We, as a nation, are obsessed by house prices and the housing market, so much so that house prices are a major determinant of consumer confidence. It’s good news, then, that the housing market appears to be back in recovery mode after the distortions caused by property tax changes in April.

House prices rose by 0.6% m/m in July after dropping by 0.9% in June according to Nationwide, which is the first to put out data. The broader picture so far this year had largely been one of weakness. Annual house price growth has slowed from 4.6% in December to just 2.4% now – below both inflation and wage growth.

However, the picture has been impacted by April’s increase in stamp duty (which, from an economic point of view at least, is a terrible tax). This caused homebuyers to bring forward purchases into Q1 and then abandon the market in April. Indeed, the number of new mortgages taken out collapsed to fewer than 61,000 in April, the lowest level since the start of 2024. They’ve since recovered to 64,200, only a little below the pre-pandemic average.

The housing market is important to the economy in a number of ways, but maybe not in the way most people think. Buying or selling an existing home doesn’t impact GDP, but as anyone who has moved house knows, there is a whole series of ancillary services, from lawyers and estate agents to removals, involved and that activity does boost GDP. At the same time, most house moves involve the purchase of something new, from furniture to paint, which also supports consumption.

Just as important as transactions, though, is the wealth effect. When house prices go up, homeowners become better off and feel more confident. Some people will borrow more against the value of their home, either to spend on goods and services, renovate their house, supplement their pension or pay off other debt. Even if they don’t borrow more, by feeling more confident and wealthier, they are less likely to save their current income, boosting spending.

There are good reasons to think that with the distortions from tax changes out of the way, both transactions and prices will recover over the rest of this year and into 2026.

First, despite increases in inflation and a slowdown in wage growth, households’ real incomes should continue to grow this year. What’s more, the house price to income ratio, a key measure of affordability, has fallen back to around 7.3 from a recent peak of 8.6 in mid-2022.

Second, interest rates have further to fall. We expect a 25bps cut on Thursday and we will probably get another two similar-sized cuts by this time next year. That should ease the burden of mortgage payments, supporting housing demand and further price rises. We expect house price growth of about 3% by the end of the year.

Admittedly, there are some key risks. The labour market is cooling, which could dent confidence and income growth. Or the Bank of England may not cut rates as far as the market is expecting given sticky inflation. But, all the indicators at the moment are pointing towards a recovering housing market. That would be good for households, businesses and the economy.

MPC will cut in August, but outlook less clear

We think it’s a solid bet that the Monetary Policy Committee (MPC) will vote for a 25bps rate cut at its meeting this week, bringing interest rates to 4%. While the committee will stick to its gradual and cautious guidance, the committee is likely to be split. We’ve pencilled in a three-way vote with two members opting for a bumper 50bps cut, five for a 25bps cut and two for a hold.

There’s very little in the recent data to push the MPC off its quarterly rate-cutting path.

Yes, GDP will probably be a touch weaker than forecast and the unemployment rate a touch higher, but that will be balanced out by inflation being above forecast.

The decision will come down to whether the MPC puts more weight on a weakening labour market, which could bring services inflation down in the medium term. Or, whether sticky inflation risks re-accelerating as it creeps closer to 4% and food inflation continues to rise.

Ultimately, the doves look set to win out this time with the market pricing a 90%+ chance of a 25bps cut. We concur.

Looking ahead, the path for interest rates becomes murkier. We think the labour market will remain weak enough to weigh on pay growth and justify one more cut towards the end of the year, despite inflation being well above target.

However, if, as survey indicators suggest, the labour market and economic growth begin to recover, services inflation is likely to remain stubbornly high. Moreover, if it becomes clear that another round of duty hikes and ‘sin taxes’ will sustain inflationary pressures, then the Bank may choose to delay a rate cut at the end of the year.

Once rates drop below 4% the MPC will have to be more careful about further cuts. Otherwise, there is a risk that policy becomes too loose, with inflation set to remain above-target through to 2027.

For now, we continue to expect a cut at this week’s meeting with another later this year, which would leave interest rates at 3.75%.

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