How far could UK house prices fall as interest rates rise?

Over the past decade, UK house prices have surged higher, supported by low interest rates and easy credit conditions. However, now the Bank of England has declared war against inflation, the outlook for property values is starting to become more uncertain.  

The central bank has hiked interest rates to 1.75% from the pandemic low of 0.1%, and it looks as if further increases are on the horizon. There’s even talk of a bumper 0.75% increase when policymakers next meet in the middle of September.  

So far, house prices have shrugged off higher borrowing rates, but a number of experts tell MoneyWeek that it’s only a matter of time before prices begin to reflect the darkening economic outlook.  

The latest data shows prices are still rising  

The latest data by Halifax published today shows that UK house prices rose 11.5% on an annualised basis in the year to August 2022, only slightly lower than July’s annual figure, which was 11.8%.  

On a monthly basis, house prices rose 0.4% with the average UK house price hitting £294,260. 

Forecasts from the Bank of England suggest the economy will move into a recession later this year as rising energy prices and the cost of living crisis crimp consumer income. 

This puts the central bank in a bit of a difficult position. Conventional economics say it should be decreasing rates to ease credit conditions and stimulate spending with the chances of a recession growing. However, with inflation taking off, it has little choice but to push rates higher.  

And the interest rate is by far one of the most important factors in determining the future direction of house prices.  

So judging by just interest rates, the direction of travel is clear: mortgage borrowing is getting more expensive. That will certainly weigh on UK house prices. Add in the threat of a recession, and the outlook for house prices is far from clear.  

How UK house prices fared during previous recessions  

“During the recession in 2008, according to Nationwide, house prices on average dropped by around 16% while during the recession in the early 90s house prices dropped by as much as 20%”, Karen Noye, mortgage expert at Quilter, tells MoneyWeek. 

And according to Kunal Sawhney, chief executive of independent global equities firm Kalkine Group, UK average house prices fell as much as 21% during the recession after the 2008 crisis, with the steepest percentage falls recorded in southern England.  

The UK housing market peaked after the pandemic, due to a host of reasons and partly because people had extra disposable incomes and reassessed their housing preferences, with some wanting to move to bigger homes as hybrid working became more common.  

“The busts of the late 1980s and 2000s also witnessed price booms like the one recently faced,” Sawhney adds.  

A report by Risk Concern, an investment strategy and risk analysis company, analysed how much UK house prices fall in a recession. 

The report, which analysed six recessions between 1970 and 2020, found that in a worst case scenario UK house prices crash about 20.4% in real terms, and 7% in nominal terms. The best case scenario saw a 1.92% appreciation in real terms, or a 9.5% increase in house prices in nominal terms.  

Crash or slowdown?  

Kevin Mountford, co-founder and financial expert at Raisin, tells MoneyWeek that increased interest rates should see UK house prices “slow down”, though the general consensus is that UK house prices would still be around 3%-5% higher by the end of 2022 as demand for homes remains buoyant. 

But he notes that there was already an 11.5% “reduction in product availability” in August compared to July as mortgage lenders reviewed the higher interest rate and inflationary environment. 

“With the recession alarms ringing for 2023, the housing market is expected to face a long-term phase of stagnation, and it may take several years to recover from such a downturn, as per the country’s past experiences”, Sawhney says.  

He expects UK house prices to rise by 8% in 2022 and then slow down to 1% in 2023.  

But according to Noye, not all recessions have the same ramifications for UK house prices. “Not all recessions play out the same way though and other factors such as how much housing stock there is will determine how far house prices will drop when we enter the next recession.” 

She reckons that while higher rates will send thousands of borrowers who aren’t on long fixed rate mortgages scrambling to find new deals, low stock of housing means falls in UK house prices could be muted despite the higher interest-rate environment.  

“This could really cool down the market but with so little stock out there and still a potentially big demand house prices may stagnate rather than drop, remaining at this level or moderately dropping only a few percentage points,” says Noye.  

But higher mortgage repossessions is another factor that could weigh on UK house prices. According to Quilter, higher interest rates will lead to a greater number of repossessions as people struggle to meet their mortgage payments and make ends meet.  

“This could have a material impact on house prices as once these repossessed houses are put back on the market by lenders it would naturally push prices down as it becomes a buyer’s market where there is more stock than demand,” Noye says.