Why UK house prices could plunge by 20% after the latest interest rate hike

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Britain’s estate agents normally radiate optimism but they will be watching anxiously at noon next Thursday when the Bank of England is expected to announce the latest blow to a rapidly weakening property market.

Crunch time has arrived for a sector that for years has appeared to defy gravity. Threadneedle Street’s monetary policy committee (MPC) is poised to raise official borrowing costs for a 10th meeting in a row, with mortgage approvals already running 30% below their pre-pandemic levels and house prices down by 4.3% from last August’s peak, according to the Halifax bank.

Further falls are inevitable as borrowers adjust to an era of persistently higher interest rates. The City is braced for a half percentage point rise, to 4%, and for the rate to remain at least as high until the Bank is sure inflation is sustainably on course to hit its 2% target.

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Analysts are agreed that 2023 will see further falls in house prices, with one predicting a peak-to-trough fall of more than 25% once inflation is taken into account.

There are structural reasons why house prices tend to go up in the UK – tough planning laws, a tax system that rewards home ownership, a sharp fall in the number of new homes being built since the 1950s and 1960s – but occasionally there are breaks in the trend.

This year is on course to be one of those break periods. A long boom driven by record-low interest rates has run its course.

The party was always going to end sooner or later as, even with rock-bottom interest rates, finding a deposit for a home and meeting mortgage payments became more and more of a struggle. Figures from the Halifax this week showed a first-time buyer was paying just over £300,000 to get a foot on the property ladder and needed a deposit of £62,000. More than 60% of mortgage completions were in joint names last year.

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But two other factors have contributed to the rapid cooling in demand: the steady increase in official interest rates since late 2021 and the impact of Liz Truss’s brief premiership, which involved mortgage rates rising to almost 6%.

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Andrew Wishart, a property economist at Capital Economics, said average quoted mortgage rates had climbed from 1.4% at the end of 2021 to a peak of 5.7% in November last year. While the effects of Kwasi Kwarteng’s budget had worn off slightly, mortgage rates were still likely to be just above 4.5% by the end of the year.

“While the current level of house prices was affordable when interest rates were 2%, that’s not the case with mortgage rates at 5%, 4% or even 3%,’ Wishart said. “Higher mortgage rates mean buyers will be less able and willing to borrow, reducing their budgets and putting downward pressure on house prices. To return affordability to a sustainable level by year-end would imply a drop in the price-to-earnings ratio from almost eight times income now to below six, consistent with a drop in prices of around 20%.”

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George Buckley, a UK economist at Nomura, said house prices would need to fall because rising interest rates had made it more expensive to service home loans. The extent of the fall would depend on how quickly this adjustment happened. According to Nomura, to return the mortgage repayments-to-income ratio to its long-term average by the end of this year would require a drop of 20% in prices. If the adjustment took place more slowly between now and the end of 2027, the decline would be just under 10%. Nomura’s central forecast is for prices to fall by 15% by mid-2024.

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Kallum Pickering, the chief UK economist at Berenberg, said the scale of the correction in house prices mattered because the wider UK economy was sensitive to large swings – either upwards or downwards. Judging by the latest bulletin from the Royal Institution of Chartered Surveyors (RICS), he said, the imminent downturn was likely to be on a par with the early 1990s, when interest rates peaked at 15%, and the global financial crisis, when the UK banking system teetered on the brink of collapse.

“In contrast to the recent string of surprisingly positive data for the economy as a whole, the December RICS housing market survey makes for grim reading,” Pickering said.

The headline house price balance – the gap between RICS members saying prices were going up against those saying they were going down – stood at -42.0% in December, compared with -25.7% in November, the lowest monthly balance since October 2010 and the third largest annual drop going back to 1978.

“The biggest annual drop happened in the late 1980s, before the early 1990s housing market crash and recession, while the second largest fall occurred during the global financial crisis in 2008. Although a housing market downturn was widely expected by economists (including us), the monthly drop in the December survey far exceeds our and consensus’ expectation,” Pickering said.

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In the early 1990s, a doubling of unemployment prolonged and deepened the house price crash, as people who lost their jobs had to sell their homes in a falling market. While the low level of unemployment currently makes a repeat of the record repossessions unlikely, Wishart says there will still be a sizeable fall in prices.

“Overall, even in the absence of forced sales we think that higher mortgage rates will lead to a severe repricing in the housing market this year. The nominal peak-to-trough house price fall of 12% we expect is shy of the falls of almost 20% seen in 2007-09 and 1989-92, and only takes house prices back to their March 2021 level. But note that in real terms it amounts to a 27% drop, on a par with those episodes.”

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