Real price of cheap credit? Unaffordable homes

Cantillon: Bank of England study debunks idea undersupply is driving up house prices

Chronic undersupply is frequently blamed for pushing up house prices. It’s the dominant narrative here. But a recent Bank of England study suggests the supply thesis may be a major misdiagnosis. The paper by two economists published just before Christmas claims that the four-decade long surge in house prices in the UK – property prices have quadrupled since the 1980s (we’ve had an even steeper ascent here)– has been caused by low interest rates, and not by a lack of supply of new homes.

The lower interest rates are, the lower the cost of borrowing to pay for a house is, and the more people are able to afford to borrow to buy a house, a scenario that translates into higher prices.

Interest rates

The Bank of England researchers calculated that even with a significant supply response, the jump in real house prices since 1985 wouldn’t have been that much less, and that the real driver of prices was cheap credit. Think of it this way: a €1 million mortgage borrowed at 0.75 per cent and €450,000 mortgage borrowed at 7.5 per cent have the same repayment of €3,100 per month.

“Nearly all of the rise in average house prices relative to incomes can be seen as a result of a sustained, dramatic, and consistently unexpected, decline in real interest rates,” the researchers write.


Serious implications

The findings are being heralded as an evolution in the bank's thinking. Back in 2014. governor Mark Carney blamed rapid price growth on a "chronic shortage of housing supply".

The findings have serious implications. If we build more homes – as we are doing – we might not get the hoped-for reduction in prices. In 2006, when a record 92,000 homes were built in the Republic, property prices here rose by 14 per cent.

Equally if interest rates return to normalised levels, the value of properties could fall significantly leaving many of those on the lower rungs with their life savings tied up in shrinking-value assets.