Inflation and the housing market: how are they linked?
By Carl Agar
Without a doubt one of the biggest factors to impact house prices is interest rates but have you ever wondered what relationship inflation has with the housing market? If you have then fear not, this article is for you.
There are two things to consider here. Firstly, the inflation of house prices in general and secondly the relationship between the UK Economy general inflation and the housing market. Put simply, inflation refers to the increase in the price of a particular product or service over a period of time. This typically happens when demand out strips supply and there is no better example than the UK housing market. If we look back over a long enough period we can see a dramatic increase in UK house prices especially post world war two. In 1952 the average home cost just £1800 and today the average house price is around £230000, that represents serious inflation in just over 60 years. The obvious point here is that this a clear example of demand at work but where has the demand come from? The answer is lots of places, to start with increasing population and increase in life expectancy has created a general increase in demand for homes. Couple that with changes in the way people live, increases in divorce rates, an increased desire for people to own their own homes and of course not enough homes being built. The end result, a more than healthy demand for homes that drives up the price.
Another big and often overlooked contributor to rising demand and increased house prices was the introduction of Assured shorthold tenancies (AST) in 1996. This measure suddenly made property very appealing as a form of investment and a viable alternative to pensions. The outcome is that very specific demand was created at the bottom end of the market, typically reserved for first time buyers as these properties represented low value, high return investments. Consequently the whole ecosystem of the housing market was disturbed and today we have seen exponential increases in house prices.
Aside from the general variables as discussed the housing market is also affected by the UK’s general economic inflation. Typically, when general inflation increases, the Bank of England interest rate increases and consequently the cost of borrowing increases. This can be used to reign the market back in and counter demand for the general property market as well as curb the new build market. However, in the investor world the impact can be two-fold; yes - they may experience an increase in finance rates - but they may also see this as a trigger to increase rents.