UK: The cushion of very low mortgage rates to prevent a fall in house prices – CE

Long-term interest rates have risen sharply since the end of 2020 and may rise further, but that shouldn’t be a drag on the housing market. In fact, economists at Capital Markets think that mortgage rates will fall a little further in the medium-term, helping to ensure that the ongoing surge in house prices isn’t followed by a correction.

Rise in long-term interest rates won’t crash house prices

“Mortgage rates in the UK could fall a little further in the short-to-medium-term. Our proxy for banks’ funding costs in the UK, calculated from the interest paid on retail deposits and the rate at which banks borrow from wholesale funding markets, has fallen since the bank rate was cut from 0.75% to 0.10% in March 2020. But banks have not yet passed this reduction onto borrowers. Instead, they increased their interest margins as the pandemic hit to account for concerns around the outlook for the economy and house prices.”

“Higher long-term interest rates will weigh on the amount investors are willing to pay for houses as the rise in risk-free rates increases required rental yield. But this is unlikely to be a big drag. First, the private rented sector is predominantly made up of amateur landlords who are likely to value capital growth ahead of yield. Second, even if gilt yields continued to rise to 1.5% by end-2022 as we expect, that would leave them low by historical standards.”

“With our forecast that bank rate will remain at 0.10% until 2025, we suspect mortgage rates will drop a little further in the near term and stay low even if gilt yields continue to rise. Even so, we suspect the housing market will cool when the stamp duty holiday ends. But the cushion of very low mortgage rates should prevent a fall in prices.”