UK house prices may tumble as much as 10 per cent next year as soaring interest rates and a deepening recession weigh down a market that thrived through the pandemic.

That’s the conclusion of a survey of economists and property-market forecasters, all of whom expect the first annual declines in a decade. None anticipate a downturn as sharp as the 16 per cent fall that came in with the financial crisis in 2008.

The outlook is, “in a word – bleak”, said Paul Hollingsworth, chief European economist at BNP Paribas Markets 360. “The cost of debt has risen materially over recent quarters, confidence is at rock bottom, while consumer real incomes are being hammered. Put this all together and you get a recipe for likely further price declines.”

The findings suggest more pain ahead for British consumers, who are already shouldering inflation near the highest in 41 years and the tightest cost-of-living squeeze in memory. That along with supply chain chaos and labour shortages left over from the pandemic are driving the UK into what’s expected to be a recession that may last into 2024.

Falling house prices and higher borrowing costs will drain more money from household balance sheets, making many homeowners feel poorer and perhaps more cautious about spending. The Bank of England (BOE) has raised interest rates nine times in the past year, bringing its benchmark to 3.5 per cent, the highest since 2008 in a bid to prevent a wage-price spiral.

“A housing correction is underway. A near 20 per cent gap has opened between the price of a house in the UK and what can be justified by fundamentals, based on a Bloomberg Economics model looking at interest rates and household incomes,” said Niraj Shah of Bloomberg Economics.

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JPMorgan Chase & Co and Credit Suisse Group are forecasting a 10 per cent decline in prices in 2023, and Bloomberg’s John Stepek goes as far as to say that declines of 30 per cent are not out of the question. Halifax sees an 8 per cent drop. Others are more cautious, seeing smaller declines. Beacon Economic Consulting anticipates a 0.3 per cent drop next year – followed by a 3.5 per cent decline in 2024.

House prices have declined for three months in a row, according to two of the biggest mortgage lenders, Nationwide Building Society and Halifax. If anything, the surprise is that it took so long for the fundamentals of the economy to catch up with the property market, which has been supported by a lack of stock for sale and a near-record low in unemployment.

“Whether or not we see a worse scenario will really come down to the strength of the labour market,” said Innes Mcfee, managing director at Oxford Economics. “If unemployment really start to kick in, that’s when you’re likely to see more forced sales.”

The main driver of the decline is a surge in mortgage interest rates, which leaped with the BOE’s rate hikes and along with the crisis that accompanied then-prime minister Liz Truss’ budget programme announced in September. 

That episode “represented a major shock to the housing market”, said Robert Gardner, chief economist for Nationwide, adding that it “fundamentally changed the affordability dynamic for prospective buyers”.

He expects a 5 per cent drop in house prices next year, but says the risks are tilted towards the “downside”.

While Rishi Sunak, who took office after Truss stepped down, has reversed most of the Truss measures, mortgage rates are likely to remain elevated for a few years, according to the Office for Budget Responsibility. That means people who remortgage in the next year may see payments double.

The cost of a two-year fixed rate mortgage is now at 5.82 per cent according to Moneyfacts Group. This has driven expectations among economists that properties will lose around a tenth of their value over the next two years.   

The BOE said this month that four million households will feel a significant increase in mortgage payments next year. That would cause a severe strain for an extra 220,000 households.

Landlords who took a mortgage to fund buy-to-let properties are likely to feel the biggest strain, according to research published by Savills. Many of them have interest-only loans that feed through rate changes quickly.

BOE deputy governor Jon Cunliffe last week predicted that about two million landlords will opt to sell “and take capital profits” instead of refinance at worsening terms.

That would have a direct impact on the stock of property available to rent, which is already in limited supply. Property portal Zoopla reported that the cost of a new rental agreement rose 12.1 per cent in the year to October, double the pace that wages are growing. 

Rent as a proportion of average earnings is now at its highest since 2009, accounting for over a third of a person’s income. Zoopla expects rents to increase by about 5 per cent next year. 

“The thing that worries me is the rental market,” said Liz Martins, UK economist at HSBC. “There’s a huge under-supply of rental properties and with rising mortgage costs. People are likely to rent for longer, so demand goes up.”

It is not all bad news, however. Some homeowners may find comfort in Cunliffe’s claim that a pandemic-driven house price boom means even a 20 per cent fall in values would not cause distress to most homeowners. Savills also predicts house price losses will actually be reversed by 2026.

“We aren’t that negative,” added Martins. “We don’t see a massive rise in unemployment. If we’re right about the peak and the bank rate coming down quite soon, mortgage rates will come down a bit too. And there is still some pent-up demand.” BLOOMBERG