Monetary tightening will hit house prices

With the Bank of England threatening to raise UK interest rates soon and US mortgage rates edging up as the Fed starts to taper its bond purchases, what will rising rates do to house prices? I think we should expect house price inflation to slow considerably, but prices are unlikely to fall outright in the near term, even though they are getting expensive.


That’s because, despite tough talk, central banks will move fairly slowly and also because it is still a little too early for the housing cycle to end. House price cycles typically last around 16-18 years and it is only 15 years since the last peak in the US and only 14 years for the UK. So, we are nearly there but probably not quite, especially in the UK.


Housing inflation has been driven by low rates

In July I posted two blogs discussing how Covid and low interest rates have driven a strong house price boom in most developed countries. Since then, house prices have continued to rise strongly in the US, up around 5% in just the last 3 months, and more modestly in the UK, up about 1.5% in the last 3 months.


With rates seemingly set to rise, housing will be under pressure. But rates are rising because of a recovering economy, falling unemployment and rising wages and prices. So, the net effect is unlikely to be a sudden fall in house prices. Rather it will show up as a slower pace of increase, at least at first, depending of course on how much rates rise.


Central banks are still saying that they expect current high inflation to be transitory, falling back in 2022-3. But they are worried that there could be some stickiness to it, particularly if wage inflation takes off too. That’s why they want to move now, to influence people’s expectations and make sure people realise that the Central Banks are on the case.


But they don’t want economic growth to slow abruptly, since unemployment is still well above 2019 levels in both the US and UK. So I don’t expect central banks to start talking of deliberately slowing growth in order to deal with high inflation. If we started to hear that sort of rhetoric then home-buyers should get scared. A small rise in mortgage rates, which is what I expect over the coming year, does make a difference at the margin when people look at what they can afford but it shouldn’t bring an outright slump in prices.


The 18-year cycle

As I discussed in the blogs in July there is international evidence for a cycle in house prices lasting around 16-18 years. In the UK there were peaks in 1973, 1989 and 2007 (16 and 18 years spacing them) while US peaks occurred in 1989 and 2006 (17 years). If we project 16-18 years from the most recent peaks we get to 2022-4 for the US and 2023-25 for the UK.

It seems plausible to me that interest rates will trend up in the next few years, moving very slowly and cautiously at first, but leading to rising mortgage rates over time. If so, it is easy to imagine that house prices will indeed be peaking out in the next few years. The US cycle is likely to end first, with the UK a year behind.


The peak of a housing cycle usually occurs 1-2 years before the wider economic cycle turns down. It often plays a role in bringing the downturn by causing a slump in house-building. In 2008 of course it brought a financial crisis too. At the moment there is little sign of over-exuberant lending and banks capital ratios are much stronger than before. So a financial crisis is not in sight, at least so far.


That said, watch for late-cycle exuberance. In the US house prices peaked in the summer of 2006 and, as we all know, it was the sub-prime lending boom that caused much of the trouble. But sub-prime lending was minimal until well into 2004 so it really was only in the last 2 years of the cycle that the frenzy came to a head. One to watch.