Why Cooling House Prices Could Be Good News For The Banks

Piggy bankA recent report by the Royal Institute of Chartered Surveyors (Rics) highlighted that house price growth in the UK may be slowing, with there being a halving of predictions for house price growth in London over the next five years among its members to 5% annually.

At first glance, this may not seem like great news for UK banks such as RBS (LSE: RBS) (NYSE: RBS.US), Barclays (LSE: BARC) (NYSE: BCS.US) and Lloyds (LSE: LLOY) (NYSE: LYG.US), as higher asset prices are generally reflected in higher profitability for the banking sector. However, a steadier growth rate could produce a more favourable environment in which the banks can prosper — here’s why.

Lower Interest Rates — For Longer

As has been widely publicised, Mark Carney is in no rush to raise the UK interest rate above its historical low of 0.5%. However, he has clearly stated that the current rate of house price growth poses a significant risk to the UK economy. This could make him more likely to increase interest rates in an attempt to curb the risk which, in turn, could mean that the rate of economic growth slows across the UK.

However, if house price growth moderates somewhat (in line with the previously mentioned report from Rics), the Bank of England may not be required to increase interest rates as soon or as quickly than they would if house prices were to continue their current trajectory. This would be highly beneficial for Lloyds, RBS and Barclays (the UK-focused banks) who would undoubtedly benefit from continued UK economic strength. So, while slowing house prices are less exciting in the short run for the banks, they could allow the fertile conditions that are currently in place to last longer, which would clearly be hugely beneficial for their bottom line.

Looking Ahead

Furthermore, RBS, Barclays and Lloyds are all focused on significantly improving their payout ratios. So, while none of them currently offer relatively attractive yields, this looks set to change in the next couple of years, with the banking sector set to become a relatively high-yield sector. If interest rates do remain at 0.5%, higher yields could attract investors to the sector and make RBS, Barclays and Lloyds highly demanded stocks, leading to possible share price gains for investors.

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Peter owns shares in RBS, Lloyds and Barclays.