How quickly things can change. After nearly 18 months of above-target inflation, suddenly last month it shrank back to below the Bank of England’s 2 per cent target. The monthly decline was the steepest in five years and took analysts and investors by surprise.

The fall – which means interest rates are a lot less likely to rise again in the coming months – would usually be a welcome sign for mortgage borrowers. But the recent turmoil in global stock markets means mortgage costs may still rise.

This week saw the FTSE 100 fall below 6,000 for the first time since March, when on Thursday it experienced the biggest one-day loss in four years. Some of the biggest sufferers have been the banks. Northern Rock, one of the more aggressive mortgage lenders, saw its shares fall 4 per cent.

Banks are having to face up to increases in the cost of their borrowing. The tightening of credit availability means there is less liquidity in the market and lenders are more wary about lending to each other, as they are concerned about the quality of their credit liabilities.

Banks’ short-term wholesale lending rate – the Libor three-month rate – has risen rapidly in the past few weeks, signalling that further volatility is likely in the money markets in the coming months. The three-month Libor rate, which is used to price variable mortgage rates, jumped to 6.39 per cent this week, from 6.05 per cent a fortnight ago. This is a significant premium to consumer borrowing rates – discounted variable mortgage rates are typically on offer around the 5.5 per cent level. This discrepancy could force variable mortgage rates up unless stability returns to the markets in the near future.

Banks have recently been relaxing their lending criteria – and increasing the risk of their mortgage debt. They have been lending borrowers higher multiples of their earnings and higher percentages of property values and have been offering loans to people with weaker credit records. They can now expect to pay more for this additional risk.

No doubt they will be swift to pass these rises back to their customers. While the prospect of another increase to the base rate is less certain, the higher cost of credit for lenders means consumers may still face mortgage rate increases. Any further increases to mortgage rates could well damp the appetite for property investment at a time when already there are fewer buyers in the market.

Recent data shows that house prices have started to cool in recent months. Nationwide figures show that the average UK house price rose just £200 in July compared with the previous month. On an annual basis, average house price growth has slowed to 9.9 per cent last month – from 11.1 per cent in June. The number of loans to first-time buyers was 36,000 in June, down nearly 11 per cent compared with the same month last year.

So far the London market has remained robust compared with the rest of the country. According to the latest FT House Price Index, the average price of a house in Greater London has risen around 15 per cent over the past year.

But signs are creeping in that price growth may be starting to slow – even in the seemingly unstoppable London market. Estate agents are reporting softening demand from househunters, and a surge in properties coming on to the market. Fewer buyers means sellers have less power to negotiate high prices. A more bearish view of house prices means that the urgency from investors to enter – or increase their exposure to – bricks and mortar that was so evident last year has faded.

The real question is where markets go from here and what happens to sentiment within the Square Mile. A prolonged downturn or equity crash, which could lead to bonuses or salaries being cut or jobs being lost, would likely spill out into the property market in London and the south-east fairly quickly. Much of the recent success of property in these areas has been driven by the large amount of money sloshing around the City. And the property markets in the south tend to have a ripple effect throughout the rest of the country.

Economists have been surprised at how well property prices have held up throughout a spate of interest rate rises. Now – just as interest rates are looking a little more stable – it could be time for property’s strong rally to finally come to an end.

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