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House of cards

These are challenging times in the UK’s housing market. Building a healthier and more resilient economy, with stable prices, affordable mortgage rates and targeted support for those in need is essential – not least to ensure that people can keep a roof over their heads.

High inflation, rising interest rates and general economic uncertainty are having a big impact on the UK housing market. Would-be buyers, borrowers and renters face challenging conditions, with many already struggling under the burden of bulging utility and food bills.

In a new article at the Economics Observatory this week, Urvish Patel (National Institute of Economic and Social Research, NIESR) unpacks the latest numbers on the housing market and explores what they mean for different households. In an earlier Observatory piece, Duncan Maclennan (University of Glasgow) and colleagues look at the interactions between the housing market and wider economic and financial instability. And Huw Dixon (NIESR and Cardiff University) asks when we can expect inflation to come down.

Crashing the house party

UK house prices have stalled somewhat in recent months. According to the latest data, the average house price was £286,532 in April – 1% lower than a year ago. This is the first annual fall in house prices since 2012.

But despite this minor dip, a longer-term lack of supply, caused by planning restrictions and a shortage of new homes, is a key reason why prices remain stubbornly high for both buyers and renters.

How are borrowers affected? For existing mortgage holders on variable interest deals, or those on fixed-term arrangements that are about to expire, the latest hike in the Bank of England’s base rate – from 4.5% to 5% – could add hundreds of pounds to their monthly outgoings. This is because these households now need to pay a larger amount of interest on their existing loans.

Figure 1 tells a scary story. According to data from the Financial Conduct Authority (FCA), for the first quarter of 2023, the weighted average interest rates on fixed-rate residential loans (pink line) and variable-rate loans (blue line) increased by around 0.8 and 0.5 percentage points, respectively, compared with the previous quarter. This means that mortgage rates are, on average, 2.3 and 2.8 percentage points higher than in the last quarter of 2021.

Figure 1: Overall weighted average interest rates on mortgages (percentage), 2007-23

Source: Financial Conduct Authority (FCA)

For those who purchased a house over the last decade – during an era of extremely low interest rates – the sudden jump in monthly payments will come as a nasty shock. Many household budgets are based on affordability tests carried out during this period, but the conditions under which these borrowers were deemed worthy of a loan no longer exist.

How painful is this squeeze going to be? According to research by the Institute for Fiscal Studies (IFS), mortgage holders are set to see their disposable incomes drop by over 8% on average.

Who is being hit hardest? Many older people own their homes outright, so no longer hold any debt. This means that it’s the millennials (the generation born in the 1980s and early 1990s) who are set to bear the brunt of the latest interest rate decision by Bank of England’s monetary policy committee (MPC). In fact, those aged 30-39 are estimated to face an 11% cut in their monthly budgets. Coupled with food inflation at nearly 20%, this shows just how challenging the situation has become.

First-time buyers – who are also more likely to be part of younger generations – may well be pushed out of the market altogether. According to data from Nationwide, the UK’s largest mortgage provider, first-time borrowers currently face the highest mortgage burden as a share of their net pay since 2009 (see Figure 2). For those trying to get a foot on the property ladder, things haven’t been this tight for 15 years.

Figure 2: Monthly mortgage payments for first-time buyers (percentage of net pay)

Source: Nationwide

Beyond the housing market, these trends could hit the wider UK economy through diminished consumer demand. Higher monthly mortgage repayments will reduce personal disposable income, potentially hampering consumption and feeding through to lower GDP.

In fact, prior to the latest policy changes, NIESR forecast that real personal disposable incomes would continue falling for the rest of 2023 and into 2024. What this means for UK GDP over the next 12 months remains to be seen.

Life for rent

Renters are also struggling. Higher interest mortgage rates could mean that more would-be first-time buyers stay in rented accommodation. This could in turn drive up rental demand – and prices. Then there is the pre-existing shortage of rental supply, made worse by tighter leasing regulations that are encouraging landlords to sell their properties. More landlords selling up could deepen the shortage of properties available for rent.

These conditions risk backing people into an unsustainable financial corner. As present, private renters are twice as likely to be struggling with problematic levels of personal debt, with 15% of this group (1.1 million people, as of May 2023) unable to afford their debt repayments on things like payday loans or credit card bills.

For the general population, the share is just 8%. Of course, defaulting on personal debt will have a negative effect on people’s credit scores, weakening their chances of eventually qualifying for a mortgage.

Clearly, rising rental costs, together with stubbornly high household bills, are pushing many people to the brink of financial desperation. And with persistent inflation and further Bank rate hikes likely, the situation for renters is expected to remain very difficult for months to come.

Target practice

These challenges are tied closely to the troublesome macroeconomic conditions facing the UK economy. High inflation – caused in part by supply shocks following Russia’s invasion of Ukraine, as well as longer-run effects of the Covid-19 crisis and Brexit – and the subsequent need for tighter monetary policy (higher interest rates) mean the situation is more or less unavoidable.

So, if the conditions are unavoidable, how should policy-makers respond? In the short run, economists argue that the UK government should use fiscal policy (taxing and spending) to help deliver targeted support to the most vulnerable members of society. Over the longer term, bringing inflation back to its 2% target is critical (and will remain the central priority of the MPC). Only then will the cost of borrowing be eased, and some of the pressures on household bills reduced.

But when can we expect inflation to return to normal levels? In a new Observatory piece, Huw Dixon (NIESR/Cardiff University), one of our lead editors, addresses exactly this question.

For Huw, any forecasts predicting a rapid fall in inflation this year were overly optimistic. Both the Office for Budget Responsibility (OBR) and the Bank of England have suggested that price growth could return to 2% by the first quarter of 2024. But Huw argues that food prices will continue to rise quickly over the coming months.

NIESR analysis also indicates that inflation is likely to remain high throughout 2023 and into 2024 (at around 4-5%), only falling back to target by the end of 2024, or even early 2025. Huw argues that this is a much more realistic assessment.

An important caveat is that the assessment assumes that there are no new big inflationary shocks. One risk that could cause even higher levels of inflation would be an escalation in the trade war between China and the United States. Further disruptions to supply chains could compound existing pressures on both food and energy costs, hindering any progress towards more stable prices.

The invasion of Ukraine has shown just how connected the global economy is. Further shocks – whether resulting from more geopolitical stresses or more protectionist trade policies – will have painful economic implications for the UK. This will be felt by ordinary people at the supermarket checkouts, through their utility bills, and as they watch their rents and mortgage costs climb.

Building a healthier and more resilient UK economy, with stable prices, affordable mortgage rates and targeted support for those in need is essential – not least to ensure that people can keep a roof over their heads.

Author: Charlie Meyrick
Image by Eshma on iStock
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