House prices – good judgement needed to avoid interest rate havoc

Trying to predict the housing market is like licking a restaurant window to ascertain the menu, writes Peter McGahan.
house prices - boom and bust

House prices? It’s that big question again.  I’ve been asked that countless times over the last 34 years and it’s like déjà vu all over again.

Firstly, let’s look at what drives house prices. The obvious logical answers are supply and demand, interest rates, and the general state of the economy.

The better answer is sentiment.

If I am asked a question about the economy in the local pub, it normally comes with a reaction to my response of ‘but surely…’. In other words: ‘this is how I feel and want to feel, so are you sure about your answer’. That is sentiment. It works the other way too.

Sentiment drives booms and busts, and the aforementioned logic rarely comes into the decision until it’s too late, by either missing the bottom of the market or getting out at the top. Let’s face it, most people make emotional decisions, as it’s rare we are armed with all the correct information or ability to fully understand it.

Pragmatic approach to house prices

The UKs house prices are no different to the rest of the world. It’s all been crazy driven by many emotive factors and some logical matters. Faced with the thought of being stuck in a city and locked down forever as the headlines had us believe, it’s natural to realise the power of nature and its benefit, so the house in the countryside or moving back close to the family is clearly the answer.

People borrowed against their main home and put that as a deposit on another, and with interest rates at near zero, why not? The need for a bigger home was everything as we worked from home or tried to hide from our children/spouse somewhere in the house for that important piece of privacy.

Add to this a stamp duty holiday in July 2020 and a tapering of this benefit until September 2021, prices were set to rocket to just crazy levels. As in the late 80s and a few times since, I had people say – it’s nuts, it’s crazy, then go ahead and make the purchase anyhow. Each house became the one that was getting away, the ebay effect of buying something for more than it’s worth because everyone else wanted it.

While there were many emotional parts to those decisions, the reverse is equally true now as many realise the power of being in their workplace for the community gain and also the feeling of being part of the business decision-making process. The two mortgages are now starting to hurt.

Crystal balls won’t influence what happens next

I won’t forecast house prices. That’s a folly and it’s like licking a restaurant window to ascertain the menu. After a while you’ll realise it’s not reliable and someone will spot you. There are too many variables. Better to ask if it’s a good idea or not and if you need it, then protect yourself against the variable of inflation by fixing your borrowing rate.

A home is a great hedge against inflation – if inflation and subsequent rising interest rates is your concern.

Consider this simplified example of a loan at three per cent interest rate and inflation at 10 per cent for the purpose of this example. After five years you have paid 15 per cent for your debt, but inflation has wiped your debt down by 50 per cent. What’s not to love?

Personally, I think inflation will fall away next year as supply chains open up. Much depends on the never-ending desire to fight with other countries either in war or economically, but if the norm returns, inflation should drop off significantly. Often misunderstood, if inflation has risen 10 per cent this year, one year from that point the 10 per cent rise is out of the numbers. Even though inflation in that next year may have been two per cent, (and so 12 per cent over the two years), the recorded headline will be ‘inflation back to BOE target’. No, it’s six per cent per year and will have created havoc in an economy.

Inflation falling eases interest rate stress which allows further borrowing at better rates.

Yes, new viewings to homes have dropped off, but that’s no surprise given the economic confusion and clouds.

More next week, but in the immediate instance, consider it a home, a necessity, and for some, a hedge against inflation. It’s heated for sure and overheated, but not all balloons pop. They can whimper and allow wages and the correct economy to catch up.

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Last modified: July 15, 2022

Written by 11:02 am Property, Finance