A return to mortgage rates of 6% or more for the first time since 2007 guarantees a renewed slump in mortgage lending and a further leg down in house prices, according to a new report by Capital Economics (CE).

The firm estimates that if mortgage rates remain at this higher level for several years, a 25% drop in house prices would be likely. However, CE adds: ‘But our forecast that inflation will ease should allow interest rates to be cut from mid-2024, limiting the total fall in house prices to around 12%. The impact of higher mortgage rates will be most severe for those reaching the end of a fixed-rate deal this year, who will endure a similar increase in mortgage payments as borrowers did in the late 1980s.

‘The renewed surge in market interest rate expectations means that mortgage rates will soon surpass the peak reached last autumn and rise to around 6% for the first time since 2007. Given the current level of house prices, that will raise the cost of buying a house with a mortgage beyond what many can afford leading to a renewed slump in transactions and mortgage lending. We have revised down our 2023 and 2024 housing market activity forecasts in response, and now expect around a 25% year-on-year drop in transactions this year with no recovery until 2025.’

As well as setting the cost of borrowing, mortgage rates determine the amount buyers can borrow, their budgets, and in turn house prices. Capital Economics says that, based on its valuation framework, house prices are currently twice the level that would be sustainable with mortgage rates at 6%.