There’s been a big change in the UK macro-outlook recently with widespread implications, not least for the housing market. Let’s start with the good news. First, the doom and gloom surrounding the near-term outlook for growth has been replaced by cautious optimism. The Bank of England and the International Monetary Fund (IMF) who were both predicting recession now see modest expansion. There has been more good news on the energy price front: the price cap for July has been announced at £2,074 which is a reduction of 17%. Not only is this good news for hard pressed households, it also means that the cost of government support in the area will disappear, with favourable implications for the budget deficit. The final bit of good news is that headline inflation has finally fallen below double digits.
So now let’s look at the bad news. Although headline inflation dropped, core inflation went up from 6.2% in March to 6.8% in April. That’s a big jump and it’s hard to put it down to one-off factors. Given the strength of UK wages and the improved outlook for the economy, almost everyone now expects the Bank of England to hike base rates to 5% over the summer. Whereas many analysts were expecting UK interest rates to a falling by year end, markets are now pricing further increases.
All of this is bad news for mortgage rates. The 5-year fixed rate had fallen steadily from the highs reached last autumn to an average of just over 4% in April, but now looks set to head back to close to 5%. For existing borrowers the hit to their finances as they re-fix mortgages will be spread out. Just as the pain from higher energy bills dissipates so the hit from higher mortgage rates will be felt. The Resolution Foundation have done some good work on this. They estimate a hit to household finances of £12 billion from higher mortgage rates with two thirds of that yet to be felt. For the 1.6 million borrowers set to refix their mortgage over the coming year, they estimate a rise of £2,300 for annual bills. The Resolution Foundation did their calculations before the inflation numbers pushed up interest rate expectations – they would get higher figures if they redid their sums today.
So, what does all this mean for UK economy and house prices? House prices fell after the jump in mortgage rates which followed Kwasi Kwarteng’s September 2022 budget. They recovered recently on the back of declining mortgage rates and better news on economy.
I expect house prices to start to decline again in response to higher mortgage rates. I do expect better news on inflation – the labour market is getting more into balance as a temporary surge in construction activity abates and immigration continues at a rapid pace. Input costs, especially energy but also food and shipping costs have fallen and will feed through to prices more generally. The Bank of England will be aware of the impact of higher mortgage rates on the economy. The widespread adoption of fixed rate mortgage is good for stability, but it also means their policy changes operate with a longer lag than in the past, they will want to avoid raising rates too far but will raise them given the strength of wages and core inflation.
Rising population and limited new house building have been long term supports for UK house prices. In the near term there is increased supply from the rented sector as landlords sell up in the face of adverse moves in tax, interest rates and regulations. With borrowers struggling to get affordable mortgages the outlook for house prices is poor. My forecast is that they will fall by 10% from their peak – that’s an uncomfortable prospect for many, but it will still leave prices higher than they were pre covid and still very high based on traditional metrics. Exceptionally low interest rates pushed house prices to extraordinary levels – a process that’s now going into reverse.