Will a house price crash be the next stage of the economic downturn and how bad could it be?

Published On: May 23, 2022Categories: Latest News4.9 min read

Stock markets have taken a slow and steady but consistent battering this year as inflation spirals to heights last seen in four decades ago. High levels of inflation and the interest rate hikes that are central banks’ main tool to control it are not good for equities, especially high growth companies with valuations based on future revenue projections.

The London Stock Market’s benchmark FTSE 100 index has actually performed better than any other major stock market for most of the same reasons that have hindered it compared to peers in recent years. It has a heavy weighting towards companies in the energy, commodities, banking and consumer staples sectors that look pedestrian compared to tech stocks when the going is good but have come into their own in recent months.

As a result, the FTSE 100 is roughly at the same level it started 2022, just 0.9% down. By contrast, the tech-heavy Nasdaq 100 is down 26.5% so far this year and things are expected to get worse before they get better.

But despite the gloomy outlook for global financial markets, and tough start to the year already endured, UK house prices have continued to rise. In the South East, ONS statistics show the average property sold for £380,500 in February, up 12% on the previous year. In the aftermath of the financial crisis in 2009, the average house price in the South East was, at £191,000, around half what it is now.

Even in Northern Ireland, the UK region where house price rises have been most modest, they are up 7.9% over the past year. The highest growth was seen in Wales with prices up 14.2%.

The average cost of a residential property in the UK is now £277,000, up almost 80% since 2009. Over the same period, UK salaries have risen by 38%, which is less than half.

In early May, Knight Frank analyst Tom Bill commented of the UK’s residential property market “we appear to have reached the summit”. He based that on what he saw as the “psychological impact” of the Bank of England raising the base interest rate to 1% alongside a cost-of-living crisis being catalysed by inflation. And rates will almost certainly have to rise further to put the brakes on inflation. Just how much remains to be seen and will depend on a number of factors but another 1% or more over the next year is not unlikely.

The question is how much the housing market might be affected in the months ahead? A serious crash would be in few peoples’ interests, regardless of increasingly loud complaints that house prices are unsustainable and a lack of affordability is storing up serious social issues.

A steadier correction of a slight drop now followed by a period of price stagnation or gradual slide over several years would be ideal. That would allow salaries to close the gap that has opened up over the past 13 years. But is that too optimistic?

How have UK house prices risen so high?

With the Bank of England’s base interest rate at historic lows of between 0.1% and 0.75% since 2008, mortgages have been extremely cheap in an historical context. Despite ever rising house prices making it difficult for first time buyers to raise deposits of 10%-20%, servicing them has been relatively comfortable. Homeowners have had to pay out only around 17% of their income to meet mortgage payments thanks to cheap offers from banks, supported by rock bottom base rates.


Source: Bank of England

How much of an impact will rising interest rates have on UK house prices?

The Bank of England has increased its base rate at each of its last four policy meetings, taking it from 0.1% in December to 1% now. Mortgage rates have also risen to 2.3% last month from 1.2% in September 2021, adding £109 per month on to the cost of an average £200,000 mortgage.

With energy bills going through the roof at the same time, that’s significant. Especially when financial markets expect the Bank of England’s base rate to hit 2.5% in a year. That would be expected to see mortgage rates rise to up to 5%, adding another few hundred pounds a month to mortgages.

Ben Broadbent, a Bank of England deputy Governor, also thinks that mortgage payment rises will only be a fraction of the cost of living increases driven by inflation over the next couple of year. He recently commented:

“The effect of higher interest rates on mortgage payments will be a small fraction of the unfortunate and unavoidable hits from rising import prices. I’d be surprised if it was much more than one-tenth of the rise. That is the unfortunate position which we are in.”

The Bank of England also expects a drop of 3.5% this year in real disposable incomes across the UK, which would be the biggest drop since records began in the 1990s. Another 0.25% drop is expected next year. Stamp duty payments are rising at the same time because more homes now fall into higher tax brackets. And next year the Help to Buy scheme ends.

Despite the issues, most economists don’t expect a drop in prices that would qualify as a bona fide ‘crash’. A majority of homeowners have locked themselves into fixed-price mortgages which means most won’t be forced to sell due to payments becoming unaffordable.

When the financial crisis hit over 70% of homeowners were on floating rates and less than 20% were locked into fixed rates for more than 2 years. Now the Bank of England estimates just 18% are on floating rates and more than 50% on fixed rates.

The UK’s underlying economy is also stronger than it was ahead of previous house price crashes. In 1993 unemployment hat reached 10.5% and it hit 8.5% in 2011, forcing significant numbers of homeowners who had lost their incomes to sell. The current unemployment rate of 3.8%, expected to drop to 3.6%, is the lowest since the 1970s.

Around 35% of homes in England are also mortgage free because owners have already paid it off or inherited the property. That means it is probably unlikely that we’ll see the kind of 20% drop in house price that took place between 1989 and 1993 or the 19% drop in the wake of the financial crises.

The supporting factors mean most market analysts believe it could be limited to closer to 5% or 10% at worst. That wouldn’t be great for homeowners but it wouldn’t be a disaster for most either. And might even help first time buyers, even if lending can be expected to be tight over the next couple of years.

About the Author: Jonathan Adams

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