- BoE report suggests that the UK banking system could withstand a 30 per cent house price drop
- Nationally, the financial system looks resilient, but regional impacts matter
The Bank of England’s Financial Policy Committee (FPC) recently stress-tested major UK banks. Their ‘severe’ scenario was the stuff of economic nightmares: unemployment increasing to 8.5 per cent, inflation rising to 17 per cent, and house prices falling by almost a third.
Fortunately, they found that "the UK banking system would continue to be resilient, and be able to support households and businesses" even under this worst-case scenario. Equally pleasingly, the latest data suggests that we should avoid this kind of economic horror show: inflation figures were a (relatively) pleasant surprise at 7.9 per cent last month and unemployment a still-fairly-measly 4 per cent.
House prices look far more resilient than the FPC’s severe scenario, too. The latest ONS house price index showed that the average UK house price is now £286,000 – £6,000 higher than 12 months ago, but £7,000 below the recent peak in September (see chart).
Andrew Wishart, senior property economist at Capital Economics, thinks house prices could fall a further 8 per cent. “With mortgage rates set to stay at their current level of close to 6 per cent until next summer, buyers will be able to afford much less than in the past. This will reduce their budgets and in turn house prices significantly”, he said. The FPC judges that although the proportion of income UK households spend on mortgage payments will rise, it should still remain below the peaks experienced in the financial crisis and the early 1990s.
One reason is the prevalence of fixed-rate mortgages, which cushion the impact of higher borrowing rates. The FPC also thinks that responsible lending requirements introduced in 2014 have increased ‘borrower resilience’.
The committee calculates that almost 90 per cent of the stock of owner-occupier mortgages are below a 75 per cent loan-to-value, “helping to provide a sizable buffer against significant house price falls”. At a national level, it looks as though the UK economy is well placed to withstand a house price drop.
But are we missing a trick? Interest rates may be determined at a national level, but house prices are a decidedly local affair: it seems logical to suspect that the impact of higher interest rates might vary across different areas.
As a result, economists think that London could take the biggest hit. The shift to remote working has changed patterns of demand: where employees were once forced to live in close proximity to work, they can now consider more affordable areas. As a result, Wishart thinks that we will find that “buyer demand in the capital falls more sharply than elsewhere”. London also has the highest share of rental homes in any region, and Wishart anticipates that we may see a larger increase in home sales as landlords sell up.
He expects average house prices to fall by 13 per cent from peak to trough in London – the largest drop of any region.
Research from Bank of England economist Danny Walker suggests that differences in regional housing supply could also impact how house prices respond to higher mortgage rates. Using data on house prices and monetary policy announcements since the 1990s, Walker found that areas of England with greater constraints on housing supply face bigger falls in prices when interest rates rise.
According to his model, Islington (where more than 96 per cent of developable land has been developed) would face a house price drop 30 percentage points greater than Northumberland (where only 1.4 per cent has been developed) in response to a 1 percentage point increase in interest rates. Walker adds that today there is “already tentative evidence that prices in London are weaker than elsewhere”.
This all has important implications for policymakers. The impact of higher interest rates on mortgages and the knock-on impacts on house prices are a key ‘transmission mechanism’ of monetary policy.
The beleaguered central bank already has to weigh the risk of overtightening against the risk of waiting for existing rate hikes to feed through to the real economy. If the impact of these hikes varies across different regions of UK, it faces an even more intense policy headache.
