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Will rising rates squeeze the market?

A whole generation of homebuyers - who had never experienced a single upward move in rates - have had a rude awakening.

If there are further upward interest rate moves this year, it is likely that higher mortgage costs will start to affect house price growth. The higher rates go, the stronger likelihood that price growth will decelerate if not grind to a halt.

Higher mortgage rates limit what people can afford to pay; first-time buyers and second steppers, who typically borrow the most proportionately, will be hardest hit. Some landlords will also be affected.

Last September, as inflation began to emerge, we forecast that house prices would rise by 3.5% in Q4 2022, followed by increases of 3.0% in 2023 and 2.5% in 2024. We stand by these numbers. But the Bank is raising rates faster than expected, meaning that the downside risk to our forecasts has risen.

Current house price growth is running well above our forecast. But we expect the pace to moderate over the rest of the year, and, probably, into 2023.

Prime markets, where cash purchases are more common, may fare better than we forecast, but the tempo seems set to be less lively in markets dominated by first-time buyers and second steppers.

If price growth is lower than our forecast, or even negative, this is unlikely to improve affordability for anyone buying a home with a mortgage. When rates rise, mortgage repayments take up a larger proportion of a borrower’s income even if what they borrow remains the same.

When considering the impact of higher interest rates, it’s worth noting that the proportion of homeowners with a mortgage has shrunk from a peak of 64% in the early 1990s to just 46% today.

But house prices and debt are at more elevated levels than in early 2007 (when the Bank raised the base rate from 5.25% to 5.50%).

As a result, each 0.25 percentage point increase in rates today is equivalent to a 0.50 percentage point rise in 2007. A decade and a half of cheap money has made the decision to raise rates a bigger balancing act than in the past.

For the moment, rate increases have yet to dampen the market which is charting a course midway between the typical levels of activity recorded in 2019 and 2021’s year of supercharged deals. Time to sell still sits comfortably under 30 days and the number of homes for sale remains around 30% below its pre-Covid average.

Property values will continue to be supported by a strong labour market, with more vacancies than job seekers. If the labour market begins to weaken, this will be a signal to the Bank to cease raising rates.

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Market Insight Summer 2022

Market Insight Summer 2022
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