In the five years since the credit crunch we have seen the average UK house price fall dramatically, rally temporarily, slip backwards and in the past two years, remain broadly static.

By the end of September 2012 the average UK house price was 11% below its peak level in September 2007, equivalent to a fall of 24% in real, inflation-adjusted terms.

Over that five year period we have had to adjust to a new set of market drivers – a weak economy, a lack of mortgage finance, low bank base rates and high lenders’ margins.

We have also moved to a low transaction market where the main source of funding has shifted from debt to equity. Gaps have widened between mature owner occupier households and would-be first time buyers, equity rich locations in the South and low value mortgageconstrained markets in the North.

Though there is significant variation across the capital, average prices in London are now above their previous peak according to Land Registry figures. But even in London, average mainstream values are effectively 9% below 2007 levels after adjustment for inflation. By contrast, in the North East of England nominal prices are 21% below their level five years ago, equivalent to a 32% discount in real terms.

Lessons for the future

What are the prospects of this changing significantly over the next five years?

Our house price forecasts are set against the backdrop of a low transaction market. This means that house price indices are being calculated by reference only to the part of the market that is trading, the relatively more affluent, equity-rich owner-occupier markets that now dominate activity.

This is likely to continue. Despite central government efforts to stimulate mortgage lending it remains heavily subdued, and the number of outstanding mortgages has reduced by more than 400,000 net over the past five years.

Low interest rates have prevented the market being flooded by repossessed or forced sale stock. This in turn limits the potential for price falls across the UK, except for example if there were to be a full blown double dip recession fuelled by a disorderly eurozone breakup. And because bank base rates are forecast to remain lower for longer, there is an affordability cushion for those in the market, even though lenders’ margins are expected to remain relatively high.

Gradual adjustment

The economic outlook remains challenging, and forecasts for GDP growth (specifically in the next two years) have been reduced progressively over the past year. Such a trend inevitably impacts on residential market sentiment.

We therefore expect ongoing inertia, with no significant short term drivers either for house price falls or price growth at a national level. But in a market that is likely to continue to favour equity-rich households and exclude those with a high mortgage requirement, there is certainly capacity for some house price growth over the medium-term.

In the short-term, we expect inflation and not headline house price falls to strip out value as the market goes through a slow and gradual adjustment.