Inflation now stands at 9.9pc – and this brings a dangerous triple whammy for house prices.
Plunging real wages are hitting buyers and homeowners’ pockets just as high inflation pushes the Bank of England to raise interest rates. Together, this is drastically reducing people’s ability to afford mortgages.
The fewer the number of people who can take out a loan, the fewer there are to buy homes. And the higher the cost of remortgaging, the more people are likely to need to sell up.
High inflation is also depressing consumer spending, meaning a recession is looming – in turn bringing a risk of rising unemployment. This could trigger mortgage defaults and force people to sell their homes.
The housing market slowdown has already begun. New buyer inquiries in June fell at the fastest rate recorded since 2020, when housing market shutdown, according to the Royal Institution of Chartered Surveyors, a professional body. They fell again in July, and then plunged even more dramatically in August.
Andrew Wishart, of Capital Economics, a research consultancy, said: “With mortgage rates continuing to rise and the economy on the brink of recession, a fall in house prices looks inevitable.”
Here is everything you need to know.
Real pay is plunging
Inflation is steadily destroying people’s earnings. In real terms, wages have been falling since November 2021 and are now plunging at the fastest rate since records began.
From April to June, regular pay climbed by 4.7pc year-on-year, according to the Office for National Statistics. When adjusted for inflation, however, wages actually dropped 3pc.
By comparison, in the wake of the financial crisis in 2008, real regular pay only fell by 1.1pc and house prices later fell by 17.6pc.
A larger, 2.4pc drop in real pay came later in 2011 and a 10-month period of house price falls followed.
Falling real wages matter for the housing market because they squeeze affordability. First-time buyers find it harder to save for deposits. Homeowners find it harder to cover their mortgage costs.
Tax rises and energy bill increases accentuate the blow and the crunch is only going to get worse. Sam Miley, of the Centre for Economics and Business Research, an analyst, said: “This downward pressure on real pay is set to continue.”
It is an economic Catch-22. If employers raise wages to help boost workers’ spending power, there is a risk of an “inflationary spiral”, said Mr Miley. This could bring greater financial pressure for households long-term and even higher interest rates.
Mortgage costs will soar
Inflation forecasts have been continually revised upwards, although the government's energy price guarantee should mean the peak is lower than previously expected. The Bank of England now expects inflation to pass 13pc this year. The Resolution Foundation, a think tank, expects the rate will hit 15pc at the start of 2023. The Bank is scrambling to bring inflation back down to its target rate of 2pc.
At the beginning of August, it made its steepest jump in the Bank Rate for 27 years – a 0.5 percentage point increase to 1.75pc.
Markets have already priced in a series of further 0.5 point increases and expect the Bank Rate to peak at 3.5pc.
Rising interest rates bring higher mortgage repayments. This time last year, the average two- and five-year fixed-rate deals were 2.55pc and 2.78pc, according to Moneyfacts, an analyst. Since then, the rates have surged to 4.03pc and 4.19pc respectively.
Adrien Lowery, of Bestinvest, a fund shop, said: “Given the speed of rate rises this year, as the mortgage market catches up, it is not unrealistic to see the average five-year fixed rate at 5pc next year.”
A buyer who took out a £200,000 mortgage last year at 2.78pc paid £926 per month. If their mortgage rate was 5pc, this monthly cost would surge by £244 to £1,170 – a jump of 26.3pc.
Higher mortgage costs hit the housing market in two ways. First, fewer people can afford to buy their first home and those that can have to reduce what they can spend and borrow.
It also affects existing homeowners. Roughly 1.9 million homeowners are on variable rate mortgages, which means a higher Bank Rate immediately pushes up their mortgage costs. These people are the minority – 75pc are on fixed rate deals, according to UK Finance, the lender body. But they are only protected from rate rises until their deals end. When they do, many will be in for a shock.
In 2022, 1.3 million fixed-rate deals will end. For those who are remortgaging after two years, the combined hit of inflation and rate rises mean their disposable income will fall by more than a quarter. The affordability squeeze could push families to sell up.
Next year, 1.8 million people will need to renew their fixed-rate deal and interest rates will be even higher.
A recession is looming
As a general rule, house prices only fall steeply when large numbers of homeowners are forced to sell up – and therefore have to accept lower sales prices. Values will unlikely crash until unemployment rises.
Soaring inflation means an economic downturn is increasingly likely. “A recession will be caused by the big drag on real spending power of households, triggered by high inflation,” according to Capital Economics.
It expects consumer spending to fall by 2.5pc and business investment to fall by 10pc. Overall, GDP will fall by 1pc.
Capital Economics expects the unemployment rate to rise from 3.8pc in May to 5pc by the end of next year. The CEBR expects a lower peak in unemployment of 4.5pc in the middle of 2023, but this will still cast a shadow over the housing market.
Karl Thompson, of CEBR, said: “This forecasted uptick in unemployment is likely to reduce average household earnings, with negative knock-on implications for housing market demand and prices.”
Economic instability will also spook lenders, who are likely to reduce mortgage availability.