What stagflation means for the UK housing market

The Bank of England’s (BoE) latest forecasts suggest a rather gloomy near-term outlook for the UK economy. While medium-term forecasts have been upgraded slightly, economists at the central bank now expect GDP to grow by 0.75 per cent in 2025, half the rate predicted in November. They think that inflation will rise to 3.5 per cent by the end of the year, up from 2.75 per cent in their November projections. The diagnosis is clear: the UK is facing stagflation. But what does this mean for the housing market?

Previous episodes of stagflation have been associated with soaring joblessness. In the 1970s, unemployment rose to double-digit levels as inflation surged above 20 per cent. This is bad news for house prices: high unemployment reduces the number of new buyers and increases the risk of forced sales as mortgage holders fail to keep up with repayments.

But the UK labour market should be in far better shape this year. The BoE expects employment to reach 4.5 per cent – a marginal increase on last year’s projections, but still close to what economists consider the ‘equilibrium’ rate. According to the BoE’s latest Financial Stability Report, the share of households that are behind with their mortgage payments also remains low by historical standards, despite higher interest rates.

The combination of slow growth and above-target inflation makes it hard to predict the BoE’s next move. Could rate-setters look through rising inflation and focus on the disappointing outlook for growth? Or will the Monetary Policy Committee find it hard to justify more rate cuts if the inflation rate heads towards 4 per cent? 

We do know that lower interest rates are already feeding into housing market figures. Monthly mortgage approvals have risen since the start of 2023, and are now slightly above their pre-pandemic average. The BoE thinks that the recovery is partly down to the decrease in mortgage rates over the past 18 months. 

But in another sense, whether the BoE makes two or three cuts this year matters very little to most mortgage holders. Thanks to fixed-rate deals, most mortgagors do not have ‘real time’ exposure to changes in the base rate.

This chart from the BoE’s Financial Stability Report shows that if interest rates fall as markets expect, far more households will see their monthly repayments rise over the next three years than fall. Although rates are lower than they were, households rolling off cheap deals secured before 2022 will still face an increase in repayments.

From next month, meanwhile, the zero-rate stamp duty band will halve from £250,000 to £125,000, while the nil-rate band for first-time buyers will fall back to £300,000. Estimates from Zoopla suggest that the proportion of first-time buyers paying stamp duty will double from 20 to 40 per cent as a result. We can expect to see a flurry of activity from first-time buyers until then, but it will probably tail off. Forecasters expect modest increases in house prices over the course of the year. 

We tend to focus on house price data, but it is worth noting that the BoE also measures something called ‘housing investment’. This tracks new dwellings, home improvements and spending on services associated with buying and selling property. And compared with November forecasts, the BoE has significantly downgraded its projections for housing investment growth, chopping it from 3.5 to 0.5 per cent. This contributed to the BoE’s more pessimistic forecast for overall GDP growth. 

The downgrade is driven by fewer households undertaking housing renovations and modest figures for home repair and maintenance. Even if stagflation doesn’t drag too much on house prices, the combination of slow growth and rising unemployment fears will dampen demand for big renovation jobs this year. It is natural to focus on house prices, but we shouldn’t overlook the industries that the market supports.