Unlike the last couple of years, this time around we have the luxury of forecasting with a relatively stable political and macroeconomic backdrop. The recent history of the cost of living crisis and growing mortgage costs appears to be behind us. Inflation has fallen back to target, the Bank of England has begun to cut the base rate and we have a new UK government with a large majority. Maybe D:Ream were right, and things can only get better. With less external noise, house prices in the medium term will be dictated by the fundamentals of demand, supply and affordability.

Drop the base

Key to that equation is the path of the base rate. This has been the most important factor driving buyer decision-making over the last two years, and that will continue to be the case in the next few years. Mortgage rates have fallen in 2024 on the expectation that base rate cuts will continue over the coming months. These lower rates have decreased monthly mortgage costs and have fed through into improved confidence amongst prospective buyers, prompting the moderate price growth we have seen in 2024 so far.

Oxford Economics expect a continued decline in the base rate over the next three years, at a pace of 25 bps per quarter. This will mean gradually decreasing headline mortgage rates and a steady improvement in affordability. With that, we expect price growth to gain momentum. Growth will peak in 2026 at 5.5%, when mortgage rates have fallen by a more substantial amount, and will continue at relatively high levels in 2027 as rates fall further.

By the end of 2027, Oxford Economics predict that the base rate will have plateaued at a long term neutral rate of 2%. But the previous years of strong growth will create increasing affordability challenges, and so house price growth is likely to slow, and will fall roughly in line with earnings growth by 2029 at around 3%. This leaves us with a five-year growth figure of 23.4%. For context, across the post-pandemic boom and then the more recent drop in prices, the five years to September 2024 have seen 23.6% growth, although we can expect a smoother ride to a similar figure over the next five years.

What does that mean for affordability?

The chart below looks at how the combination of price growth and falling mortgage rates influences affordability for the average household looking to buy the average house. Towards the second half of our forecast window, we expect households to be spending a similar proportion of their income on housing as they did in the middle of the 2010s.

Changes to regulation mean that stress-tested affordability will improve quite substantially, making it easier for buyers to get around affordability tests. But price growth will be contained by tests on loan-to-income (LTI) ratios instead, which have limited room to increase by the end of our forecast window – another reason to suggest that price growth will fall in line with income growth. 

The limited headroom on these tests will also mean that the ability to raise a deposit to supplement the amount you can borrow will remain a crucial barrier to buying a home. First-time buyers used an average deposit of £57,000 in the UK in Q1 2024 according to the Regulated Mortgage Survey, and in London that figure was as high as £139,000. This hurdle seems insurmountable for many households, and will place an upper limit on the amount by which prices can grow.

Keeping it real

While house prices are now -2.3% below their August 2022 peak on a nominal basis, in real terms they have fallen by -10.5% over this period, according to Nationwide and the ONS. In fact, real house prices are now at the same level as they were in 2015, and are lower than they were between 2005 and 2007. With inflation back around target, our forecast involves a return to real house price growth in the order of 11% over the next five years. This will bring real prices back to the level they were just before the mini-budget in September 2022, but below the peaks of real prices seen in early 2022 and 2007.

Interest rate sensitivities

Of the variables we consider, our modelling is most sensitive to the interest rate assumption we put in. There are a number of risks around the path of interest rates which cannot be reflected in the fixed set of assumptions in our central forecast scenario. While Oxford Economics think the neutral interest rate is 2%, the long term base rate forecast by other economists, as well as the rate implied by financial markets, is higher. We have learned the hard way how the market’s view on government policy can influence interest rates in the short and medium term. And an escalation of conflict in the Middle East and increased tension between China, Russia and the US are top of a list of further geopolitical risks.

In the table below, we have shown how changing our mortgage rate assumption would impact affordability, measured by the proportion of income the average household would spend buying the average house. For example, if the average mortgage rate ends 2029 at 3.5%, for affordability to fall to the same point as in our central scenario, price growth would have to be limited to around 10% over the next five years. With the same level of price growth, affordability would be considerably worse than the pre-pandemic level. A materialisation of one or more of these risk factors therefore has the potential to stifle what is otherwise a relatively positive outlook for price growth over the next five years.