UK house prices are rising at the fastest rate in 17 years. How?!

There’s a cost of living crisis in the UK.

Energy bills are rocketing. Tax bills are rocketing. Your food bills are rocketing.

The headlines are full of it, and for once, they’re not particularly over-exaggerating. There is a squeeze on people’s incomes; the worst is yet to come and at current levels of pay increases, your wages are not going to keep up.

It’s a grim backdrop. But you know what else is rocketing, in spite of all this?

House prices.

UK house price growth just hit its highest since 2004

This month, annual house price growth hit 14.3%, says Nationwide. In February, it was “just” 12.6%. This is the strongest annual growth seen since November 2004 – 2004! That was smack bang in the middle of the last house price boom. In all, the average UK house price has gone up by 21% compared to early 2020.

Who knew that a pandemic would be so good for house prices?

And this is all at a time when the “cost of living crisis” is not just the top economic story in the UK, but a daily topic of conversation for many people. We’d all hoped that 2022 would be a post-Covid party year. Instead, it’s frankly pretty bleak out there.

So how on earth is this happening? How can the item that constitutes the biggest lifetime expense for most people still be seeing its value rise not just in nominal terms, but also at a rate massively above inflation (even inflation at current levels)?

There’s actually a logical answer for all this, even if it’s not the one you want to hear. It boils down to two things: employment and interest rates.

Houses are an unusual asset in that buyers are almost entirely price-insensitive – or rather, they are insensitive to the “headline price” of a house.

How do most people buy a home? They buy it with a mortgage – with debt. So what’s the “real” price of a house? Is it the price in the estate agent’s window? No – it’s the monthly payment that will secure the house for you.

If you’re a cash buyer, then the difference between £100,000 and £150,000 is very significant indeed. But if you’re buying with a mortgage, then this isn’t the figure that matters.

Let’s say you can afford a monthly payment of £750. You want to repay the mortgage over 25 years (so it’s not an interest-only loan, you own the house at the end of the term).

Let’s ignore the issue of the deposit for the moment and pretend it’s all mortgage, for the sake of illustration.

At an interest rate of just over 7.6%, that monthly payment will get you a £100,000 house. At an interest rate of around 3.5%, that monthly payment will get you a £150,000 house. And to be clear, assuming that you could fix the rate for the entire 25 years, this makes sense, because in both cases, you’re paying the same amount in the end – around £225,000.

That hopefully gives you a pretty clear illustration of how interest rates affect house prices. When the cost of debt goes down, the price of houses goes up, because the same monthly payment gets you a bigger loan, and that’s what you buy the house with.

So while the post-pandemic bounce would have been influenced by the stamp duty cut, the desire to flee the cities, the desire to move right back again, various government schemes to prop up housebuilders’ profits, etc etc – the main driver has been the fact that the pandemic provided another reason for the Bank of England to loosen monetary policy.

Will UK house prices crash soon?

OK, so we can establish that the monthly payment is what matters, and we know that if a given monthly payment will fetch you a bigger mortgage, then that’s going to push prices higher.

What’s the other important thing? It’s your ability to make that payment.

At this point you might think that the rising cost of living will be a problem here. That’s where I think you’re probably wrong. You have to remember that rent or mortgage payments are generally the bills that are prioritised above all others, because you lose the roof over your head if you don’t make them.

The reality is that people will a) borrow as much as the bank allows and b) do what they have to in order to make the payment that involves.

In most cases, the thing that stops people from making their mortgage payments is a catastrophic financial event, which for most of us, is losing your job and not being able to find another one.

So the other big variable that matters for average house prices is the level of unemployment. And right now, unemployment is very low.

In short, as long as people have jobs, they can make their mortgage payments. And while that’s the case, house prices will largely depend on how much debt that mortgage payment will buy you.

The obvious next question is: what does that mean for house prices from here? That of course is much harder to answer. Could the UK face a recession and thus rising unemployment this year? As I said earlier this week, I think that’s possible but it’s not a foregone conclusion.

What about interest rates? They could certainly go higher from here, but, as the Bank of England has already pointed out, there’s a real tug-of-war going on. Inflation is too high, but it’s the sort of inflation that threatens growth.

In short, there’s a great deal of uncertainty. I can see house prices flattening, certainly. But the other big factor is momentum. If I’m in the market for a house right now and I see prices rising at their fastest rate in nearly 20 years, does that make me more or less desperate to buy? I think the answer is that most buyers would feel a horrible sense of panic.

I do think this will all end in tears at some point, because something has to give.

And in the long run we need to sort out the housing market because this boom-bust cycle is exceptionally damaging to the economy and the amount of capital (both financial and intellectual) tied up in houses probably has some bearing on our productivity problems.

But I’m not sure I’d be betting on a big slide in prices happening this year.

If you’re buying a house to live in, this is all academic – to an extent. Your personal circumstances are far more critical to your decision than anyone’s opinion on where prices go next. I explained why here. 

Meanwhile, if you do have any thoughts on how the UK could fix its dysfunctional housing market, I’d love to hear them. I’m particularly interested in any evidence from other countries that appear to get this right (affordable housing with fewer economy-wrecking booms and busts).

Email us at editor@moneyweek.com with your take (by the way, I’ll assume you give me permission to quote your ideas – with your given name – in Money Morning unless you explicitly state otherwise).