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Soaring UK property prices are due to low interest rates, not lack of housing supply, Bank of England finds

‘Sustained, dramatic, and consistently unexpected decline’ in rates has driven property values sky-high

Ben Chapman
Monday 23 December 2019 16:21 GMT
Property values could plunge by one-fifth if interest rates rise by just 1 percentage point for a sustained period, bank says
Property values could plunge by one-fifth if interest rates rise by just 1 percentage point for a sustained period, bank says (Reuters)

Soaring house prices over the past four decades have been caused largely by low interest rates, not by a lack of supply of homes, research by the Bank of England has found.

A paper by two economists at the bank found that falling real interest rates have been responsible for the majority of the rise in prices of homes.

“Nearly all of the rise in average house prices relative to incomes can be seen as a result of a sustained, dramatic, and consistently unexpected, decline in real interest rates,” the researchers wrote.

This leaves the UK exposed to significant falls in house prices when interest rates rise and mortgage debt becomes more expensive.

Average house prices could plunge by one-fifth if there is an unexpected interest rate rise of 1 percentage point which is then is sustained over several years, the Bank of England forecasts.

Average property prices have quadrupled in the past 40 years, leaving many people struggling to save enough for a deposit.

Other countries have also experienced rapid house price inflation as mortgage lending has expanded but prices in the UK have risen faster than in any other advanced industrialised nation.

Real, inflation-adjusted house prices are 3.5 times higher on average in the UK than they were in 1980 whereas prices in Germany and Japan have barely changed, while in France they have doubled. Only Canada comes close to the UK, with a threefold increase in average property prices.

House prices in the UK have also risen substantially faster than incomes. Average house prices are now almost twice as high relative to a measure of average household disposable income as they were 40 years ago.

Chronic undersupply of housing in the UK has frequently been blamed for pushing up prices but David Miles and Victoria Monro at the Bank of England found this has not been a significant driver.

Instead it is the abundant supply of cheap credit that has accounted for most of the change. The researchers compared house prices, which have risen sharply, with rents, which have remained relatively stable compared to incomes.

They concluded that if the main cause of rising prices was lack of properties then rents would also have increased sharply – but this has not happened.

According to the bank, UK homeowners currently have a record £1.6 trillion of outstanding home loans.

The latest research suggests the property market would be vulnerable to sustained interest rate increases – despite the "stress tests" that loan applicants take to estimate whether they could afford rising monthly mortgage payments in the event that interest rates go up.

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