Observations on UK housing
We have been studying the drivers of UK housing market activity. Here are five observations.
House prices have held up despite interest rate rises
Inflationary pressures from the pandemic and Russia's invasion of Ukraine drove the Bank of England to raise interest rates to a peak of 5.25% in 2023. It has eased policy since but Bank Rate remains at 3.75%, well above levels in 2021. Yet, instead of falling, UK house prices have risen by 11% since late 2021. They haven't kept pace with inflation though, which has risen 24% over that period. But this is a better performance than after earlier episodes of rapid monetary tightening.
The fact that house prices have avoided outright declines is notable given the surge in mortgage rates and recent economic shocks. This relative resilience is down to several factors. The popularity of fixed-rate mortgages has delayed the impact of rate rises, tighter lending standards after the global financial crisis have meant borrowers are more resilient to shocks and a strong labour market has kept unemployment low and supported robust wage growth.
London has underperformed the rest of the UK
Housing markets in London and the south have underperformed the rest of the UK. London has been the worst hit, with house prices now 6% below the peak in late 2022, having lost over one-fifth of their value when accounting for inflation. The South East and South West of England have also underperformed in recent years, though the declines have not been as steep as in the capital.
Northern Ireland has been the best-performing UK nation or region, with house prices up by almost a third over the last five years. Its outperformance reflects relative affordability, with prices well below the UK average, limited supply and a strong labour market supporting demand.
London’s recent underperformance is tied to its stretched affordability, which makes buyers more sensitive to rising interest rates. Areas such as Kensington and Chelsea, known for their high-end properties popular among foreign investors, have been hit by the introduction of a stamp duty surcharge for overseas buyers, and the forthcoming High Value Council Tax Surcharge. House prices here are down by almost 25% since 2022.
Five million households still to refinance onto higher mortgage rates
As the Bank of England cut interest rates, mortgage rates had been falling gradually since 2024. But the outbreak of the war in Iran has meant markets expect higher inflation and, subsequently, higher interest rates. As a result, banks have raised mortgage rates, which jumped from an average 4% for a five-year fixed 75% loan-to-value deal before the war began to 4.6% now.
Higher mortgage rates and the lagged pass-through of earlier interest rate rises to household mortgage payments mean that an estimated five million households are set to refinance their mortgages onto higher rates by the end of 2028. However, for the average mortgagor rolling off a fixed rate in the next two years, monthly mortgage repayments are projected to increase by £45, significantly less than the median increase of £120 over the last few years.
Affordability has deteriorated
According to house price-to-income ratios, housing is now more affordable than at any time in the last ten years. The median house price to median earnings ratio was 7.6 in England and Wales last year, the lowest reading since 2015. With house prices rising by just 5% since the pandemic while average earnings are up by 25%, housing affordability seems on the rise.
Unfortunately, this analysis doesn’t account for higher mortgage rates and is, therefore, misleading. The ultra-low interest rate environment preceding the pandemic helped keep mortgage rates and monthly repayments low (and housing affordable), despite rising house prices. With the end of the easy-money era, two and five-year mortgage rates hover above 4.5% today, compared to 2% or less five years ago. Looking at average mortgage repayments as a share of income reveals that affordability has weakened significantly, to its lowest level in 18 years.
Housebuilding activity remains weak
The S&P Global purchasing managers’ indices for construction show that housebuilding activity has been contracting for much of the last four years, reflecting weak demand and cost pressures. Housebuilders have seen sharp rises in building costs, driven by higher energy and other raw material prices, costlier building regulations and skills shortages. Alongside that, higher mortgage rates have crimped demand.
The failure of housing supply to keep pace with a growing population is the root cause of the UK’s housing issues. The government’s pledge to build more new homes is an important step towards addressing this but the backdrop for housebuilding remains a difficult one.
Chart of the week
US ‘hyperscalers’ are forecast to invest $750bn in AI infrastructure this year, an 83% rise from 2025. The Economist estimates that they will be spending 40% of their revenues on capex this year, exceeding spending by oil majors in the US shale boom or the telecoms industry during the dotcom bubble. This, coupled with the delayed returns from these investments, has led analysts to sharply lower their expectations of hyperscalers’ free cash flows over the next year. These tech majors have gone from being some of the world’s biggest accumulators of cash to dipping into existing reserves or issuing debt to fund their AI buildouts.
Meanwhile, free cash flow expectations for the firms making chips, a crucial component of the AI buildout, have almost quadrupled from two years ago. This huge transfer of cash from the buyers to the sellers of AI infrastructure is the reason why stocks issued by the latter outperformed big tech equities in the first half of the year.
While the majority of AI investment has been backed by cash so far, US tech majors are increasingly tapping debt markets for funding. Bloomberg reports that the top AI hyperscalers are twice as indebted now than they were five years ago. Investor demand for these corporate bonds remains strong but surging issuance has significantly raised their spread over benchmark rates.
What we're looking out for this week?
On Thursday, the Office for National Statistics will release its GDP growth estimate for the UK economy in June. Although monthly GDP data can be choppy and are prone to revisions, Thursday’s release will allow us to assess underlying momentum and growth across the second quarter. Economists expect a month-on-month contraction of 0.1% in June resulting in growth of 0.4% in the second quarter. This would mark a slowdown in quarterly activity but growth would still have come in line with the UK’s long-term trend. We expect a further slowing in the second half of the year though, as the full impact of the war in Iran feeds through to inflation, weighing on business and consumer sentiment.
US inflation data for July is also out this week. Economists expect an annual inflation rate of 3.4%, marginally lower than June’s reading but much higher than the Federal Reserve’s 2% target. Last week’s weaker-than-expected jobs numbers prompted traders to scale back bets on the Fed raising interest rates but an upside surprise on inflation could raise expectations of a hawkish response.
And finally...
Underwater divers recently discovered an unopened, original Guinness bottle dating back to 1864 in a ship wreckage off the English Coast. Scientists are hoping to analyse the bottle’s contents, which may still be drinkable, in the hope of producing an authentic recreation of the original recipe – st-out of the blue