As the UK economy teeters on the brink of recession, finances stretched, many people are asking, “should I sell my house during a recession”. Unfortunately, there is no simple answer to this question. It will depend upon several factors, many of which will be exclusive to the homeowners involved while others are more economy-related. However, while the current situation is challenging, to say the least, it is crucial to understand why the UK economy is under so much pressure.

Ultimately, the UK housing market is intrinsically linked to the UK economy. You will see governments announcing huge financial packages to support the economy during times of recession. As your home is integral to your finances, the sector has and continues to attract massive levels of government support. The housing market is critical whether this is help for first-time buyers, deferred mortgage payments during the covered pandemic, or regular tweaks in stamp duty rates.

We will now take a closer look at the current economic climate. What impacts growth in gross domestic product (GDP) and the short, medium and long-term impact on the housing market.

UK economy

When looking at UK economic statistics, such as growth in GDP, it is essential to recognise a lag. For example, the full effect of the increase in energy prices will take some time to filter through into the economy. Therefore, as you can see below, at first glance, it looks as though the UK economy is rebounding after the Covid pandemic. However, the ongoing situation is highly challenging and there is no short term fix.

Source: https://www.ons.gov.uk/economy/grossdomesticproductgdp/timeseries/ihyr/ukea

The Bank of England recently confirmed that the UK economy contracted by 0.3% in April, greater than the 0.1% reduction in March. Initial estimates suggest that the economy grew by 0.8% in the first three months of 2022, but the rest of the year will be challenging. The Organisation for Economic Co-Operation and Development (OECD) believes the UK economy will grow by around 3.6% in 2022, falling to nil growth in 2023. While the British Chambers of Commerce is a little more optimistic, suggesting growth of 0.6% in 2023, rising to 1.2% in 2024. Whatever happens, these are depressing figures!

There are many factors which are impacting UK economic growth in the short to medium-term. So when asking the question, should I sell my house during a recession, it is essential to be aware of the broader scenario.

What is inflation?

In basic terms, inflation is a measure of change in the cost of living over a period of time, reflected by the change in the cost of an average basket of goods/services. The Bank of England has come under massive pressure over a perceived failure to react to the worsening inflationary environment towards the end of 2021. The following graph shows three indicators which monitor inflation:-

1. CPI (Consumer Price Index)
2. CPIH (Consumer Price Index including owner-occupier’s Housing costs)
3. OOH (Occupiers’ Housing costs)

The CPI figure is the more widely used inflationary measure as it strips out rent and other owner-occupier housing costs. This figure measures the increase in the price of goods/services, i.e. the cost of living.

Source:-
https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/may2022

Records show the UK has been on the brink of negative inflation during 2015/16 and 2020/21. During the last decade, it has fluctuated between 0% and 2.5%. This is because the Bank of England has an official inflation target of 2%, deemed “healthy” for the economy. This allows an ongoing increase in the cost of products/services, which filters through to wages and general household income.

How does inflation impact households?

An inflation rate above 2% is potentially damaging to the economy as it can be difficult for household income to keep pace. For example, a 5% inflation rate would see a product/service increase from £100 to £105 over 12 months. If there was no increase in your household income (wages) over the same period, your relative spending power is reduced, and you would have a £5 shortfall.

If this situation were to continue for the next five years, the cost of the product/service would increase from £100-£127.63. Consequently, over five years, you would experience a 27.63% relative reduction in your spending power, a £27.63 shortfall in funds available, compared to the cost of the product/service. In this scenario there is an element of compound interest as a simple £5 increase per year would only take the price up to £125. The additional increase of £2.63 is similar to compound interest, an annual 5% increase but on the ever increasing cost. This is how inflation can eat away at the economy!

Why is UK inflation so high at the moment?

In theory, this is a relatively simple question, but it can be highly complex in practice. The initial increase in inflation in 2021 was related to:-

1. Increased consumer spending in the immediate aftermath of the worst of the Covid pandemic
2. Supply chain issues, predominantly caused by the Covid pandemic, saw an increase in the cost of raw materials, leading to a rise in the price of goods/services
3. Demand for a reduced pool of skilled employees led to increased wage inflation, which also filtered through to the cost of goods/services and consumer spending

Many experts predicted that a spike in the inflation rate would be short-term and rectified when supply chain issues were resolved. Then we saw the conflict between Ukraine and Russia, which disrupted the supply of gas and oil worldwide. This ongoing conflict prompted a large increase in energy prices. In April, the UK energy price cap increased by 53.5% for gas and 95.5% for electricity, with further increases expected later in 2022.

Even though the UK government has made significant funds available to address the problem of energy price increases, this has decimated household discretionary spending. Households are now diverting funds from other areas of their budget to address rising energy costs. Many industries have also seen a considerable increase in their bills, forcing them to increase the price of goods/services. This feeds the monster that is inflation, prompting employees and unions to demand substantial wage rises to keep pace with inflation/the cost of living. The vicious circle begins!

Forecasts for inflation

The headline annual inflation figure in the UK increased from 9% in April to 9.1% in May, the highest rate for 40 years. This means that the cost of living has increased by 9.1% over the last year. As if this was not bad enough, the Bank of England has constantly been increasing expectations for inflation. Way off the mark with historic estimates, the Bank’s reputation has suffered. Currently, the Bank of England MPC expects inflation to peak at 11% towards the end of 2022. While unlikely to remain in double digits for too long, inflation will remain relatively high.

Even though several tools/levers are available to the Bank of England to combat inflation, the base rate (otherwise known as the official bank rate) is the most basic and practical.

Base rates

The following graph shows changes in the UK base rate over the last decade. As you will see, the base rate was relatively low in the aftermath of the 2008 US mortgage crisis and the initial stages of the Covid pandemic.

Source:-
https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp

The Bank of England and central banks worldwide were forced to retain low base rates to fund economic recovery. As the interest rate for loans, mortgages and other financial arrangements is directly linked to the base rate, this ensured cheap finance was available. This encouraged consumers to borrow and spend, supporting the economy and fuelling the bounce back from the short-term economic hit when Covid arrived.

In a perfect world, the Bank of England would have maintained base rates at relatively low levels. This would have encouraged a more robust economic recovery. Then they would have introduced a gradual increase based on a relatively strong economy. In this scenario, an increase in GDP would also positively impact wages, therefore neutralising/reducing the impact of increased interest rates on credit card, loan and mortgage repayments. But unfortunately, the Ukraine conflict has blown this plan out of the water!

Tackling inflation before the economy

We now have the double whammy of an increase in the cost of debt and a relative reduction in household income due to the economic downturn. In December 2021, the Bank of England increased the base rate from 0.10% to 0.25%, the first move since March 2020. There was an increase to 0.50% in February 2022, 0.75% in March, 1% in May and 1.25% in June. Some members of the Bank of England MPC, who collectively set monetary policy, had been calling for a 0.5% increase in June. Across the pond, the US Federal Reserve is taking a much tougher approach to interest rates. This is likely to put pressure on the Bank of England to go bigger and bolder with future interest rates increases.

Experts predict that UK base rates could touch 3.5% over the next two years, significantly increasing the cost of debt and variable rate debt repayments. The immediate focus on bringing down the inflation rate by reducing consumer spending comes at the expense of economic growth.

Household incomes

In what could become something of a vicious circle, household incomes will come under increasing pressure from 2022. With the increase in inflation unlikely to be matched by wage increases, relative spending power will fall dramatically. In addition, the massive increase in energy costs means that more funds will be directed to this area. This will leave less to acquire goods and services, thereby reducing economic activity/growth.

In a frightening knock-on effect, this will reduce business profits, see cost-cutting and also prompt a rise in unemployment. This would further pressure consumer spending and economic growth, creating another vicious circle.

Unemployment

UK unemployment rate is expected to increase from 4.15% in 2022 to 4.6% in 2023 and 4.9% in 2024, according to The Global Economy website. While this still compares favourably to the average of 6.9% between 1980 and forecasts for 2027, it will impact short term economic growth. However, this does not fully represent the considerable impact of the cost of living crisis in the UK.

Impact on the housing market

Before we look at the impact the expected economic downturn will have on the UK property market, we need context. The following graph shows the annual rate of growth in house prices between 2006 and April 2022:-

Source:-
https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/housepriceindex/april2022

The UK housing market remains an integral part of the UK economy with considerable influence on monetary policy. ONS data shows annual house price growth between March 2022 and April 2022, increased from 9.7% to 12.4%. According to the Land Registry, the average UK house price now stands at a staggering £281,000. This is an increase of £31,000 over the last 12 months. However, akin to economic influences, there will be a lag between the economic downturn and the impact on property prices. Consequently, the full impact on the UK property market may not be felt for some time to come.

Mortgage rates

It is fair to say that the UK housing market has benefited from historically low base rates. This has dragged down mortgage rates to attractive levels. If, as expected, UK base rates reach near 3.5% over the next two years, this will significantly increase mortgage rates/repayments. While the strict mortgage affordability test, brought in after the 2008 US mortgage crisis, included several stress tests, an increase in the base rate will still stretch many budgets.

Over the last 12 months, we have seen significant demand for mortgages and remortgages. First-time buyers have also been looking to take advantage of lower rates before the expected increase in the base rate. Unfortunately, this programme of planned staggered increases has been speeded up somewhat due to record-high inflation. Consequently, expect mortgage rates to mirror base rate movements in the short to medium term.

Bizarrely, while the Bank of England encouraged financial regulators to bring in the strict mortgage affordability test in the aftermath of the 2008 US mortgage crisis, this will be removed in August 2022. Surely, as the UK economy faces a possible recession, the regulator should be taking the lead on responsible lending?

Demand for houses

Fuelled by relatively cheap mortgage finance, many people are still chasing house prices higher. However, we recently saw the first monthly fall in the rate of house price growth for 11 months. Many experts believe demand will tail off much quicker in the short to medium term. A fall in the number of buyers, and increase in the number of sellers does not create the perfect scenario. So what are the short to medium-term expectations for the UK property market?

Forecast house price growth

Property giant Savills recently published a report covering UK house price growth over the next five years. House price growth forecasts for the period are as follows:-

These figures are somewhat disappointing compared to more recent double-digit house price growth. However, Savills have a relatively positive view of GDP growth, base rates and inflation in the short term. Consequently, these figures may soon be under pressure. Unfortunately for homeowners, these are some of the more optimistic forecasts in the market!

What does the future hold for the housing market?

Historically, UK house prices have been one of the best performing investment assets in the longer term. As the UK population grows, this long-term demand for property will continue, but there will be short-term challenges. At the moment, there are several factors to consider, such as:-

1. An increase in base rates will increase mortgage rates and debt repayments
2. Inflation is eating away at consumer purchasing power, putting household budgets under pressure
3. Pressure on household budgets will see a fall in consumer spending, leading to a fall in economic growth
4. High energy prices placing continued pressure on household budgets, with many families struggling
5. Reduced economic activity will increase unemployment and home repossession numbers
6. As the economy downturns, experts predict a fall in the number of home buyers and more sellers emerging
7. An imbalance between buyers and sellers will significantly reduce upward pressure on house prices

While many will bring Brexit into the mix, this is a different conversation that includes many other factors. We know the UK economy is weakening, inflation is eating away at household budgets and mortgage rates are set to increase. This does not bode well for property prices in the short to medium term.

Conclusion

There is no simple answer when people ask, should I sell my house during a recession. On the one hand, the UK property market has attracted strong support in the longer term and impressive annual returns. But, on the other hand, in recent times, we have seen historically low base rates, fuelling cheap debt, which many may struggle to repay due to a prolonged cost of living crisis. Consequently, we will almost certainly see a short-term reduction in demand for UK properties, an increase in the number of houses for sale and a fall in mortgage applications. At best, this will remove any froth from the market. However, at worst, it could tip UK house price growth into negative territory.

In truth, while UK house prices have performed incredibly well in the longer term. In the short-term, as a consequence of the many challenges, the only price guarantee is the price today.

Update:-

Today the Bank of England published its quarterly review of the UK economy. There was significant focus on the housing market. In a move that surprised many, the Bank also re-installed a “counter cyclical capital buffer”. This will see banks put aside 2% of their capital over the next year. Equating to £22 billion, this will be used to help stretched businesses/individuals navigate their way through the economic challenges ahead.

Interestingly, the Bank of England also confirmed that around 80% of UK mortgages are currently on relatively low fixed-rate deals. Even though 40% of these mortgages are up for refinancing over the next 18 months, the Bank believes that mortgage holders will be able to afford higher repayments. This is certainly a more positive picture of the UK mortgage market than many experts are painting.