Would Brexit be bad for UK house prices?

As the date of the referendum approaches, it is perhaps inevitable that politicians will be producing fresh dollops of rhetoric to try push the public behind their cause.

 Would Brexit be bad for UK house prices?

The latest example of this is George Osborne’s assessment that if the electorate vote for the UK to leave the EU on June 23, house prices would suffer, but do the numbers stack up?

Any examination of the economics behind the chancellor’s claim is necessarily hindered by the fact that it is layered with hypotheses.

But amid the swirls of speculation and rumour, most analysts agree that if the referendum result favours Brexit, the value of sterling will fall.

Rob James, financials analyst at Old Mutual, noted that a prolonged period of sterling weakness would make goods that the UK imports into the country more expensive, effectively importing inflation.

In the first instance, this would push the cost of living up for many households, potentially making their mortgages less affordable, and increasing the risks of default.

It is also likely that if this situation were to play out, buyers would find it more difficult to save for a deposit.

Read more: UK property investors likely to suffer if Brexit happens, agree analysts

Both of those scenarios would serve as downward drivers for house prices, as supply would increase, while demand would be restrained.

There is a significant segment of the UK property market, both commercial and residential, that attracts overseas buyers.

The motivations of these investors vary, but have one element in common, the view of the UK, and its currency, as a safe haven.

A vote in favour of the UK leaving may dent this safe haven status. Eric Moore, a fund manager at Miton, doesn’t agree, he commented that one of the attractions for buyers from countries such as China and Russia, is the rule of the law, the protection property owners enjoy here, ‘and the knowledge that even if the lose 10 per cent on their investment, that is preferable to losing all of it because the government of your country has seized your property.’

Read more: When will UK interest rates rise?

But there is another buyer, investors from the Eurozone, who, expecting their currency to decline drastically, and with negative interest rates at home, have bought UK property to profit both from robust demand and the perception that sterling would be strong against the euro over the medium term. If sterling weakens that investment case would wilt.

The traditional response from policy makers eager to protect the value of a currency in order to contain inflation, is to put interest rates up.

But while raising rates should serve to protect the currency, it would cause the mortgage payments of most homeowners in the UK to rise, potentially leading to increased defaults, which would push housing supply up, and probably prices down. Additionally, the UK high street banks still receive a portion of the capital they lend out to investors and house buyers from international capital markets. Weak sterling and greater uncertainty would likely cause the cost of that capital to rise for the UK banks, and they would pass that on in terms of higher mortgage rates.   

There had been, until this year, considerable expectation amongst market participants that UK interest rates would rise in the near term, as the economy appeared to be strengthening.

Policy makers have been debating the timing of a UK rate rise for a considerable period of time, but one thing upon which they all agree is that rates should be moved from a position of strength, that is, when those with their hands on the tiller of the economy feel the country can handle it.

Putting rates up in response to market action, such as a sell-off in sterling, would be acting from a position of weakness, and, whether it proves to be the correct path, that is not ideal.

Bank of England governor Mark Carney has made it clear that he takes a dim view of the economic case for Brexit, and he appeared to hint of late that a cut in interest rates would be his favoured response to a vote to leave. There is also the argument that UK inflation is below target, that, in the words of the eminent fund manager Neil Woodford, ‘the threat is deflation, not inflation’, and in that scenario, allowing some inflationary conditions to develop may be no bad thing for the economy.

Cutting interest rates should serve to increase the level of demand in the economy, by increasing the velocity of the money supply and pushing the cost of debt down.

Theoretically, that would be good for house prices, as mortgage rates should be cheaper.

But with UK interest rates already at record low levels, for a further cut to be the prudent course of action, Brexit really would have to cause a steep decline in economic activity, or a drastic drop in sentiment.

Such a shift in the fundamentals of the economy would, according to traditional economic theory, provoke market participants, including house buyers, to delay activity until a greater level of certainty exists.

That, in itself, would serve a brake on the housing market. Amid the torrents of political sophistry, it is often forgotten that if the public vote to leave, there would follow a two year transition period during which time a negotiated exit would be arranged.

If the immediate impact of a vote to leave is uncertainty, that two year period may guide investors as to how long the turbulence would last.  

Comments (0)