Inflation likely to ease

With a cost-of-living crisis, interest rates at a 16-year high of 5.25%, and the wider backdrop of weaker global growth, the UK economy flatlined in 2023. Could this be considered a recession? Technically, yes, as GDP is likely to have fallen over the fourth quarter, following a small contraction in the third.[1] However, it appears to be a shallow recession, with signs of improvement through 2024.

Inflation is a crucial factor. In recent months, it has dropped to 4% – still above the Bank of England’s 2% target, but considerably better than the 11.1% seen in October 2022. Looking behind the inflation figures gives us insight into what happens next, as some of the big drivers of previous rapid inflation are now on the wane. Energy prices have fallen, while the cost of food and goods is still rising but at a much slower rate. However, services inflation is more stubborn and is now the biggest contributor to inflation. Much of this is related to wage costs.[2]

Winding road going through mountains

Interest rate falls predicted

One of the principal reasons the Bank of England (BoE) has not started reducing interest rates is the threat of “inflation persistence.” It worries that prolonged high inflation could lead to the kind of wage-price spiral last seen in the 1970s.

We believe overall inflation should start to come down to the 2% target by the middle of this year. However, considering how ‘sticky’ services inflation is proving to be, core inflation will still sit above that level. Could this be enough to convince the Bank of England to start cutting rates? Looking at projections from the bank’s Monetary Policy Committee, actual inflation has now fallen below the MPC’s projections for five months in a row (up until recently the MPC had been underpredicting inflation)[3]. This trend could well convince the committee to start lowering rates. We expect to see three 25 basis-point cuts this year, taking the base rate to 4.50%.

side of cliffs going into the ocean below

The great mortgage reset

One note of caution, though. The Bank of England believes less than half of the impact of higher interest rates has so far been transmitted to the economy. Mortgages are a central part of this. More than 80% of UK mortgages are on a fixed rate. This makes 2024 another year of mortgage resets, with more than 400,000 renewals due in the first quarter of the year alone.

So, while mortgages have started to drop – with the average interest rate of two-, three- and five-year mortgages close to the 4% mark – they are still much higher than the sub-2% deals of pre-October 2022. The reset is likely to have a huge impact on household spending power.

close up of green mountain ranges

No house price collapse, but fewer transactions

What about house prices? Soaring mortgage rates during 2023 led to fears of a collapse in the housing market, with some commentators even predicting price falls of 30% or more. But the collapse didn’t come to pass. From peak to trough, between October 2022 and the start of January 2024, average house prices fell around 5.5%.[4]

Barring exceptional circumstances (such as the aftermath of the global financial crisis), house prices rarely plummet. Instead, it is activity in the market that drops. Transactions and mortgage approvals were around one-third lower during the last year.

Looking down at a loch with mountains behind it

Election time – but no one wants to frighten the horse

In an election year, Conservative plans for re-election revolve around tax cuts. Rumours abound that March’s budget could include plans to scrap Inheritance Tax and cut Income Tax. Ahead of last year’s Autumn Statement, Chancellor Jeremy Hunt said he would want to avoid any actions that could fuel further inflation. One scheme reportedly being considered by ministers is plans for a 99% mortgage, which some have warned could lead to another housing bubble. It is difficult to see how this mortgage scheme would work though with the current lending rules that banks face.

Polls suggest the most likely winner in the election will be Labour. But it appears that they are also seeking to avoid doing anything reckless that could lead to mortgage rates rising again, as they did in October 2022.

Lighthouse at the end of cliffs

After two strong years, rental growth slows

Looking at the buy-to-let market, rental growth in the last two years sat at unprecedented levels. Year-on-year growth for new lets was consistently around 10% or above.[5] However, there are already signs this growth rate is dropping. This is most pronounced in areas around London and the South East. In London, the rate of growth fell from 17% in December 2022 to 9% a year later.[6] We expect this easing to continue UK-wide in 2024. As earnings growth slows, this will limit the extent to which rents can continue to grow while remaining affordable to tenants.

Rental yields, on the other hand, could be driven down if house prices start to rise. Here, the outlook appears uncertain. In January, property agent Knight Frank reversed its outlook on house prices for 2024, from a 4% fall to a 3% rise.[7]

green mountain with lake below

Tackling the lack of housing supply

There’s been significant tenant demand over the last 18 months, a combination of lack of supply and higher borrowing costs that limit mortgage accessibility for first-time buyers. On the supply side, higher mortgage rates have prevented would-be buyers from entering the property market. Mortgage rates have now started to fall, as the market anticipates that Bank of England could start to cut the base rate. As such, there has been an increase in first-time buyers moving into the property market, which helps ease some burden on the rental market.

However, the underlying lack of supply remains. As an example, seven out of nine regions across England granted fewer planning consents than delivered new homes in the 12 months to September 2023. The problem is at its most acute in London and the South East.[8] This lack of supply means demand is likely to remain strong and continue pushing rents upwards.

looking towards a mountain in distance from the ground

A landmark bill – with limited potential impact on returns

The Renters (Reform) Bill is the most substantial new legislation to affect the private rental sector in 30 years. With several amendments to current laws that govern the rental market, it aims to restore the balance between tenant and landlord rights. The most talked about change is abolishing “Section 21”, which currently allows landlords to evict tenants on a no-fault basis with two months’ notice. The bill also doubles the notice period for rent rises and scraps fixed-term contracts, which are particularly prevalent in student lets.

The wide-ranging set of reforms has naturally led to speculation on the potential impact on property portfolios. Some sub-sectors could feel the pinch more than others, with an increased burden on management and administration. However, we do not expect the bill to have a significant impact on the fundamentals of property investment.

Stone path leading towards mountain ranges

Optimism in the real estate market

In the real estate sector, anticipated interest rate cuts are expected to boost property investor sentiment and transaction volumes, which may even mirror the post-Covid-19 rebound. The bid-ask spread is likely to narrow, particularly in resilient sectors like logistics and residential. Refinancing deals are also expected to increase due to alternative lenders having limited flexibility, which could reduce their willingness to extend favourable terms.

Construction lending also presents opportunities following a decline in construction work in 2023. If predicted interest rate reductions and subdued land costs persist, the development finance market will continue to recover. Developers believe build cost inflation has peaked, making developments and major refurbishments attractive. Both borrowers and lenders are drawn to the inherent protection in value creation asset projects. Developments and refurbishments are poised to become more appealing in the coming year.

View across a lake towards mountains with relfection showing in the lake

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Important information:

This article is for general information purposes only and should not be used or relied upon as professional advice. It is advisable to contact a professional advisor if you need financial advice.


[1] Source: Macrobond and Investec
[2] Source: ONS, Macrobond and Investec
[3] Source: Bank of England, Macrobond and Investec
[4] Source: Nationwide house price index Macrobond and Investec
[5] Zoopla Rental Market Report, December 2023
[6] Zoopla Rental Market Report, December 2023
[7] Knight Frank, UK House Price Forecasts: January 2024
[8] Savills, English Housing Supply Update Q3, 2023