Things are about to get worse for the housing market

Last year was full of surprises. For most of us, one of the biggest was the rise in UK house prices: according to Halifax, they ended 2009 around 4% higher than they started it.

But actually, the most surprising thing should have been not that house prices rose at all but that they rose so little.

Interest rates were 5% in mid-2008 and 0.5% at the end of 2009. That's important because, in the main, it is not the actual price of a house that determines its affordability to the average buyer but the price of the credit that he can get his hands on to pay for it with.

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So, all other things being equal (which, of course, they never are), if rates halve, we shouldn't be surprised if house prices double particularly in a country where most people still think you can't lose with bricks and mortar. Yet in the past 18 months, rates have rather more than halved they've fallen 90% while house prices have barely budged. Why?

The answer was neatly exemplified this week by Skipton Building Society as its management ripped up the "guarantee" on its standard variable rate mortgage. Until this week, borrowers thought they had a promise that they would never pay more than 3% over the base rate for their loans.

It turns out they didn't: from now on, they have to pay whatever Skipton wants them to pay (4.95% at the moment). That means that someone with an interest-only deal on £200,000 will see their monthly payments go from £583 to £825 a rise of more than 40%.

Skipton hasn't been alone in its reluctance to charge rates anywhere near the base rate. Indeed, as James Ferguson of Pali International likes to point out, for many people the cost of mortgage debt has not fallen much at all. He points to one of the few 90% loan-to-value products on the market: Nationwide's two-year fix. It isn't cheap. It comes in, including fees, says Ferguson, at about 6.5%, "almost a ten-year high".

It is, of course, perfectly possible to get a better deal if you have a lot of equity, but the first-time buyers who are supposed to be the lifeblood of the market, by definition, do not have a lot of equity.

• Why UK property prices are going to fall 50%
• When it will be time to get back in and buy up half price property

And things aren't that much better elsewhere.

The last year has been characterised by a good deal of gloating from mortgage holders who are still on trackers taken out two years ago. But those deals will soon expire. And when they do, would-be refinancers are going to get a shock. They'll find that if they have equity of 25% or more, they can shift on to a standard variable rate at around 4% (or 4.95% at Skipton, of course) or they can get a new two-year fix at roughly the same price.

That's OK, in that when they took out their mortgages they probably expected to be paying 5% by now. But it is still three to four times what lots of them pay on their old deals. If they have less equity, things will be worse: it'll be the SVR or 6%. Sounds nasty, doesn't it?

It might be about to get a whole lot worse. The inflation numbers this week created yet another surprise the consumer prices index (CPI) hit 2.9%. It is unlikely that the Monetary Policy Committee would go so far as to raise interest rates before the election it wouldn't make sense for them to do so before they see the new government's fiscal plan. But if the CPI numbers stay high, it is possible that rates will rise later this year. And while mortgage rates haven't come down with interest rates, you can bet your kitchen extension that they'll rise with them.

Then what will happen to house prices? I can't believe they will continue to rise, particularly given the state of the labour market. The unemployment numbers out last week, while spun as wildly encouraging, were actually awful. They showed a loss of 113,000 full-time jobs, a nasty rise in the number of involuntary part-time workers and yet another fall in real wages.

The headline number showed the weekly average wage up 1.1%, less than half the rate of inflation. Worse, the number was only positive at all because of a 3.8% rise in public-sector wages. Knock that out and the average private-sector worker ended last year about where he started it, even in nominal terms.

This is important simply because, if we know anything, we know that the current level of public sector spending can't go on. When the new government comes in, taxes will rise and salaries and jobs will be cut. That may bring on a new fall in GDP (note that the recession caused by the removal of stimulus measures in Japan in 1997 caused a new one worse than that which the measures were trying to cure). But even if it doesn't, everyone will still have less disposable income to chuck around the housing market.

Bubbles need momentum. The housing market lost its momentum in 2008. It clawed a little of it back in 2009. But it is hard to see where it is going to get any more from in 2010.

This article was first published in the Financial Times