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Is Britain heading towards a house price crash?

Inflation and interest rate hikes could soon undo record house price growth
Inflation and interest rate hikes could soon undo record house price growth

The property market has been booming for more than a year. But in July the disappearance of stamp duty holiday savings triggered a drop in transactions to 22pc below normal levels.

Sales in August recovered to a more "normal" pre-pandemic level. But demand has cooled since the summer, and now high inflation is a threat to low interest rates. How quickly could the market turn?

The stamp duty holiday brought a fever to the property market, but it was not the key driver of price growth. Broadly speaking, analysts attribute the current house price rises to two factors. First, a shortage of homes has brought an extreme imbalance between supply and demand. Second, this demand is underpinned by affordability, which is driven by low interest rates.

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The short-term indicators for both of these factors are strong. But few economists expect these circumstances to last long-term. Here, we take a closer look at when the tide could turn.

Interest rates are key for affordability

Massive house price rises have caused the ratio of home values to earnings to reach its highest level since 2007 – just before the financial crisis triggered a 20pc drop in prices.

But record low interest rates mean that homes are still affordable. A person only needs to spend 37.8pc of the median income to pay a mortgage on an average priced home. This is low by historical standards.

Andrew Wishart, of Capital Economics, a consultancy, said: “This is still the best indicator of overvaluation in the housing market in my opinion.”

As long as interest rates stay low, buyer demand will stay high. But the market is vulnerable to hikes in the Bank of England's Bank Rate.

Capital Economics’ current forecast is that house prices will rise by 7.5pc between now and the end of 2023, while mortgage rates stay low. If the Bank Rate rose to 0.75pc sooner than expected, however, the growth in house prices would be a lesser 4pc, said Mr Wishart. If the rate rose to 1.5pc, Capital Economics calculates house prices could drop by 4pc.

The threat of inflation

“I think the major risk to the housing market is the widely anticipated impending rise in inflation proving more persistent than economic forecasters expect,” said Mr Wishart. If this happened, the Bank of England would need to raise interest rates quickly in response.

“That would cause mortgage servicing costs to rise to a more concerning level, and point to a period of weaker price growth or even a drop in house prices,” he said.

Stronger than expected inflation means many analysts have brought forward their forecasts for rate rises to 2022. Some are even betting on a rate rise before the end of this year.

Kay Neufeld of the Centre for Economics and Business Research, a consultancy, said: “There is talk of inflation getting out of hand, and in a year’s time that could mean the tightening of monetary policy just as the economic recovery is maturing. That is where we see potential problems.”

Analysts do not expect interest rates to rise quickly. CEBR expects the Bank of England will raise the Bank Rate from 0.1pc to 0.25pc in the second quarter of 2022, followed by a rise later in the year to 0.75pc.

Rising mortgage costs will hit buyer demand, and buying power, said Mr Neufeld. “That will tip house prices into correction territory.” CEBR has forecast a 2pc drop in house prices by the end of 2022.

When supply will be in sync with demand

The ratio of sold stock to available properties – which essentially means demand and supply – is historically high, according to the Royal Institution of Chartered Surveyors, a trade body. Since October, it has exceeded the pre-Covid level. In June, it hit 58.7 – the highest point since July 2002.

But the ratio has since fallen for two consecutive months, down to 50.8 in August. This was still exceptionally high historically, but it was also the lowest level recorded since March. It seems the imbalance between supply and demand has now passed its peak.

Simon Rubinsohn, of Rics, said the July number would still mean annual house price growth between 7pc and 9pc. This would be the case as long as interest rates remained low.

Watch the lead indicators for forced sales

Big house price falls are typically triggered by a jump in forced sellers, said Mr Rubinsohn.

The lead indicator for this will be mortgage repossession claims, which preclude bailiff repossessions. These homeowners need to sell fast, and are therefore likely to accept discounts.

Mortgage repossessions were banned during the pandemic but this moratorium was lifted in April. There were 2,498 claims between April and June – more than triple the number in the first three months of the year, but still roughly half the pre-Covid level.

Still, even without the added economic pressures of the pandemic, there is likely to be a backlog of claims that were not made during the last year. This number could climb fast. But the better than expected economic recovery and employment statistics mean that analysts do not expect a rise in repossessions large enough to make a material difference to national prices.

“Some pain could be felt, and there could be an uplift in repossessions, but it would only be in specific areas where there have been structural changes in local employment,” said Mr Rubinsohn.

Look at the stage of the housing cycle

Beneath the headline indicators, there are massive variations across price points and different regions.

When it comes to the future likelihood of growth, it is useful to look at how values compare to their pre-financial crisis peak. Areas that are below their pre-crash peak are likely to have further capacity for growth.

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According to property website Zoopla, in Northern Ireland, house prices were still down 29.9pc. In the North East, prices were 1.5pc below their last peak. These areas are in very different stages in their housing cycles to, say, London, where prices were at 63.6pc above the pre-crash level.

Areas where house prices are far above the 2007 level, however, are more likely to be constrained by affordability.

At a local authority level, values in Middlesbrough were 6pc below their pre-crash level, while in Cambridge prices were up 57.7pc.