Inflation And Rate Rises Could Pose Threat To Property Values

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Although the property market has been on fire for over a year, inflation and interest rate increases could result in falling house prices, while the reduction in the stamp duty holiday in July caused a drop of 22pc in transactions.

Given that demand is past its peak, the moratorium on mortgage repossessions has been lifted and high inflation threatens low interest rates, how likely is it that the market will turn? Experts have credited the price rises to two factors. First, the shortage of stock has resulted in an extreme imbalance between supply and demand and second, low interest rates have made homes affordable.

Though the short-term indicators for both these factors have been robust, they will not last for ever.

Interest rates are critical

Huge price increases have meant the ratio of home values to earnings has hit its highest level since 2007, just before values nosedived during the financial crisis. Yet record low rates have meant homes are still cheap to buy. According to consultancy Capital Economics, an individual needs only 38pc of an average income to pay a mortgage on an average home, which is low by historical standards.

The firm’s Andrew Wishart says this is still the best indicator of overvaluation in the housing market, which is vulnerable to hikes in the Bank of England’s Bank Rate.

Capital Economics has forecast that house price inflation will rise by 7.5pc by the end of 2023, as long as rates remain low. If, however, the Bank Rate rose to 0.75pc sooner than later, growth would be a lower 4pc. If the rate climbed to 1.5pc, prices could fall by 4pc.

Threat of inflation

The major risk to the market, Mr Wishart says, is if the widely expected imminent rise in inflation proves more enduring than forecasters anticipate. If this happened, the Bank could raise rates speedily. That would cause the cost of servicing a mortgage to rise to a more worrying level, and indicate a period of weaker growth or even a fall in house prices, he said. The firm has already brought forward its forecast for the first rate hike from February 2024 to August 2023, due to stronger than expected inflation.

Kay Neufeld, of the consultancy Centre for Economics and Business Research (CEBR), says if inflation gets out of hand, it could result in the tightening of monetary policy in a year’s time just as the economic recovery is maturing. That is a potential problem.

CEBR has forecast the Bank will raise the rate to 0.25pc in the second quarter of 2022, then to 0.75pc later in the year. Rising mortgage costs will hurt buying power, Mr Neufeld said, and that will make house prices vulnerable to correction. CEBR has forecast a fall of 2pc in house prices by the end of 2022.

Supply and demand

According to trade body the Royal Institution of Chartered Surveyors (RICS), the ratio of sold stock to available properties, i.e. demand versus supply, hit 58.7 in June. This was the highest point since July 2002.

The rate fell by 3.3 to 55.4 last month, which was still notably high but also the lowest level since March. The supply and demand imbalance has, therefore, passed its peak. Simon Rubinsohn, of RICS, says the July figure would still mean annual house price growth of close to 10pc, as long as rates remain low.

Forced sales

According to Mr Rubinsohn, large price falls are usually only brought about by forced sellers, and the lead indicator for this is mortgage repossession claims, which precede bailiff repossessions. The moratorium on repossessions was lifted in April, followed by 2,498 claims between April and June, triple the number in the first three months of 2021, though roughly half the pre-Covid level.

There is likely to be a backlog of claims and the total could rise quickly. Yet better-than-expected economic and job statistics have meant analysts do not expect a sufficiently large rise to adversely affect national house prices.

Mr Rubinsohn believes there could be some hardship but only in areas where there have been structural changes in local employment.


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