What happens to house prices during inflation?

We’re heading into a period of dramatic inflation, and we don’t know how long it’s going to last. We’ve already seen UK mortgage interest rates going up, and they’ll probably go up more unless things change. Right now the cost of living is rising at the fastest rate for 40 years, with prices 9.9% higher in August 2022 than they were at the same time in 2021. If you’re wondering what happens to house prices during inflation, it’s a very wise question – and it’s an extremely important thing to understand when you’re about to invest in a home of your own. Read on to find out all about house price rises in an inflation-led economic landscape. By the end of this article you’ll know whether or not you’re willing to take the risk now, or would prefer to wait until things settle down.  

What is inflation?

Inflation is the increase in something’s price over time. Inflation happens naturally over long stretches of time. In 1969, for example, people earned a lot less than they do now, but things were also a lot cheaper. A three bed terraced home in an ordinary town in the north east of England cost around £3000. Fifty years later it’s more like £150,000. But inflation can also be a runaway phenomenon, caused by economic mismanagement and unexpected events.

Inflation affects more or less everything, from the most expensive to the cheapest goods and services. And that includes house prices. The cost of everyday basics like food goes up, as it is right now. The price of a simple loaf of bread has gone up 14% since 2017, for example.

There’s a relationship between higher interest rates and inflation. As a rule the government harnesses higher interest rates as a policy response to rising inflation. When inflation falls and economic growth slows, the Bank of England often lowers interest rates to stimulate spending.  

What causes inflation?

Low inflation is good for the economy, while too much inflation means serious problems. So what causes inflation? Inflation reflects broad price increases throughout the economy, measured by statistical experts who compare today’s prices to the past. Analysts talk about the percentage change that reflects the change in our purchasing power. Here’s how it happens.

First, there’s demand led inflation, where the demand for goods and services shoots up but the supply doesn’t change. Shortages mean people are happy to pay more, so prices increase. Cost-led inflation is different. There’s an increase in demand and it drives up prices, but because the cost of making the goods also goes up, you get something called ‘cost-push inflation’. You can see it happening at the moment as spiralling energy prices push manufacturing costs sky high. The same happens when the cost of labour goes up across the board.

Currency devaluation happens when a currency loses value in comparison to others, like our own pound at the moment. This makes imports more expensive, which drives price inflation. And while some say wage rises push prices up, most experts strongly disagree that better wages push prices higher. Minimum wage increases in the past haven’t led to higher inflation. In fact inflation can fall because businesses might hire fewer people. Or businesses might see better productivity levels, simply because people are happier at work.

What’s been happening in the UK recently? The Bank of England governor blames Russia’s war on Ukraine first and foremost, but economists have added high oil and gas prices, petrol and diesel prices, food prices, the cost of used cars, big increases in the costs of raw materials, household goods, and furniture, and the hospitality sector. Higher interest rates are also impacting mortgage payments, making them more expensive. And Brexit is having an ongoing impact, making UK inflation worse than the rest of the EU. The official data reveals how Brexit alone has pushed up UK inflation by 2.9%.

How much has UK inflation increased in 2022? According to the Office for National Statistics low fat milk has gone up 40.4%. Butter is up 29.5%. Flour is up 28.2%. And cheese is up 21%. Wages aren’t keeping up. While pay rose 5.2% in the three months to July 2022, high inflation means people have actually seen their pay drop by 2.8% in real life.   

How does inflation impact house prices?

Most of the time houses behave like any other ‘product’ when there’s inflation. They tend to increase by the rate of inflation, as does the amount you’ll need to save up as a deposit.

Rising inflation means slower house price growth. It can also make it more of a challenge to find a mortgage. If you feel confident you can afford a higher mortgage rate, you can still buy. It might even be the best time to buy since a slow market where demand has fallen tends to send house prices down. As you can see it’s a balancing act between the inflation itself, which sends prices up, and inflation’s ultimate downward effect on house prices when it suppresses demand.

Let’s look at it another way. Housing is a good asset when inflation is high, partly because the value of a house will rise along with the inflation rate, partly because it is a ‘leveraged’ asset. If your interest rate doesn’t change, the value of the property can go up while your repayments stay the same. And if you have a fixed-rate mortgage, you’ll end up paying less for the loan than you were paying back when you took it out.

Is inflation good for homeowners or sellers?

For homeowners, inflation affects the value of long-term mortgages, which can decrease, leaving you having to pay less. At the same time a variable rate mortgage can dramatically go up, leaving you with enormous repayments. As a result house prices will go up, and house values can massively increase. 

How does inflation impact buyers? It boosts the number of properties coming onto the market. The price of houses increases, leaving fewer buyers in the market, which means buyers have more wriggle room and less competition.

Can you take advantage of inflation?

Now you know exactly what happens to house prices during inflation. Even if inflation is high, an oversupply of homes for sale reduces prices. If mortgage rates get too high, people won’t apply for loans. Demand will decrease, house prices will fall. Can you take advantage of the current situation, with inflation at an all-time high, or will you be better off leaving your decision until the economy has cooled back down and looks like it might be steadier? Whatever you decide, we can help you get where you want to be.