Skip to main content

Fourteen years since the collapse of Lehman Brothers and the implementation of austerity, the memory of the 2007-2008 global financial crisis remains vivid. The spike in mortgage rates after the announcement of Liz Truss’ mini-Budget this September would not normally constitute a major concern. However, it came at a time when house prices were already in decline and inflation was steadily rising.

As the availability of mortgages falls and mortgage rates are expected to exceed 6%, this raises some concerns over the government’s control of the situation. So far, the Bank of England remains confident in its focus on inflation targeting and rules out a repeat of the 2008 scenario as improbable. Taking the current government’s commitment to expenditure cuts into consideration, the “wait and see” approach appears a coherent option.

While a significant part of the UK economy suffered severe losses during the COVID-19 pandemic, the housing market was on the rise. Since the beginning of the pandemic, prices increased by 25% across the country. Part of this growth came from the temporary Stamp Duty cut. This trend has since reversed, with prices this June declining to May levels.

This shift can be plausibly attributed to the cost-of-living crisis and rising energy prices, both of which have put pressure on the demand for houses. As everyday spending increases, mortgage repayments have become increasingly unaffordable. Therefore, customers are less keen to purchase houses, contributing to a slowdown in demand. 

Indeed, some estimates suggest that we can expect a 10% fall in house prices over the next two years. Similar concerns are expressed by other market stakeholders and analysts, with Oxford Economics projecting a 30% collapse in house prices. A fall within the 10-30% range will not only constitute the biggest drop in house prices in fifteen years but will also come worryingly close to the 18% decline during the global financial crisis of 2007-2008. 

The government has several established fiscal policies to shore up demand in the housing market. It is worth considering the two that the Chancellor updated in his recent budget. First, house demand can be incentivised with the Stamp Duty easing. Second, the Support for Mortgage Interest scheme may help the most vulnerable to meet their mortgage repayments obligations.

The former has proven to be effective during the pandemic. The current policy that got prolonged in the Autumn Statement exempts buyers from Stamp Duty for deals under £250,000. This allows more people to afford house purchases. However, increasing the threshold further does not seem like a coherent solution to the current decline. Giving up this source of the tax revenue goes against the fiscal responsibility endorsed by the new Government.  

Under the Support for Mortgage Interest scheme (SMI), the government provides financial assistance towards interest rate payments on mortgages and house-related loans. The scheme has, however, limited capacity to influence broader economic trends. Although the Autumn Statement has relaxed eligibility restrictions, SMI is only available to those already claiming social benefits. Therefore, the scheme appears more as a measure to protect the most vulnerable during a crisis than restoring the house demand per se. 

A monetary response to the rise in house prices would be to indirectly lower mortgage rates, which are tied to the Bank of England (BoE) interest rate. Currently, as the BoE sets the interest rate higher to fight inflation, this puts upward pressure on mortgage rates. The BoE could reduce or at least freeze the interest rate. As inflation climbs higher, however, this policy is highly unlikely to materialise. 

In its report on the Financial Policy Committee meeting this October, the BoE has clearly prioritised inflation targeting over housing market stability. Although the BoE recognises the vulnerabilities of UK households’ debt, it believes that establishing control over inflation is the most comprehensive long-term solution to the current crisis. When inflation is under control, the interest rate can be decreased, pushing mortgage rates down. 

This seems justified. In comparison with the years before the global financial crisis, lenders are better capitalised and are restricted in the use of repossessions. Therefore, a sharp fall in house prices should not trigger a broader crisis. It is noteworthy that the BoE does nonetheless take the danger of a market collapse seriously. The BoE is ready to increase the countercyclical capital buffer rate for banks if the situation escalates. 

What this tells us is that the government and the BoE are constrained in their response. Both fiscal and monetary solutions conflict with broader economic objectives. The government will, therefore, likely allow house prices to decrease. The expectation is that the housing market will follow the national economy’s path and stabilise when inflation and growth are back to normal. If the government follows the situation closely and acts promptly when needed, this seems like the least worst option.

Mikhail Korneev is a Research Assistant at Bright Blue. Views expressed in this article are those of the author, not necessarily those of Bright Blue. [Image: Jac Alexandru]