The upwards trend over this period generally was also driven by the secular decline in the long run equilibrium interest rate that we have seen over the past 30 years, and which makes higher levels of debt more sustainable2. By 2008, household mortgage debt relative to income had risen to 110% from 67% at the beginning of the decade and roughly four times its level in 1980. The debt service to income ratio remained relatively constant as the impact of higher levels of mortgage debt relative to income was offset by lower debt servicing costs. Access to credit was easy and the cost of credit was relatively low. By 2007, the spread on a 2 year fixed rate 90% Loan-To-Value (LTV) mortgage product over risk-free rates was just 0.4pp. And a large share of mortgage products advertised were available to relatively riskier borrowers, such as 90%+ LTV or to borrowers who had recently faced repayment difficulties. Over this period, the market was very active, with mortgage approvals averaging over 100,000 per month. In the financial crisis and ensuing recession, house prices dropped and the market effectively froze. Transactions fell from their peak of 150,000 in December 2006 to their trough of 52,000 in January 2009. And house prices contracted by over 15% in February 2009, from a peak growth rate of over 10% in June 20073. The housing recovery, as with the UK economic recovery in general, was slow and painful.
New houses take time to construct and there are multiple frictions, not least planning and other regulations. This will affect whether a boom in demand for housing is reflected in new building and increased supply, or in upward pressure on prices. There is, however, variation between countries. The literature bears out the intuition that that the more inelastic the market, the greater the impact of demand side factors on price. The UK scores very poorly on elasticity of housing supply. The IMF estimates that the elasticity of housing supply in the UK is about half the OECD average4 (Chart 3). Chart 3: Estimated Long-Run Housing Supply Elasticity  4  Geng (2018), “The Fundamental Drivers of House Prices in Advanced Economies” 5  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  5  On the demand side, the fundamental drivers of the market are population and income. But credit conditions and expectations clearly play a role, as do non- credit constrained investors who can arbitrage between the rental and the owner occupied market. It is difficult to disentangle these factors. At a fundamental level demand for housing – whether as a renter or as an owner – is determined by the number of households, their incomes, the housing stocks and households’ intrinsic preferences. And so in areas with rapid population and income growth – especially in areas where supply cannot adjust – we’d expect to see an increase in both rents and house prices.