Are car sales finally running out of road?

09 May 2017

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New car registrations fell month-on-month by almost 20% to 152,076 units in April, as new Vehicle Excise Duty (VED) rates came into force and imported car prices rose.

New VED rates, which came into effect on 1 April 2017, introduced a flat-rate of £140 for all petrol and diesel vehicles after the first year, compared to the CO2-based system used previously.

The new VED rates effectively pulled forward car registrations in March, which were up 8% year-on-year, before slumping in April. Most buyers would have been about £400 better off over three years by buying a low-emission car before the VED rate hike.

While electric cars continue to be tax-free, lower-emission models, including hybrids and plug-in hybrids, will pay between £10 and £100 in first-year excise duty after previously being exempt. This has triggered the first downturn in alternatively-fuelled car registrations in nearly four years, with registrations down 1.3% compared to April 2016.

Private sales slumped, with registrations by private buyers down by 28%. Businesses and large fleets also registered fewer cars, down 21% and 12% respectively.

Despite the big hit in April, the Society of Motor Manufacturers and Traders (SMMT) said that the overall new car market remains 'strong', with registrations over the first four months of 2017 up 1.1% compared to 2016.

Yet the 20% drop surprised many, and it represented a significant hit for a market which has boomed in recent years on the back of new models and financial innovation in the form of Personal Contract Plans (PCPs).

Diesel cars took the biggest hit, with wider concerns over possible higher duties going forward and tighter restrictions in the wake of the Dieselgate scandal.

It wasn't just the new VED rates that acted as a drag on the market, though. Imported car prices have been rising on the back of the Brexit induced depreciation of sterling last year. With real wages being squeezed by a wider pick-up in inflation, households may start to hold off on new car purchase, a traditional cyclical 'big ticket' item.

Car sales have been a boost for the UK's economy since 2014. Low petrol prices and attractive financing deals have boosted sales which in turn has helped economic growth in the UK.

A softening economy, falling consumer confidence, rising prices, muted earnings growth and possible weakening labour market are likely to mean a slowdown in car sales in 2017, with consumers likely to delay purchases or trade down to cheaper models.

The SMMT itself said late last year that 2017 would likely see sales down by 5-6% compared to 2016. That is anyway optimistic - I see sales dropping by 5-10% this year (even a 10% fall would still see sales at historically high levels).

Signs of stress appeared in the market late last year, with so-called 'pre-registered' sales rising - as far as I can tell, to 10-15% of all car registrations by the last quarter of the year.

These arise where dealers don't actually sell cars to real customers but register the cars themselves so as to hit sales targets and qualify for bonuses from manufacturers. Pre-registrations have always been around but the levels observed indicate that the market is if anything 'overtrading'.

I also expect sales to fall through 2017 as the credit-fuelled new car sales boom reaches the end of the road. Over 75% of UK new car sales are financed by lenders and cheap credit has driven sales, particularly via PCP financing schemes.

Under a PCP, drivers pay an initial deposit and then a fixed monthly payment over a term of – say - three years which in effect covers the depreciation in the car's value.

After the three years are up, the driver then has the option to make a 'balloon payment' to take ownership of the car, or, as manufacturers hope, trade in the residual value in the car as a deposit on a new vehicle.

The key difference comparing PCP as against a traditional Hire Purchase deal is that the driver is paying off a much smaller amount of money, so s/he has a lower monthly payment or lower initial deposit or shorter repayment term.

So on a new car deal over three years with a low deposit, a PCP offers a much lower monthly payment than an HP, with the caveat that at the end of the agreement the outstanding balance will need to be settled.

All this is a way of saying that on PCP the same car will cost considerably less per month to finance than on an HP, or can mean that the driver can drive a more expensive car for the same monthly payment. That's what has made PCP so attractive to the car 'buyer' (and has helped the growth of the premium sector).

It's a nifty financing model, for sure. But, the entire PCP structure depends on that residual value remaining robust and keeping the monthly repayments affordable.

And while PCPs have kept the corks popping at dealer sales events, dark clouds may be looming on the horizon which may dent to the ability of PCP to keep cars coming out of the showrooms at quite such a dizzy rate: used car values and a likely slowdown in growth.

In effect, the surge in PCP-propelled new car sales may lead to a wave of used cars hitting the second-hand car market, in turn depressing second hand values (unless broader economic growth is fast enough to boost confidence and used car sales).

That in turn could impact on the very collateral that lenders rely on to make PCP deals work. If so, car firms may take a hit on the value of used cars being returned, and PCP rates may start be less attractive in the future. That in turn will act as a drag on the market.

So 2017 will likely see a slowdown in car sales. March's bumper sales figures could have been a 'last hurrah' for the market before dark clouds set in.

This article was written by Professor David Bailey from the Aston Business School in Birmingham and originially appeared in the Birmingham Post in May 2017.

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