Will interest rates force property prices down?

Another month, another base rate hike. As pressures build on the housing market, might interest rates be the straw that breaks the camel's back?

Image credit | Nick Youngson CC BY-SA 3.0 Pix4free.org

The Bank of England did it again - the base rate has been increased by 0.5% to 1.75% as the Bank tries to get inflation under control. The move was widely anticipated but the size of the hike made the announcement a big moment.

While this will be a blow to those on variable mortgages, the effect will be delayed for most borrowers as 75% are on fixed rates. Only when those fixes come to an end will the pain be felt.

Interest rates and house prices

Intuition says that interest rates and house prices should move in opposite directions - as rates rise, prices fall and vice versa. But is that really the case? Property data company Twindig looked back over the last 40 years to find out if that correlation stands up to scrutiny.

Since 1983 there have been 13 periods of rising or falling interest rates. Of those, 8 followed the expected pattern where the intuitive answer held true. Perhaps surprisingly, the other 5 periods saw interest rates and house prices move in the same direction at the same time. It seems that other factors are also at play.

The desire to move house

There are two main reasons why people move home. Necessity and aspiration.

Necessary moves might include, for example, a growing family or relocation for a job change. Affordability may affect the size and price of the new house, but not the move itself. Necessary moves account for half of all house purchases and remain almost constant, regardless of economic conditions. There is no reason to suppose that this will change.

Very recently we have seen a fine example of aspirational moves, with the race for space driving a 20% rise in house prices over the last two years. Higher income groups are more able to absorb inflationary pressures and the continued high level of new enquiries to estate agents suggests that they remain very active buyers.

Banks' willingness to lend

The 2008 financial crisis saw an abrupt halt to mortgage lending. As a result, the housing market lost a major part of its demand, pushing house prices down by more than 15%. Only when the banks were recapitalised did lending return and house prices recover.

So far during this rate rise cycle mortgage lending has maintained a steady level, with the Bank of England expecting just a slight decrease in the current quarter.

Forced sales

In 1988 the property market hit an artificial peak due to the ending of MIRAS tax relief. Shortly afterwards, interest rates shot up to 15%. As a result, mortgage repayments became unaffordable for many and a wave of repossessions followed. House prices fell.

At the start of the Covid crisis, there was the risk of another wave of repossessions, but government intervention and the banks' policy of forbearance over foreclosure prevented a property price slump.

It is likely that similar policies will be seen this time, with the government addressing energy prices and banks' continued forbearance where possible.

Will house prices fall?

Twindig's research demonstrates that interest rates on their own are unlikely to drive down property prices. Aspirational purchases are higher than pre-pandemic levels. Banks continue to lend and high levels of forced sales look unlikely.

Unless and until one or more of those last three factors come into play, a period of flatlining seems to be the most likely scenario. A correction, not a crash.