Nobody needs reminding that inflation is high at the moment. Recent annual inflation of around 10% hasn’t been so high for over 40 years.

But how does inflation affect the property market and how might it affect it in future?

Inflation means higher mortgage rates

The main way inflation affects the property market is that higher inflation rates = higher mortgage rates. It’s the way in which the Bank of England controls inflation. (It’s an extremely crude tool. It doesn’t seem to be working too well either and some people have questioned whether the Bank of England actually knows what it is doing in this regard. But it is what it is.)

Inflation impacts demand in the market

Inflation also pushes up the cost of living by way of rising day to day bills. And that has an indirect effect on consumers’ ability and likelihood to move home.

In particular people are unlikely to move to a larger home if they are struggling to afford their existing one. This interferes with the normal movement up the property ladder that is so important to the industry. It can even prevent first time buyers and those who can afford to move from buying because it impacts the supply of available properties.

People who are able to move are likely to make lower offers, which could spur a decline in values.

Ways inflation can benefit the property market

It’s often not realised, however, that inflation is generally considered to be a good thing in the property market. Not consumer price inflation of course, but property price inflation.

Is there anybody who has ever bought property in the last few decades and not hoped, if not actually EXPECTED, that its value will go up as a result of inflation?

The thing is, property price inflation is seen as a good thing by almost everyone in property. It’s considered good by owners. It’s considered good by investors and developers. It’s considered good by lenders. It’s even considered good for agents. (It isn’t considered so good by those who don’t own property but want to buy it of course.)

Even better, property price inflation has generally always been higher than consumer price inflation in recent decades. And, more importantly, higher than the interest rate too.

Here are a few examples:

* In 2000 UK consumer price inflation was approximately 1.2%, property price inflation was approximately 16% and the interest rate was approximately 6% over the year.

* In 2010 UK consumer price inflation was 2.5%, property price inflation was 6.5% and the interest rate was 0.5%.

* In 2020 UK consumer price inflation was 1%, property price inflation was 1.6% and the interest rate was 0.1%.

This also has a very important implication for the property market. It means that property has tended to be a good hedge against inflation. Money put into property has generally always kept pace or exceeded the wider rate of inflation and the interest rate.

Property, inflation and the future

Recently there has been parity between consumer price inflation and property price inflation, with both being around 8-10% pa. Currently property price inflation is slipping behind consumer price inflation at around 5.5% versus 8%. But property price inflation is still just ahead of the interest rate at 4.5%.

This situation seems likely to change in the medium term however. Some forecasts suggest that property prices will drop over the next few years, by 5-7% pa on average while price inflation will be 5% by sometime next year. Other forecasts suggest the interest rate has not quite peaked and may reached 5.25% or thereabouts later this year.

Potentially, the situation as regards property price inflation might not be so favourable over the next few years as it has been. Based on long term trends however it is difficult to see that this situation won’t be restored. It is difficult to see why property inflation won’t continue to at least keep pace with and probably exceed both consumer price inflation and the interest rate in the longer term.

So ultimately, while everyone hopes that consumer price inflation will fall back as soon as possible inflation in the property market is generally seen as a positive thing. Property price inflation encourages people to buy for the first time, and encourages people to move. Property price inflation encourages investors to invest. Property price inflation encourages wider investment, innovation and development in the property market too.

In short, though usually seen as bad, price inflation is very much the thing that drives the property market.


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