Morgan Stanley Sees U.K. Home Prices Extending Drop in 2012

Morgan Stanley said U.K. house prices will continue to decline through 2012 as a squeeze on consumers’ incomes and higher interest rates restrain property demand.

Home values will fall a total of 10 percent in the two years through 2012, compared with a previous estimate of a 7 percent decline to the end of this year, Morgan Stanley economists including London-based Melanie Baker and Cath Sleeman said in a note to clients dated yesterday. The declines will cause U.K. banks to post larger loan losses, with Lloyds Banking Group Plc (LLOY) the most exposed to price drops, they said.

Housing “demand looks set to be relatively unsupportive for prices over the next year and a half or so given our expectation for weak real household disposable income and rising mortgage rates,” Baker and Sleeman said. “We don’t expect any significant further increase in availability of higher loan-to- value mortgages and expect only modest improvements in credit availability more broadly.”

Bank of England data today showed mortgage approvals fell more than economists forecast to 45,166 in April. The property market may come under further strain as the government cuts spending to reduce the budget deficit and inflation at more than double the Bank of England’s 2 percent target pressures policy makers to raise interest rates.

Morgan Stanley said rising home-loan arrears will see Lloyds, whose Halifax unit is the U.K.’s largest mortgage lender, post cumulative loan losses of 1.4 billion pounds ($2.3 billion) this year and next, compared with 300 million pounds in 2010. By December next year, Lloyds will have 90 billion pounds of mortgages in negative equity, where the property is worth less than the loan, the economists said.

Morgan Stanley expects British home values to drop 3 percent this year and 7 percent in 2012. The forecast is based on the Bank of England increasing its benchmark interest rate from its current 0.5 percent to 2 percent in the period. If the central bank delays raising borrowing costs, that will push back house-price declines by a year, the U.S. bank said.

The U.K. economy will expand 1.2 percent this year before growth accelerates to 1.8 percent next year, Morgan Stanley said. Its predicted house-price declines increase the downside risk to the 2012 growth forecast, Baker and Sleeman said.

To contact the reporter on this story: Scott Hamilton in London at shamilton8@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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