As inflation rises, average house prices tend to increase with it. That’s why historically, property has been seen as a great way to hedge against it.
Whilst inflation diminishes the purchasing power of money, having assets such as property can mean that your purchasing power remains the same or even increases.
However, we’ve seen an exponential rise in house prices independent of the current inflation rates. The property market has been bullish since 2020, something that has continued well into this year, and it seems like current inflation levels are fueling the market even more.
To understand why this is, in this article, we’ll explore what house price inflation is, why it’s occurring, how current inflation levels are impacting the housing market, and whether property prices will fall later this year.
What is house price inflation?
The definition of inflation is that it’s a general increase in the prices of goods and services and a fall in the purchasing value of money. Essentially, this means that as the cost of goods goes up, your money is worth less as it can no longer buy as much as it once could. For instance, say 1 litre of milk costs £1.00 one year and then rises to £1.08 the following year; that’s an annual inflation rate of 8%. Your £1.00 is now worth less since it cannot buy you what it once could.
As it pertains to the property market, inflation drives up the cost of houses. As with goods and services, fewer and fewer people can afford properties due to the elevated house prices. If demand is still high, which it has been over the last two years especially, it is excellent news for sellers since they can squeeze as much money out of their homes as possible. On the other hand, this is terrible news for those looking to buy a property since they will now have to pay more than they typically would have. Also, it eliminates a large percentage of potential buyers, particularly first-time buyers, as the downpayment for the deposit is simply too high.
What is the average UK house price?
According to UK house price index data by Office for National Statistics (ONS), in March 2022, average house prices in the UK increased by 9.8% over the year. This means that the average UK home costs £278,000, a staggering £24,000 increase from the same period last year.
Wales saw the highest annual growth with 11.7%, resulting in an average house price of £206,000. Next is Northern Ireland, with a 10.4% increase, resulting in an average house price of £165,000. Following closely behind is England with 9.9%, resulting in an average house price of £298,000. Lastly, the lowest annual growth was seen in Scotland with 8%, resulting in an average house price of £181,000.
Whilst growth is still high, it does seem to be slowing down. UK house prices increased by 11.3% over the year in February 2022, but it now stands at 9.8%. This could mean that we are seeing a gradual decrease from the record growth we’ve experienced over the last two years.
Why is the average house price in the UK so high?
Average prices for UK properties have almost trebled since the turn of the 21st century. Whilst basic economics of supply and demand is the reason for this, there are numerous factors within that which have drastically influenced demand levels, particularly over the last two years.
Interest rates have been incredibly low for over a decade. On 5 March 2009, the Bank of England lowered the interest rate from 1.00% to 0.50%. It remained at this rate until August 2016, when it was reduced to 0.25%. After a brief increase over the following years, it was lowered to 0.25% at the onset of the 2020 pandemic in March 2020 and again to 0.10% a week later.
The record-low interest rate was introduced to offset the market crash in 2020 and to keep businesses afloat during the stringent government restrictions that were in place – e.g. lockdowns. The UK government was banking on the idea that low interest rates would encourage residents to borrow and spend money. It was seen as one of the main ways the UK economy was going to survive.
With interest rates so low, that’s precisely what happened. It meant that loans were now highly affordable, especially mortgages. In order to take advantage of these interest rates, we saw a surge in housing demand and, therefore, house purchases.
Interest rates stayed at 0.10% until 16 December 2021, when they increased to 0.25%. Interest rates have since increased a further three times, now standing at 1.00% in order to lower inflation. But since March 2020, more and more people have looked to capitalise on marginal interest rates which have raised demand and thus house prices. It partly explains why we have seen record-breaking highs in property prices over the last two years, something that has continued well into 2022.
Stamp Duty Land Tax Holiday
Perhaps the factor that impacted average house prices the most was the Stamp Duty Land Tax (SDLT) Holiday. The stamp duty holiday meant that for a property valued at £500,000 or less, and was bought before 1 July 2021, it would be exempt from paying stamp duty. To give an example of how much this would be, a property valued at £500,000 would have to pay £25,000 in stamp duty. In some areas of the UK, that amount could be the downpayment for a second property, and with savings that high, property buyers flocked to the market looking to cash in.
The stamp duty holiday was extended further to 30 September 2021, but this time it was only applicable to a house price of £250,000 or less. Even still, there was a rush to get deals finalised before these deadlines to take advantage of the stamp duty holiday. This is evident in HMRC data on the number of housing transactions leading up to both deadlines, which spiked average UK house prices.
‘Race for space’
The various stages of lockdowns imposed in the UK throughout the pandemic took a toll on many people. They were being forced to spend a significant amount of time confined to their homes which made people rethink their surroundings and what they valued. Increasingly, many people found that being locked away in a tiny apartment wasn’t what they wanted and began to look further away from cities in the search for more space – both inside and outside their homes.
Combined with many businesses having now gone to hybrid or fully remote working conditions, employees don’t need to be located in a city. They can work from home and, as such, spend their hard-earned money on a spacious property in the countryside as opposed to paying a premium for a smaller house or apartment in the city.
This shift in mentality has carried well into 2022 and has continued to raise prices throughout the country. The largest annual house price growth has been seen in the South East and South West of the country as it’s still a commutable distance to the centre of London. Significant annual growth has also been seen in the East Midlands.
These three factors – buyers bringing their timelines forward to take advantage of the stamp duty holiday, a surge in people moving out of cities for more space, and low-interest rates – led to a perfect storm that has propelled demand to record levels. Supply in the UK has always been limited, and the demand has eclipsed it in recent years due to the factors mentioned above. But, there is one more factor that is contributing to soaring house prices, inflation.
Why is inflation so high?
2022 has seen inflation rise significantly. Over the year inflation rate between April 2021 and April 2022 was 9%, the highest rate since records began in January 1989. There are a few reasons for this.
Currently, energy is the most significant contributor to inflation. The increase in the energy price cap, combined with oil and gas prices rising due to the Ukraine war, has seen gas prices jump by 53.5% and electricity prices jump by 95.5% over the last 12 months. In addition to this, food prices are up, the cost of raw materials is up, fuel prices are up, and water bills are rising. The cost of living has gone up drastically over the past year, and it doesn’t seem to be slowing down just yet.
Some experts are claiming that essentials such as food could rise up to as much as 15% this year. With these increases, it’s no surprise that the pound’s purchasing power is diminishing; £1 is simply not worth as much as it was a year ago.
What does this mean for annual house price inflation rates?
When it comes to properties, they are typically seen as an excellent asset to have during times of inflation because the home’s value will increase according to the inflation rate, particularly in the UK housing market where supply is low. If you took out a mortgage with a fixed interest rate over the last few years, you’d find that the value of your home has increased exponentially, but your payments are still relatively low. Essentially, you’ll be paying less for the loan than you did when you took it out since the house price has increased.
How can inflation be lowered?
To combat inflation, usually, the Bank of England simply raises the interest rate. The logic behind this is that borrowing money becomes much more expensive, and as a result, people will have less money to spend. Therefore, they’ll buy fewer things, and since the demand for items will decrease, the prices will stop climbing so fast.
Whilst this method usually works, it’s much less effective when the cause of inflation is due to global issues, such as the energy shortages related to the Ukraine war. Having said that, we’ve seen four increases in the interest rate since December 2021, and it is expected to increase further before the end of the calendar year.
Who measures the inflation rate in the UK?
The Office for National Statistics is responsible for measuring inflation in the UK. They have a “shopping basket” of items which is used to make up their consumer price inflation indices. These items that are used to determine current inflation rates are not fixed; they change year on year depending on consumer spending patterns. This ensures that the inflation rate measured is as accurate as possible.
Luckily, the ONS releases their inflation data every month which can help us compare inflation rates to the previous month and to the same time last year. The inflation rate for May has not yet been disclosed. However, April figures show that inflation rose from 7% to 9% over the previous month and 9% over the last 12 months.
Will house prices fall in 2022?
In the short term, it’s doubtful that the housing market will crash and lead to falling house prices. We are expected to continue seeing the upward trend we’ve experienced over the last few years. However, as interest rates are expected to increase and the cost of living rises, the growth rate will most likely decline. We should see the average price of a home begin to taper towards the end of the year.
In the long term, the average house price should continue to increase, but nowhere near the annual growth rates we’ve had since 2020. They are expected to plateau over the next 12 to 18 months, and some UK regions such as London could even see prices fall slightly.