Will the flagging housing market tip us into recession?

It takes more than 18 months for the full force of rate rises to hit the economy – and a year and a half ago, interest rates were only 0.75 per cent. There is a lot more monetary tightening yet to pass through, and the housing market is already feeling the impact. 

Average mortgage rates have risen from a low of 1.3 per cent two years ago to over 5 per cent, worsening an already bad affordability picture for would-be borrowers. Analysts at consultancy BuiltPlace point out that they are also still “facing all the preexisting issues around the cost of buying (big deposits, higher incomes etc)”. As a result, activity has stalled. 

Although house prices have fallen by around 5 per cent from their post-pandemic peak – and more than double that if you adjust for rising earnings – it has not been enough to counteract higher lending rates. As the chart shows, latest mortgage approvals are a third lower than they were a year ago, marking the worst September since 2008. Sales are down by a less severe 17 per cent on last year, thanks to cash buyers cushioning the impact. 

BuiltPlace analysts note that thanks to rigorous stress-testing, borrowers have limited ability to stretch repayments further. This means that “far fewer people are able or willing to buy at current price levels” – though this is not for lack of trying. Mortgage holders have tried to ease the squeeze of higher rates by extending the period over which they are repaying their mortgages (through terms of up to 40 years) and switching to interest-only deals. But the Bank of England’s Financial Policy Committee (FPC) fears that “while this eases pressure for these households in the short-term, it could result in higher debt burdens in the future”. 

The good news is that though the housing market has weakened, it still looks strong by historical standards. The FPC expects the proportion of income spent on mortgage payments to increase next year, but expects it to remain below the peak reached on the eve of the global financial crisis. While the number of homeowners who are behind in paying their mortgages has risen modestly, the proportion also remains low by past standards.

The worse news is that a weak housing market can still hurt the economy in a multitude of ways. When the market stalls, house building activity slows, as does spending on loft conversions and extensions. This so-called ‘residential investment’ has already fallen by 7 per cent since its peak in the third quarter of 2022. Ashley Webb, UK economist at Capital Economics, expects it to drop by the same amount again as housing completions drop by almost 10 per cent by the first quarter of 2024. 

And this will weigh directly on the economy: furniture, carpet and appliance sales all depend on the number of people moving house. It could be easy to dismiss this as spending on fripperies, but it packs a very real economic punch. Capital’s Webb calculates that lower spending on household goods has already stripped 0.2 percentage points from real GDP since the start of last year. 

Then there's the wealth effect to contend with, the idea that falling house prices leave homeowners feeling worse off, triggering lower consumption. There is lively debate among economists about the magnitude of the impact, but even a conservative estimate suggests that falling housing wealth has reduced spending by £15bn already. Webb calculates that this has already shaved 0.5 percentage points off real GDP, with another 0.4 percentage points expected by Q1 2024. 

According to his calculations, the weaker housing market itself has taken 1.1 percentage points off real GDP since the start of 2022. His forecasts imply that it will take off another 0.9 percentage points over the next three quarters – hugely significant as the UK treads a fine line between expansion and contraction . We will avoid a housing market induced economic crisis. We might not avoid a housing market induced recession.