The correlation between inflation and the housing market

Iain McKenzie, CEO of The Guild of Property Professionals, recently spoke to property market analyst and CEO of Twindig, Anthony Codling, about his views on the property market and what the data is telling us and whether we can expect a correction in the market.

Mentioning house price data Codling had presented at The Guild conference, McKenzie asked him what he thought we could see happening to house prices. “The data shows that since 1931, there have only been 16 years of house price decline, and every other year house prices have gone up,” says Codling. “This data would have included the second World War, and of course the global financial crisis where prices dropped by around 19%. Subsequently house prices have recovered and continued to climb. While we will see a slowdown in the rate at which we have seen prices increase over the past two years, and perhaps even a drop in prices, the housing market will remain robust and I doubt we will see any real correction in the market, a correction that many expected would happen for the last 25 years.”

McKenzie asks, given the current rising inflation rate and increase in interest rates, is there any correlation between this and transaction volume within the property market?  Pointing to the data, Codling says that looking purely at historical figures, there is no correlation between underlying bank rates and mortgages approvals, which is the huge lead indicator of housing transactions.  “When mortgage rates were at 15%, there were more mortgage approvals than there were during the pandemic. There is currently concern about the mortgage rates going up and they are going up, however, contrary to what people would think, there is so little relation between the cost of a mortgage and how many housing transactions there are,” he adds. 

If interest rates do not have as much of an impact on housing transactions as one would think, what does impact housing transaction volumes?  According to Codling, there are two aspects that influence and drive housing transactions, the first being the need to move. “In a normalised market, I would say that the need to move would account for around half the housing transactions. This would be people whose circumstances have changed because of a growing family or other factors that make their current living situation unsuitable for the needs. When these aspects come into play, it doesn’t matter what is happening in the broader economy, if you need to move, you move,” he comments. “The other half of the moves are aspirational moves. Factors influencing this kind of move could include a pay rise or wanting a different type of lifestyle. You are not forced to move but want to. I say these account for around half the moves because during the credit crunch, these are the moves that we lost in the market. People that didn’t have to move stayed put. The big difference is the motivation behind the move.”

Speaking to McKenzie about today’s market, Codling says that if inflation continues to rise as it has been, he believes that we could see the interest rate at around 2% by the end of the year. “The Bank of England said they could see the interest rate at 2.5% by mid-2023, which is in line with where our thoughts were when we put out our forecast in the beginning of the year. In terms of house prices, I think we will settle on 5% house price inflation for the year. They are currently higher than that, but I do think we will see some softening in the second half of the year as the cost-of-living increase starts to have an impact. As for transactions, I think we will be around the one million to 1.1 million mark, so more in line with the levels seen in 2019. Housing transactions levels remained remarkably stable during 2016, 2017, 2018 and 2019, all around the 1.1 million number, which currently seems to be the natural rate of transactions if there were such a thing given the current make up of the housing market.”

Codling says that while inflation will have many feeling the pinch and tightening their belts, it will ultimately have a positive impact on the housing market after a period of adjustment. “Looking at retail price index data going back to 1950, when overlaid with house price inflation, on average over those 72 years, the level of inflation has been approximately 5.3% and the average house price inflation has been 7.3%. What that tells me is that if there is inflation, house prices are more likely to go up, and more than inflation. There are several reasons why, but the main one is that inflation will feed through into pay rises. People will ask for more money, which will eventually feed through the economy. Mortgages are based on income level, so if your salary goes up, you can borrow more money and history shows us that people tend to borrow as much as they can, which feeds into the housing market,” Codling explains. “Inflation also reduces the value of your debt; in that it becomes a smaller percentage of your increasing wages. This means that inflation is actually good if you have a mortgage because that mortgage will get relatively smaller over time as salaries increase. If your house price is going up, your loan to value is going down, so you can get a better mortgage rate and you can borrow more money. Debt falls, assets price go up and you can borrow more,” he concludes.