Many of the events that we are experiencing in 2022 are unprecedented in every sense: political, social, and economic. The global economy is in turmoil. How will this affect the UK property market? We share our thoughts in this article.
In recent months, we have seen an unfolding inflation shock around the world, which has arisen due to a combination of several factors:
- The breakdown of international supply chains caused by Covid-19 and the unsynchronized anti-COVID measures in different countries. It was aggravated by the internal problems of production in China.
- Rising fuel, energy and other resources prices due to the war in Ukraine.
- The monetary expansion made by Central Banks to support the population and economies during the pandemic. The Bank of England, the US Federal Reserve, European Central Bank cut interest rates to their all-time minimum in 2020. Governments were giving money directly to households, building up public debt.
In the UK, Brexit became another such factor. As a result, annual inflation (expressed by the consumer price index) in June reached here an unprecedented value since 1989 of 9.4% and turned out to be the highest among the G7 countries.
The danger of inflation is that it can become self-reinforcing and persist even if the initial factors that triggered it have disappeared. If the economy is based on services (and 75% of the British economy services, including financial services), then the main component of rising prices is wages. Inflationary expectations lead to an increase in wages, which generates an increase in costs, which leads to an increase in prices, and so on.
Does this mean that inflation cannot be stopped? Not really. People’s actions in anticipation of a recession have a self-regulating effect on inflation. They start borrowing less and spending less. Purchasing power goes down, demand goes down. On the one hand, all this in itself leads to a recession, on the other hand, it reduces inflation and thereby reduces the scale of the coming fall in the economy. Commodity markets, anticipating a decrease in demand, adjust prices in advance. We are seeing this in the current cycle: in July, commodity prices on world markets, which have been peaking since March, fell to the level of February 2022. The price of Brent crude fell to $95/bbl for the first time since February.
How does this affect property prices?
The combination of high inflation and recession is called stagflation. Economists have already encountered it in the 70s and 80s of the 20th century, and, in general, understand how to deal with it. The first thing central banks do to curb inflation is to raise interest rates. The Bank of England raised its base rate for banks to 1.25% in June. And banks, in turn, raise mortgage rates for the population. In the UK, the mortgage rate is usually fixed for a period of no more than 2-5 years, and then either is changed to a new one through a remortgage or becomes variable. Therefore, unlike in the US where the mortgage interest rate is usually fixed for the life of the loan, the British are more vulnerable to raising rates. This relatively quickly affects the size of monthly payments and directly reduces the demand for real estate. Reduced demand leads to slower growth or lower prices.
But is it a slowdown in price growth or a decline? To answer this question, let’s look at the labour market. Since the 70s of the last century, there have been only three occasions when house prices in the UK have fallen (in 1982, 1991-1993 and 2008-2009). And in each of these cases, there was a surge in unemployment. With no source of income, people could no longer pay their mortgages and were forced to sell their houses. These periods also corresponded to periods of recession in the British economy. Now unemployment in the UK is only 3.8% – the lowest in the last 45 years. This year, it has fallen to pre-pandemic levels, while the number of open vacancies, on the contrary, has grown and reached a record 1.3 million. So, if we consider high unemployment as a predictor of falling property prices, then nothing threatens prices now.
In addition, falling property prices are usually the result of a recession. A recession is the state of the economy when it contracts for two consecutive quarters. There are no signs of it in the UK yet. In June, data that came out pointed to the unexpected fall in British GDP in March and April, and many experts started saying that recession is already around the corner. But since then, ONS has corrected its figures – so that the fall was in February (by 0.1%) and in April (by 0.2%), but in May, GDP again grew by 0.5%. From this point of view, there are no prerequisites for an early sharp drop in real estate prices either. And even during periods of recession, property prices in the UK were falling for a maximum of three years and then bounced back again.
The main answer to the question of why price increases have persisted over the past decades lies in the imbalance of supply and demand. We continue to observe a shortage of quality properties on the market, and despite the growth in construction in recent years, there are no signs of its imminent decline. According to Zoopla, in May, the number of those wishing to buy houses and apartments was 61% more than the average for the past five years, and the number of properties for sale was, on the contrary, 37% fewer. Even in the event of a recession, real estate prices do not necessarily have to fall: during a recession, industrial production and construction are reduced, and this, in turn, maintains a shortage of property supply.
Summing up, we expect prices to slow down rather than decline. In periods of high inflation, there are no good solutions for increasing your capital. The stock market falls, and the money stored “under the mattress” is eaten away by inflation. Investing in real estate remains almost the only way to keep your savings. This problem is especially acute for those who are renting: the rents in London this year increased even more than inflation. Therefore, we advise our clients not to postpone the purchase in the hope of a quick fall in prices. If your life circumstances require you to move or to switch renting a home to home ownership, take action and go ahead according to the initial plan.
Published 22 July 2022
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