London house prices fall for first time in 8 years

• London weakest performing region for first time since 2005
• With house prices down 0.6% year-on-year
• UK annual house price growth stable at 2.0% in September

Nationwide’s Chief Economist analyses the Society’s latest house price data and considers what any potential rise in interest rates would have on households.

​The annual rate of house price growth remained broadly stable in September at 2.0%, compared with 2.1% in August.

Housing market activity, as measured by the number of housing transactions and mortgage approvals, has strengthened a little in recent months, though remains relatively subdued by historic standards.

Low mortgage rates and healthy rates of employment growth are providing some support for demand, but this is being partly offset by pressure on household incomes, which appear to be weighing on confidence. The lack of homes on the market is providing ongoing support to prices.

House price growth rates across the UK have converged in recent quarters. Annual growth rates in the south of England have moderated towards those prevailing in the rest of the country. London has seen a particularly marked slowdown, with prices falling in annual terms for the first time in eight years, albeit by a modest 0.6%. Consequently, London was the weakest performing region for the first time since 2005.

At its September meeting, the Bank of England’s Monetary Policy Committee (MPC) signalled that, if the economy evolves broadly in line with its expectations, an interest rate increase is likely in the months ahead. This would be the first increase in the Bank Rate since July 2007. 

Clearly, much will depend on how the economy evolves, but most economists and financial market pricing suggest that a small rise of 0.25% is likely at the MPC’s next meeting in November, which would take Bank Rate to 0.5%.

We would expect a modest rise in Bank Rate, by itself, to have only a modest impact on economic activity. Indeed, if rates are raised to 0.5%, monetary policy settings will still be a little more supportive than they were before Bank Rate was lowered to 0.25% in August 2016.

This is because the MPC is unlikely to reverse the other measures it put in place last year to support credit availability in the wider economy (such as the additional purchases of government and corporate bonds, which have helped to keep longer term borrowing costs low). Moreover, the MPC has signalled that it expects any increase in interest rates to be gradual and limited. Indeed, financial market pricing suggests that Bank Rate is only likely to rise by around one percentage point (to 1.25%) over the next five years.

Providing the economy does not weaken further, the impact of a small rise in interest rates on UK households is likely to be modest.

This is partly because the proportion of borrowers directly impacted will be smaller than in the past. In recent years the vast majority of new mortgages have been extended on fixed interest rates.

The share of outstanding mortgages on variable interest rates (and which are therefore likely to see an increase in payments if Bank Rate is increased) has fallen to its lowest level on record, at c40%, down from a peak of 70% in 2001.

Moreover, a 0.25% increase in rates is likely to have a modest impact on most borrowers who are on variable rates. For example, on the average mortgage, an increase of 0.25% would increase monthly payments by £15 to £665 (equivalent to £180 per year).

That’s not to say that the rise will be welcome news for many borrowers. Household budgets are already under pressure from the fact that wages have not been rising as fast as the cost of living. Indeed, in real terms (i.e. after adjusting for inflation) wage rates are still at levels prevailing in 2005.

Moreover, some households already have a relatively high debt service burden. For example, the English Housing Survey suggests that around 12% of households already spend over 30% of their gross income on their mortgage each month . For these households, some of which will be on variable rates, the rise will be a struggle, even though the impact on the wider economy and most households is likely to be modest.

A first increase in interest rates for ten years will be welcomed by savers, though it is likely to provide limited relief. An increase in Bank Rate will not be passed on to all savings accounts (for example, we estimate that around 15% of balances are on fixed rates) and, even where the rise is passed on in full, rates will remain low by historic standards.