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Are UK house prices finally heading for a crash?



The latest house price figures show a fall of 0.1% in July. With interest rates rising, inflation hitting double figures and a recession on the cards, are we finally about to see a house price crash?

by: John Stepek

© Getty Images

Good morning. As you may be aware if you read Dominicís article (I didnít pay him to write that, honestly), Iím leaving MoneyWeek after 17 years. So thisíll be my last Money Morning. 

And what better topic to round off those 17 years than the one that has vexed us all more than any other during that period. 

Couple looking in an estate agent's window

The wonderful UK housing market.

The economic outlook is horrendous, if the Bank of England is even half-right
Yesterday the Bank of England raised interest rates by half a percentage point, to 1.75%. It also issued one of its gloomiest ever forecasts. 

The Bank reckons that inflation will hit 13% before the end of the year (and remember thatís CPI, so RPI Ė the one we used to use Ė will probably be closer to 15%). Itíll stay at double-digit levels until at least the middle of next year.

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Thatís not great. But on top of that, the Bank expects the economy to be in recession by the end of the year, and for that to last for the entirety of 2023. 


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As a result, real (after-inflation) post-tax incomes will fall by more than 5% during that period, which is the worst drop on record.  

Thatís extremely grim. Thatís stagflation and then some. 

The obvious question is: why raise rates? We discussed that in more detail yesterday, but the short answer is that it doesnít really have much choice. This is not a pain that central banks can alleviate with the tools available. 

Given the gloomy prognosis, itís perhaps appropriate timing that after an extraordinarily bullish run, this morning brought news that the housing market might finally be showing some signs of weakness. 

According to Halifax, house prices fell by 0.1% between June and July. That doesnít sound like much Ė it isnít much Ė but itís the first such drop in a year. Prices are now up 11.8% on the year, down from 12.5% last month. Moreover, Nationwideís most recent report said something similar (prices fell by 0.3% on the month). 

As weíve always pointed out here at MoneyWeek, the main driver of soaring house prices has been falling interest rates. Itís practically a mechanical relationship. (That doesnít mean our planning laws are any good, or that we shouldnít build more houses Ė itís just that physical supply is not the main driver of prices.)

Once you understand this, itís pretty obvious why prices might be starting to wilt. As Neal Hudson of BuiltPlace points out, mortgage rates are shooting up. In July last year, you could get a two-year fixed rate mortgage at 60% loan-to-value (ie, a 40% deposit, or equity in your house) for 1.16%. Now the average rate is 3.44%. 

That is going to make a big difference to the amount of money a new borrower can lend, and itís going to make a big difference to the monthly payments for an existing borrower coming to the end of a fix (for more on all this, read Ruthís latest monthly mortgage update).

Throw in everyone (rightly) worrying about the extraordinary rise in energy bills which is either already hitting or about to hit extremely hard, and you can see why people might be pulling back somewhat.  

Capital Economics is now forecasting a 5% drop in house prices over the next two years. That seems very possible. If things carry on as they are, it might seem overly optimistic.

If weíre getting a year-long recession on top of double-digit inflation and rising mortgage rates, then the final component necessary for a full-blown crash Ė rising unemployment, which means rising repossessions and forced sellers Ė might well arrive too. 

Whatís the case for optimism?
The irony that I might be writing my final MM right at the peak of a housing market about which I have complained bitterly for the best part of two decades is not lost on me. (As Dominic pointed out, ďyouíve become your own contrarian indicatorĒ.)

So is there any way to avoid this unpleasant scenario? It would be much, much better for all concerned if house prices deflated in ďrealĒ terms via wages rising and prices stalling. Thatís still possible, but itís not easy to see how we get from where we are to there. 

The obvious factor that could forestall all of this is government intervention. Weíve seen plenty of intervention in the housing market over the years, but I donít think this would be the priority of the incoming prime minister.

Itís clear that the biggest factor in the current squeeze on incomes is energy prices. Addressing this is going to turn into a priority as winter comes and households face a succession of price hikes. 

However, itís also worth noting that even if we get a very significant intervention in the energy market (probably at the consumer end), that would make it easier, rather than harder, for the Bank to continue raising interest rates.

So, to cut a long story short Ė the optimistic case is that the sting is taken out of energy bills, the consumer stays relatively healthy, and unemployment therefore stays low. Meanwhile, higher interest rates mean the housing market cools right down, allowing wage growth to surpass price growth, meaning a genuine improvement in affordability. Savers also finally get a little bit of a break (though maybe not that much of one).

And I think, on a perhaps uncharacteristically hopeful note, Iíll leave it there.

Youíve been a fantastic audience. Thank you for your support over the last 17 years, particularly to those whoíve been there since day one. 

Itís a privilege to have your attention and I hope I can keep it Ė Iíll be back writing about money after the summer, so Iím hoping youíll continue reading at my new venue. Meanwhile, you can follow me on Twitter at @John_Stepek and Iím also on LinkedIn.

Until we meet again Ė may all your investments be suitably diversified ten-baggers




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