Mortgage Rate Hikes Trigger Decline in UK Housebuilding: An Unfolding Scenario

The housing market in the UK is witnessing a significant change as housebuilders are reducing their construction of new homes. This contraction comes in response to potential buyers expressing concern about the prospective hikes in mortgage rates in the coming months. Such uncertainty has been fueled by the Bank of England, which has raised official interest rates twelve times over the previous eighteen months. This series of increases has pushed mortgage rates steeply upwards in recent weeks, causing a substantial ripple effect in the housing market.

Amidst this environment, a report on the construction sector indicates that work on residential building sites in May fell to the weakest level since 2009, barring the period when sites were locked down during the Covid pandemic. While the other two sectors of the construction industry, namely commercial building and civil engineering, continue to expand, the housebuilding activity is being restrained by the steady ascent in the cost of borrowing.

This decline in housebuilding has become the focal point of the latest analysis by S&P Global and the Chartered Institute of Procurement and Supply (Cips). John Glen, the Chief Economist at Cips, voiced his concern, stating, "Though overall output in the construction sector showed an improvement for the fourth month in a row, the steepest drop in housebuilding activity since April 2009, barring the initial pandemic lockdown in early 2020, will send a chill down the spine of the UK economy."

The housebuilding sector's performance was gauged using the construction sector purchasing managers’ index. This index presented a concerning picture, with housebuilding activity dropping from 43.0 in April to 42.7 in May. This decrease marked the lowest level since the Covid-19 lockdown in May 2020, and excluding the pandemic period, this decline is the most substantial since 2009. In comparison, commercial building and civil engineering were the strongest performers, registering index readings of 54.2 and 53.9 respectively.

The downturn in housing construction is being interpreted as a response by developers to a softer property market. Nationwide Building Society noted that UK house prices fell at their fastest pace in 14 years in May as rising interest rates dampened buyer demand. Mortgage rates, which had seen some easing after hitting a 14-year high last autumn, have begun to climb again. This rise is attributed to speculators betting on the Bank of England's commitment to continue increasing interest rates to suppress persistent inflation.

The impact of increasing mortgage rates is already manifesting. The average two-year fixed-rate mortgage saw a substantial leap of 15 basis points recently, with five-year deals also following suit, as per data from Moneyfacts Group Plc. The rates for home loans now stand at 5.64% and 5.32% respectively, marking the highest level in five months. There is growing speculation that these changes may prompt the Bank of England to increase the benchmark rate as high as 5.5% this year.

The state of the market has inevitably affected the morale of builders. Rising costs of living, coupled with the expected rise in interest rates, are causing prospective buyers to hesitate about purchasing homes. Such market conditions have led builders to remain cautious about their own affordability rates. As a consequence, the expansion of workforce numbers in building firms is progressing at only a modest pace, further illustrating the impact of the market's uncertainty.

Despite these headwinds in the residential sector, the broader construction industry is showing resilience. The sector's new order books are healthier than they've been in over a year, indicating a potential recovery. Additionally, price pressures and supply chain bottlenecks, which have been considerable issues, have started to ease, providing some relief to the industry.

The current state of the housing market has implications for the wider economy and the UK government's policies. The government's attempts to increase the supply of homes, particularly for younger generations who have been priced out of the market following decades of housing boom, are being hindered by the downturn in housing activity. Some economists have even raised concerns that the shock from the increase in mortgage rates could potentially tip Britain into a recession.

However, amidst these challenges, there are signs of positivity within the broader construction sector. Hiring has picked up for the fourth straight month, providing a much-needed boost to the industry. Furthermore, the easing of price pressures in the sector is a welcome development, which, coupled with the strongest increase in construction order books since April 2022, indicates potential stability in the future. In this context, the commercial building and civil engineering sectors have emerged as bright spots, showing continuous improvements and strong performances that counterbalance the decline in the residential sector.