Inflation, interest rates and housing: is this 2022 all over again?

Hansen Lu, Aviva’s Senior Economist, looks at how the Iran war is feeding into inflation, rates and the housing market, and what that means for financial advisers.

Iran war is a new energy shock, but it’s not a repeat of 2022

The Iran conflict has created new headwinds for the UK. Mortgage rates have ticked up over the last month, with the best buy rate on a 2-year 75% LTV fixed rate loan reaching around 4.7%. That was a 0.75% to 1% rise since February. There were also tentative signs that buyers have become more cautious, with the RICS measure of buyer enquiries dipping in March.

Still, the wider picture does not look like a repeat of 2022. Economic growth is weaker now, the labour market cooler, and there is no post-Covid burst of pent-up demand. Energy costs, especially gas prices, also remain far below their last peak. As a result, forecasters expect inflation to reach maybe 3% to 4%, well below the 11% peak around four years ago.

This fairly modest inflation outlook has held back interest rate expectations, limiting the impact on both house purchase mortgage rates and the later life lending market. 

Housing will probably be resilient to what’s coming

The housing market is also in a better place than it was four years ago. Wages have been rising faster than house prices for some time, meaning the house price to earnings ratio is far less stretched than it was four years ago.

As a result, the market can probably absorb the rise in rates seen so far, and likely a bit more, before the risks to house prices become material. So looking ahead, this looks to be a fairly subdued year for housing, with higher mortgage rates weighing on the market. But conditions aren’t in place to trigger a material fall in house prices.

This current outlook depends on the shock fading soon

The main caveat is that the relatively benign view of the economy, interest rates and housing market depends on the current energy shock easing over the next few months. This reflects both markets’ and most forecasters’ expectations.

But this outlook is not guaranteed. In the months ahead we could see the war escalate, drag on for significantly longer than assumed or throw up unexpected downstream impacts on inflation. In those scenarios, rates could end up higher than expected, negatively affecting both the mortgage market and later life lending prices.

This matters especially for later life lending, where the risks look asymmetric. If the shock fades, rates should settle down and the outlook changes only a little. But if it drags on, advisers and borrowers could face a mix of higher rates and weaker house prices at the same time.

Conclusions

Overall, despite serious headlines about the risks facing the UK economy, the housing market is heading towards a fairly subdued year, but not a dramatic decline. Of course, the latest shock has clearly made conditions more difficult. But if markets are right that the crisis will ease over the next few months, the wider damage can stay fairly contained.

To find out more, visit our Equity Release web page or you can call us on 0800 015 4909.