Rising Interest Rates Cause the UK’s Housing Market to Cool

The UK’s housing market has faced unprecedented conditions recently, spurring significant growth over the three years through 2022. Following the Brexit vote, house price growth slumped, but prices unexpectedly accelerated over 2020 and continued on the up through most of 2022. However, the Bank of England’s (BoE) retaliation to inflationary pressures has started to kick in, taking a toll on house prices.

Looking back: Pent-up demand kickstarts renewed house price growth

Recovering from a period of uncertainty and reduced transaction activity, house price growth turned positive in May 2020, growing by 0.3% over the month as pent-up demand trickled into the market. Monthly growth accelerated to 2.7% in June as easing lockdown restrictions helped strengthen buyer demand, sales and new listings.

From July 2020, the government began offering reduced rates of stamp duty for residential properties.

The rate of stamp duty applicable for properties of £500,000 or less was 0%, between £500,001 and £925,000 was 5%, 10% for properties between £925,000 and £1.5 million and 12% for anything above.

The BoE reduced the base rate of interest to historic lows in April 2020, to 0.1%, increasing the affordability of lending for buyers. Rock-bottom interest rates combined with the holiday accelerated the number of buyers wanting to take advantage of the reduced tax burden, supporting annual house price growth of 8.5% in December 2020.

The stamp duty holiday was initially set to last through March 2021, but was extended through July with a gradual taper to normal rates running through September 2021. The extended stamp duty holiday, combined with record-low interest and mortgage rates through the majority of 2021, contributed to further demand from buyers and propelled annual house price growth to 10.8% in December 2021.

Inflationary pressures spur a response from the BoE

While house prices were on the up, so were prices for other goods and services. As lockdown restrictions were eased for the majority of 2021, economic activity picked back up, but supply chain disruptions caused by the pandemic meant that demand outpaced supply.

The Consumer Price Index jumped by 5.4% in the 12 months to December 2021 according to the Office for National Statistics (ONS), a huge jump from 0.6% in 2020.

In 2022, pandemic-induced supply chain disruptions were worsened by further devastation caused by Russia’s invasion of Ukraine. Ukraine is a significant supplier of agricultural products and raw inputs, like metals and non-metallic minerals. Trade was initially hit due to the war, but imploded when Russia enforced a naval blockade until a grain deal was brokered by the UN.

The war, in addition to economic activity continuing to recover, meant demand continued outstripping supply for many goods and services, especially construction materials.

The UK Consumer Price Index peaked at 11.1% in October 2022 and increased by 9.2% in the 12 months to December 2022.

In retaliation to soaring inflation, the BoE increased the base rate from 0.1% to 0.25% in December 2021 and made 25 basis point increases up to 1.25% in June 2022. As inflation remained undeterred, 50 basis point jumps were made up to 4% in February 2023.

Mortgage rates grew in line with expanding interest rates. According to the ONS, the average mortgage rate at a 75% loan-to-value ratio (LTV) for a five-year fixed rate plan was 1.59% in December 2021, but reached 5.05% in December 2022.

Climbing mortgage rates have reduced the affordability of property, especially for first-time buyers – something only made worse by the Help to Buy scheme having come to a close. The last purchases made through the scheme have to be legally completed by the end of May 2023.

In late 2022, lenders started pulling mortgage offers as increased rates showed no signs of slowing. Some of these offers were permanently revoked, as buyers could no longer pass the affordability assessments. This has caused the housing market to start cooling, even leading to monthly price declines over the six months through March 2023.

The BoE has made subsequent increases to the base rate, the most recent being a 50-basis point jump to 5% in June 2023. This has increased the average five-year fixed rate mortgage rate to 5.79% based on a 75% LTV, hiking the cost of borrowing even more.

Poor conditions in the construction sector threaten the UK’s housing supply

The government’s landmark target of adding net 300,000 homes to the UK’s housing stock annually by the mid-2020s was disrupted by the pandemic; although housing starts have increased from their pandemic lows, the Trade Skills Index 2023 forecasts new starts will fall by 36% over 2023.

The Construction Material Price Index for All Work peaked at 27.2% over the year through May 2022 according to the ONS.

Its growth has since slowed, but prices remained 4.7% higher in the year through April 2023. Rising prices combined with the increased cost of borrowing has put pressure on housebuilders, compounding the skills gap. According to the Trade Skills Index, the construction sector needs nearly one million new recruits over the next decade.

This trifecta of hurdles has likely contributed to the government stating this commitment has been downgraded to 'advisory,' taking into account local circumstances. So, although house prices are cooling, the UK’s housing crisis is far from over.

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