House prices will crash by 25 percent if interest rates keep rising with higher borrowing costs sparking the greatest drop in wealth since World War Two, a think tank has said. Rising interest rates have caused household wealth across Britain to fall by £2.1trillion over the past year, according to the Resolution Foundation.
It says there will be winners, mostly among younger generations, and losers if higher rates are sustained, according to the new analysis published on Monday.
The Bank of England raised its base rate from 4.4 percent to 5 percent last month with some expecting a further rise when the central bank’s Monetary Policy Committee meets again on August 3.
If higher rates are the norm, then the house to price earnings ratio could fall from last year’s peak of 8.9 to 5.6, which would represent a low not seen for 20 years. This could mean house prices fall in cash terms by about 25 percent over five years, the latest analysis shows.
The Resolution Foundation’s Peaked Interest? report, which is part of a partnership with abrdn Financial Fairness Trust, examines the impact of rising interest rates on household wealth and what a “new normal” of higher rates might mean for living standards and wealth accumulation.
It comes as the average price tag on a home coming to market fell by £905 or 0.2 percent month-on-month in July, according to a property website.
Rightmove said rising mortgage rates are now biting with house sales lagging behind the more “normal” market seen before the Covid pandemic in 2019.
The Resolution Foundation report notes that the UK has seen an unprecedented wealth boom in recent decades, with total household wealth rising from around 300 percent of national income in the 1980s, to 840 percent (£17.5tn) by 2021.
But the Bank of England’s rapid rate-rising cycle since late 2021 has caused mortgage rates to rise, house prices to fall and the price of government and corporate bonds to nosedive.
Plummeting bond prices have reduced the measured value of pension assets, largely in DB schemes or already in payment, normally the biggest single source of household wealth in Britain.
The Foundation’s estimates suggest total household wealth fell to 650 percent of national income in early 2023 – a cash fall of £2.1tn over the past year and the biggest fall as a share of gross domestic product (GDP) since World War Two.
The Resolution Foundation says if higher rates remain, it could drive further falls in wealth to around 550 percent of GDP, ending a 40-year long wealth boom which has been a key driver of inequality between the generations.
Surging house prices and pension values have largely benefited older generations with many young people locked out of home ownership altogether, according to the think tank.
The foundation adds that in the pre-pandemic world, a typical worker would need to save around £5,000 a year to achieve an income in retirement worth two-thirds of their income prior to retiring.
But under today’s higher interest rates, the same worker would need to save around £3,000 to achieve the same standard of living in retirement – making it easier for younger cohorts to save sufficiently to enjoy decent living standards in old age.
The authors warn, however, that millions of people are still not saving enough for retirement and minimum contribution rates into pension schemes still need to rise, but by much less than in a low-interest-rate environment.
Ian Mulheirn, Research Associate at the Resolution Foundation, said: “Over the past four decades wealth has soared across Britain, even when wages and incomes have stagnated. But rapid interest rate rises have ended this boom and brought about the biggest fall in wealth since the war, of £2.1tn.
“Those with significant mortgages will be hit by these major changes. But there are winners too from a shift to a world of higher rates and lower wealth.
“Higher returns will make it far easier for younger people to save for a pension that delivers a decent standard of living in retirement, while lower house prices will make it easier for younger generations to get on the property ladder and others looking to trade up.
“The future path of interest rates is very uncertain. The current surge could be a blip, or herald a new era for the UK. Either way, policymakers should focus more on whether and how to insulate households from wild swings in their fortunes from these forces well beyond their control.”
Mubin Haq, Chief Executive of abrdn Financial Fairness Trust, said: “The short-term pain of higher interest rates for mortgage holders could also mean a longer-term gain for young people hoping to buy their own homes and saving for their pensions.
“Both become more affordable and allow for a fairer sharing of wealth. In these turbulent times, when assets have tended to be held by older generations, we may see rising interest rates reversing the growth in wealth gaps Britain has seen over recent decades.”
