTY FRANCHISE GROUP (TPFG:AIM)

After a better-than-expected 2022, which chief executive Gareth Samples called his ‘busiest year ever’, the first quarter of 2023 has already surpassed management expectations in terms of lettings demand.

The sales business will undoubtedly be a drag, but the firm’s franchise model and its recurring rental revenue put it in a strong position.

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