We’re in the middle of a global house prices boom. This tells us something about the speed of the economic bounce-back from the pandemic, and perhaps also a new desire for more living space. But mainly it’s the result of the most powerful economic and political force of our time: low interest rates.
The topic of interest rates is normally confined to the financial pages, but their impact on society and politics is hard to under-estimate. Think about the frustration felt by younger generations for whom home ownership feels like an impossible dream, especially in London and the South-East. Or the global growth in wealth inequality between those who own property or financial assets and those who don’t.
In the UK, high house prices are often blamed on our restrictive planning system. This view is part of the motivation behind the planning reforms that have proved so controversial. It’s true that we have a bureaucratic system that benefits the major house builders, stifles competition and often inhibits good design. And even though we’re building more than we used to, it’s also true that we still need more affordable homes in economic hotspots like London.
But even if we achieve an increase in the number of new homes, the evidence shows that it won’t put more than a small dent into affordability. A decade of effort might knock two or three per cent off prices at best, just a few months of price growth at current rates. The reality is that high house prices — and indeed high prices for all assets — are a global phenomenon, and for almost 40 years there have been much more powerful forces at work: a huge fall in the interest rates set in financial markets.
These low interest rates aren’t mainly caused by central banks, they’re market prices set by fundamental global influences outside of anyone’s control. The most important is demographics: ageing populations and rapid growth in the developing world have created a huge pool of savings looking for safe assets that generate a steady income. That has driven up the price of those assets and so pushed down the annual income they provide for each unit of value. This powerful force isn’t going to change soon.
The pandemic — and the policy response to it — has driven another leg down in global interest rates, helping to trigger the housing boom. This began in the Eighties when policy makers vanquished the spectre of high inflation. Some fear that it might be about to make a comeback, bringing the era of falling interest rates to an end, but the evidence doesn’t support that yet and in the last month or two markets have started to bet that we’re heading back to a familiar mix of low inflation and low rates.
Understanding these forces leads us to very different conclusions about how to turn around the falling rate of home ownership in the UK. One solution is to go further in reducing the uncertainty faced by many private renters, which in turn would help them build up their savings. But the basic impulse to own your home remains a fundamental feature of our society. The answer then lies not in an ultimately doomed attempt to build our way out, but in gradually changing the distribution of who owns the existing housing stock. And that requires a level playing field between first-time homeowners and private landlords.
That playing field is currently tilted against first-time buyers by limitations on access to mortgage finance. For example, affordability tests brought in after the financial crisis — for good reasons — mean it’s very difficult to borrow more than four times your income, even though the resulting interest payments would still be much more affordable than paying the equivalent rent. In high-price areas like London this puts the vast majority of properties out of reach.
Of course, the understandable motivation behind these rules is to protect people from the risk of higher mortgage rates in the future. Many countries solve this problem with housing finance organisations that help to ensure the availability of competitive, long-term, fixed-rate mortgages — largely absent in the UK — which essentially solve the affordability problem.
So, in a world of low rates, importing some tried and tested improvements to the mortgage market would do more to boost home ownership than building millions of new houses. And Londoners would benefit most of all. I told you interest rates were at the heart of politics.
Rupert Harrison is a former chair of the Council of Economic Advisers and a multi-asset portfolio manager at BlackRock
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