Above all other things, the speed at which the cost of mortgage debt falls and housing affordability pressures ease holds the key to house price movements over the next five years. 

Slightly more downward pressure on prices in the short term

Even though it appears we have hit the peak of the interest rate cycle at a bank base rate of 5.25%, the first cuts in interest rates still look someway off. That means heightened affordability pressures are likely to result in further house price falls over the first half of 2024. A peak-to-trough house price adjustment of in the order of -10% still looks like it is on the cards, albeit occurring over a longer period than we anticipated during late 2022. However, the worst is certainly behind us, with -7% of falls forecast expected to have materialised by the end of 2023.

Turning points and gradual acceleration

The point at which the Bank of England has the economic capacity to start cutting rates will be an important milestone for the market.

We expect the market to bottom out mid-way through 2024 as mortgage rates start to ease in anticipation of a base rate cut later in the year. Although affordability is only likely to improve gradually, it should buoy buyer confidence and allow the first shoots of recovery to appear. But with the prospect of a general election in late 2024, we only expect that to translate into a return of modest price growth from 2025 onwards. 

The expectation of a gradual reduction in bank base rate (and a corresponding improvement in mortgage affordability) over the forecast period suggests a steady, step-by-step recovery in buyer demand and a progressive restoration of buying power. So we expect growth to accelerate as affordability pressures ease. The strongest price growth is pencilled in for 2027 when rates reach their long-term neutral level and buyers are at their most positive. From there we would expect a return to more modest levels of price growth, as some of this exuberance dissipates.

In a nutshell, that explains the shape and scale of our house price projections. But for those of you who hanker for a bit more detail, there’s more, much more.

The technical bit: home buyers affordability

Despite the easing cost of debt over our forecast period, the market will remain constrained by affordability. 

Our model looks at affordability for the average household buying the average house. 

More recently this affordability model has been complicated by mortgage regulation, which requires us to look at both “underlying affordability” and what it looks like when mandatory stress tests are applied by lenders.

As the chart shows, the sharp increase in mortgage costs quickly eroded the excess affordability that prevailed during a period of ultra-low interest rates; before pushing it into stretched territory.

Where does that leave us?

“Stress-tested affordability” is currently on a par with “underlying affordability” seen at the peak of the market in 2007. But, regulatory changes made by the Bank of England in August of last year have prevented that “stress-tested affordability” from hitting the extremes of the early 1990s. 

By the end of our forecast period, stress-tested affordability is expected to be back at the levels of the mid-1990s and late 2000s, after previous market corrections. 

This will also allow for some normalisation in the length of mortgage terms. The average term length of mortgages have seen a step change of late, given the specific affordability pressures faced by buyers, but this is expected to ease as the cost of mortgage debt falls.

Impact on cash buyers and investors 

Of course, market demand is not just determined by mortgaged owner-occupiers. In theory, cash buyers do not need to worry about the cost of debt, however, they do not act entirely in isolation from the rest of the market, remaining sensitive to market sentiment.

Investors also need consideration. Demand from mortgaged buy-to-let investors is likely to remain heavily suppressed over the next 12 months. Why? Because in the prevailing interest rate environment, making a reasonable cash profit relies on having a low or no mortgage requirement. 

While a gradual fall in interest rates is likely to ease that situation, the prospect of a more heavily regulated private rented sector is likely to temper demand from private individuals, acting as an overall drag on buyer demand and meaning pricing is more dependent on the owner-occupied market than at any time in the past 25 years.

Economic and Political Sensitivities

As ever, our forecasts reflect a fixed set of economic assumptions. Of all of the variables, our affordability model is most sensitive to interest rate assumptions, which in turn are dependent on where inflation sits relative to the Bank of England’s 2% target. In the current geopolitical environment, this carries a higher degree of uncertainty than normal, particularly given recent disruption in the Middle East. 

We are mindful that the Bank of England, the markets and the economists, shifted their inflation expectations from “transitory” to “sticky” over the course of 2022 and 2023, as they watched the situation unfold. That provided us with a useful reminder of the need to consider different economic scenarios. The infographic below shows our expectations for prices and activity based on different rates, reminding us that if bank base rates aren’t cut as aggressively as projected, there will be less capacity for price growth.

From a political perspective, in arriving at our forecasts we have been mindful of the prospect of a general election in late 2024 or early 2025, which we expect to inhibit any recovery in the second half of 2024.

The domestic policy environment following the general election has the potential to impact the outlook for the market. In this respect, the political focus on housebuilding (in terms of how much, of what type of housing, is built where), has the potential to affect prices over the longer term. Short-term impacts are more likely from more direct policies that stimulate or suppress demand from different buyer groups such as first-time buyers and buy-to-let investors. In this respect, our forecasts only reflect current policy and the potential impact of existing policy proposals.