Market News

Inflation has soared to a new 40-year high of 9.4pc in June – 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, which when combined, has drastically reduced people’s ability to afford a mortgage. The fewer people can take out a loan, the fewer there are to buy homes.

High inflation has depressed consumer spending, meaning a recession is looming – in turn bringing a risk of rising unemployment. This triggers mortgage defaults and forces people to sell their homes, normally for less than they are worth.

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.

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 March to May, regular pay climbed by 4.3pc year-on-year, according to the Office for National Statistics. When adjusted for inflation, however, wages actually dropped 2.8pc.

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. According to fund shop Hargreaves Lansdown, real disposable income will fall even further, dropping 3pc in the three months to July.

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

Deutsche Bank expects the consumer prices index level of inflation to peak at 11.3pc. Capital Economics has forecast an even higher peak at 12pc. The Bank of England is scrambling to bring inflation back down to its target rate of 2pc.

Governor Andrew Bailey said a 0.5 percentage point rise is the Bank Rate was “on the table” for the next rate decision on August 4 – the steepest rate rise for 27 years.

Markets have already priced in three consecutive 0.5 point increases. Deutsche Bank expects the Bank Rate to hit 2.5pc by November. Capital Economics has forecast the rate will hit 3pc in 2023.

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. Today, the rates have surged to 3.74pc and 3.89pc 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.