We saw house prices rocket recently, as the economy restarted after 16 months of lockdowns and other restrictions – which (it’s easy to forget!) included a practical freezing of the property market and a near 20% contraction of the UK economy.

What was driving this post-pandemic housing boom? How is that house prices are continuing their rise despite all the economic headwinds?

Perhaps the biggest single contributor is interest rates - a.k.a the ‘Bank Rate’ or ‘base rate’, set by the Bank of England (BoE) - these have been at historic lows for some time:

Bank of England Bank Rate timeseries chart. Chart data: Bank of England, Official Bank Rate (%) since 2005. Accessed on 18th November 2021.

Low interest rates reduce the cost of borrowing, which is great news for those looking to get mortgages. It means they can afford the repayments of a bigger mortgage than they would be able to otherwise, if rates were at upwards of 5%, for example.

Low rates mean cheap money and so, despite the global covid pandemic and other uncertainties, such as Brexit, cheap money has continued to put upward pressure on the housing market.

The Bank of England cut rates to their lowest ever level during the covid pandemic in 2020 to prop up the economy. There was also a stamp duty holiday to add some heat to the market.

Inflation is a thing our chancellors haven’t had to worry too much about for some time, with the annual Consumer Prices Index (CPI) being less than 3% since 2012. However, with costs increasing now, from energy to restaurants, and supply chain worries, inflation is returning at 5.1% in November 2021. As we’ve seen in the news this week, the BoE has responded correspondingly increased the base rate to 0.25% on Thursday, this is up from 1% before.

If inflation is here to stay, it could lead the BoE to increase the bank rate further, and if this happens the cost of servicing a mortgage could increase, pushing the affordability of mortgages down.

If mortgages start to become unaffordable to many people, demand will drop.

What is inflation and why does it lead to increased interest rates?

Stock image of newspaper heading.

Inflation is a measure of how the cost of goods and services increases over time. It is tracked by the Office for National Statistics (ONS) who gather the prices of roughly 700 goods and services each month, using this they publish an index called the CPI. The Bank of England then use this CPI to understand the measures needed to keep it stable at a target of 2%. One of those measures at the banks disposal is interest rates.

An increase in interest rates set by the Bank tend to reduce spending overall in the economy and reduce business. This tends to lead to a reduction in inflation, giving the Bank an important lever to pull to maintain the health of the economy.

Now you can see why the interest rate is linked to house prices and a key reason why prices have continued to rise despite the challenging economic environment.