In the aftermath of the Bank of England’s Stress Test conducted in September last year, a bleak scenario emerged, painting a picture of house prices plunging by a third, interest rates soaring to 6%, inflation surging to 17%, and the economy spiraling into a deep recession. The stress test aimed to assess the resilience of the UK’s largest banks in the face of a severe economic crisis characterized by escalating inflation and plummeting property values.
However, it is crucial to note that the stress test scenario was not a projection of what was likely to occur in the economy, but rather an annual exercise aimed at identifying potential weaknesses within the banking system that could endanger the country’s financial stability.
Since then, the Bank of England’s rate-rising cycle, initiated at the end of 2021, has continued unabated. The consequence has been an increase in mortgage rates, a decline in house prices, and a significant drop in the value of government and corporate bonds.
While inflation remains a pressing concern, the rate of price increases has subsided to 8.7%. Nonetheless, certain food items, including bread, cereal, and chocolate, continue to experience high inflation at 18.3%.
Interestingly, while overall inflation has followed a general downward trajectory this year, core CPI inflation rose to 7.1% in May, up from 6.8% in April, marking the highest level since 1992.
In an effort to curb escalating prices, the Bank of England has raised interest rates 13 times, bringing them to 5%, with further increases anticipated.
The adverse economic conditions have undoubtedly impacted house prices, which have witnessed a decline in recent months. However, they have not experienced the drastic one-third reduction in value. Nevertheless, according to The Resolution Foundation, if interest rates continue to rise, the decline could become steeper.
The thinktank warns that residential property prices could plummet by 25% if the Bank of England persists in hiking the base rate. The prediction by The Resolution Foundation aligns with the forecasts of some economists, who anticipate another surge when the bank’s Monetary Policy Committee convenes in early August.
In a newly published report, titled “The Peaked Interest?” and part of a collaboration with abrdn Financial Fairness Trust, The Resolution Foundation examines the impact of rising interest rates on household wealth and explores the potential ramifications of a “new normal” characterized by higher rates for living standards.
The report suggests that the house-to-price earnings ratio could decline from its peak of 8.9 in the previous year to 5.6, a level not witnessed in approximately two decades. This decrease would likely lead to a roughly 25% decline in house prices over a five-year period in cash terms.
The research highlights the unprecedented wealth surge the UK has experienced in recent decades, with total household wealth soaring from approximately 300% of national income in the 1980s to 840% (around £17.5tn) by 2021.
Ian Mulheirn, a research associate at the Resolution Foundation, emphasized the significant changes in wealth dynamics, stating, “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, amounting to £2.1tn.”
Mulheirn noted that those burdened with substantial mortgages would bear the brunt of these major changes. However, he also acknowledged that a shift to a world of higher rates and lower wealth could create winners as well. Younger generations could benefit from higher returns, making it easier to save for a pension that ensures a decent standard of living in retirement. Moreover, lower house prices could facilitate entry into the property market for younger individuals and those seeking to upgrade their homes.
The future trajectory of interest rates remains uncertain. The current surge may be a temporary phenomenon or herald a new era for the UK. In either case, policymakers should prioritize examining ways to safeguard households from the volatile fluctuations in their fortunes resulting from these forces beyond their control, Mulheirn asserted.
Mubin Haq, the chief executive of abrdn Financial Fairness Trust, added his perspective, stating, “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.”
Haq also highlighted the potential reversal of wealth disparities in Britain, which have predominantly favored older generations during these turbulent times. The rising interest rates may bring about a shift in wealth gaps witnessed in recent decades.