How will the cost of living squeeze affect house prices in the UK?

UK house prices rose by around 10% last year. But with inflation and interest rates on the rise, can that continue in 2022?

Woman looking in an estate agent's window
The UK housing market has started 2022 in fine fettle.
(Image credit: © Darren Staples/Bloomberg via Getty Images)

2021 was a staggeringly strong year for the UK housing market: property sales were at their highest levels since 2007, and prices rose at double-digit rates (it varies depending on which survey you use, but 10% is a good rough estimate).

And all the latest surveys suggest that 2022 has started off strong too.

But with consumers facing painful cost increases and interest rates rising at the same time, is that really likely to continue this year?

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Why rising living costs might not hit the housing market quite yet

According to the latest survey from the Royal Institution of Chartered Surveyors, the UK housing market started 2022 in fine fettle.

New buyer enquiries shot up, well beyond expectations, to their highest level since May last year. More people put their homes on the market, but demand is still outstripping supply. And agreed sales rose too. In all, it was a much stronger survey than expected.

But how long can this continue? For one thing, as if you hadn’t noticed, we have a burgeoning cost of living crisis. For another, central banks around the world are starting to put up interest rates, so the cost of mortgages is going to go up too. It’s also worth remembering that this is all happening at a time when house prices – even by recent standards – are very, very expensive.

Well, let’s think about this. The rising cost of living is an issue. That eats into disposable income. This makes it harder to save for a deposit. It also makes it harder to meet monthly mortgage payments.

However, I’m not sure that the rising cost of living by itself would be enough to dent the housing market for now. Home owners and would-be home owners tend to be drawn from the ranks of the better off. The rising cost of living hits the poorest hardest.

(You can argue about relative rates of inflation, but I don’t think there’s any argument that those on the lowest incomes spend a much bigger proportion of their income on necessities, which therefore means rising energy and food costs are going to batter their household balance sheets hardest.)

Certainly, rising living costs cut into everyone’s disposable income. But if they’re regarded as a temporary hurdle (either costs go back down or wages rise to match) then households with savings will be willing to use some of those savings with the expectation of replenishing them further down the line.

So while inflation matters, at current levels, I don’t think that alone is enough to stifle activity in the housing market.

The most important variable is the cost of borrowing

So what might do it? On this front, it can be very valuable to look at what’s going on in other countries. In the US, sentiment in the housing market has taken a sudden tumble. A record low number of US consumers think that it’s now a good time to buy a house, whereas the number who thinks it’s a good time to sell has shot up.

Why? US houses are expensive too (I mean, by American standards – I think most British people would look at what you can get in most parts of the US with gawping envy), having seen prices rocket during the pandemic. And Americans are seeing their living costs rise too.

But what I suspect is most important is that, as Gary Shilling points out on Bloomberg, the interest rate on a 30-year mortgage has risen from 2.82% in February last year to 3.84% more recently. Most Americans use 30-year loans to buy their homes, so that means that the cost of borrowing has gone up sharply.

In the UK, our mortgage market is very different, so mortgage costs haven’t gone up by anywhere near as much. But to my mind, it’s an excellent illustration of how important credit availability and cost is to the housing market, and thus to house prices.

The one thing I’m virtually certain of (as sure as you can be of anything in markets) is that by far the biggest driver of house prices is the cost of credit. So there’s no doubt at all in my mind that if mortgage rates rise significantly, house price growth will stall, and prices might even fall. No question about that.

So the question is: how high will mortgage rates actually rise, and how quickly? That’s a much tougher one. How high will the Bank of England really raise rates before markets get vertigo and it has to stop? And how much of this is ultimately dependent on the Federal Reserve, America’s central bank?

And if banks are seeing healthier margins, and lenders are willing to lend over ever-greater periods of time, will borrowing conditions really deteriorate that significantly? I suspect that it’s the flexibility of our mortgage market that makes the UK housing market so much more volatile than the US one, for example.

For now, Andrew Wishart at Capital Economics argues that “house price growth will remain high until the summer, by which time rising mortgage rates will start to weigh on demand”. That sounds as good a guess to me as any. We’ll keep an eye on the direction of mortgage costs and see what happens.

As for what this means for you: as we’ve said countless times before, there is no sense in trying to time the housing market. The decision to buy a home to live in is driven by many more things than money alone, so rather than second-guess the market, all you can really do is try to make sure that you can afford it under reasonable assumptions.

There will be plenty of booms and busts during your lifetime in the housing market, after all, so to an extent, it’s swings and roundabouts. That said, now is probably the time to favour longer-term fixes where you can get them.

John Stepek

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.