The UK has recorded its first annual contraction in house prices in more than 10 years after rising interest rates piled pressure on mortgage borrowers, new research from Halifax shows.

The mortgage lender said house prices were 1%, or £3,000, lower in May than they were in the same month last year, marking the first annual decline since 2012.

However, the average price of a house in the UK is still £25,000 higher than it was two years ago, and £5,000 higher than the level recorded at the end of last year.

The price of property boomed over the pandemic, when demand was boosted by the stamp duty tax break and the race for space that followed the expansion of working from home.

Average house prices peaked at around £294,000 in August last year, according to the monthly index by Halifax. They have since fallen to £286,532.

Prices were broadly unchanged between April and May, following a 0.4% decline in the month to April.

Household incomes have been squeezed by the cost of borrowing, which has increased at its fastest pace in 26 years over the course of the cost of living crisis. The Bank of England has increased the base interest rate 12 times since the end of 2021 to its present level of 4.5%.

Separate figures published by UK Finance showed that mortgage arrears continued to rise in the first three months of the year as borrowers struggled to keep up with rising repayments.

Total bank deposits fell for the first time in years as households drew on savings built up over the course of the coronavirus lockdowns to help navigate the squeeze on their incomes, the trade association said.

Household spending was resilient at the start of the year as shoppers sought to make the most of shop discounts in January, but their confidence about their personal financial situations remained weak.

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Andrew Wishart, senior property economist at the Capital Economics consultancy, said: “House prices were unchanged in May according to Halifax. Given that lack of momentum, the increase in mortgage rates following the bad inflation data published on the 24th of the month is set to tip house prices into a renewed leg down.”

Forecasts published by the consultancy expect the average quoted mortgage rate to rise from 4.3% in April to 5.7% by the end of the year, with the economy set to enter a recession, defined as two consecutive quarters of negative growth.

House prices will fall by a total of 12% from peak to trough, according to Mr Wishart. “The Halifax [house price index] is only down by 3% since its peak in August 2022, so we anticipate a further 9% drop in prices on this measure,” he said.

Cooling demand

Kim Kinnaird, director of Halifax Mortgages, said that the annual decline in house prices reflects their strength last year.

“As expected the brief upturn we saw in the housing market in the first quarter of this year has faded, with the impact of higher interest rates gradually feeding through to household budgets, and in particular those with fixed rate mortgage deals coming to an end,” she said.

“With consumer price inflation remaining stubbornly high, markets are pricing in several more rate rises that would take base rate above 5% for the first time since the start of 2008. Those expectations have led fixed mortgage rates to start rising again across the market.”

Inflation is at 8.7%, down from a 41-year high of 11.1% in October last year, according to the latest official figures published by the Office for National Statistics.

House prices are expected to fall further, Ms Kinnaird said, adding: “This will inevitably impact confidence in the housing market as both buyers and sellers adjust their expectations, and latest industry figures for both mortgage approvals and completed transactions show demand is cooling.”