Era of booming house prices ends as central banks raise rates | Larry Elliott


Iit’s over An era of ever-increasing house prices fueled by cheap money is coming to an end. Central banks created a colossal real estate boom and will soon have to deal with the consequences of the bubble bursting.

This is already happening in China. Banks in the world’s second-largest economy have orders to bail out property developers so they can complete unfinished projects. Mortgage boycotts are on the rise because people, not surprisingly, are unhappy about paying home loans for properties they can’t live in.

New property sales have fallen and new home starts have almost halved from pre-pandemic levels, spelling trouble for heavily indebted property companies, the banks they borrowed from and the economy as a whole. The property sector accounts for about 20% of China’s gross domestic product. Rising housing prices are now a thing of the past.

The US economy shrank for a second straight quarter in the three months to June, and one factor was a rapid slowdown in the housing market. In the two years since the start of the coronavirus pandemic in spring 2020, US home prices have soared, rising 20% ​​in the year to May. But the market is cooling quickly, with the average price of new homes falling sharply in June.

Residential construction in California, USA
The US housing market is cooling. Photo: Mike Blake/Reuters

Britain seems to be bucking the trend. According to data from Halifax, the country’s biggest mortgage lender, house prices are rising at an annual rate of 13% – the highest in almost two decades. And here the picture changes.

Last week the Office for National Statistics released data on housing affordability, based on the ratio of house prices to median incomes. In Scotland and Wales the ratio was 5.5 and 6.0 respectively, below the peaks reached during the global financial crisis of 2007-09. In England the ratio was 8.7, the highest since the series began in 1999.

There were regional variations in England. In Newcastle upon Tyne, the price of an average home was 12 times the annual income of a person in the lowest 10% of incomes. In London it was 40 times, and now it is almost certainly higher. The ONS data covers the period up to March 2021, and since then house prices have comfortably outpaced wages.

There comes a point where housing simply becomes too expensive for potential buyers, but a prolonged period of ultra-low interest rates means it has taken time to reach this reality check point. Central banks have made the unaffordable affordable by ensuring that monthly mortgage payments remain low.

This is true all over the world, which is why from New York to Vancouver, from Zurich to Sydney, from Stockholm to Paris, the trend in housing prices is relentlessly upward.

At least until now. Central banks in the West are aggressively raising interest rates, making mortgages more expensive. Even before the U.S. Federal Reserve last week announced a second straight 0.75 basis point hike in official borrowing costs, a new borrower taking out a 30-year fixed home loan was paying an interest rate of about 5.5 percent — double the rate a year ago. -early. This increase explains why fewer Americans are buying new homes and why prices are falling.

In the UK, the Bank of England cut interest rates to 0.1% at the start of the pandemic and left them there for almost two years. This allowed homebuyers to take out term mortgages at extremely competitive rates, which reached a low of 1.4% last fall. But since December last year the bank has been tightening policy and those mortgages will rise when fixed terms expire. Average interest rates on home loans are now 2.9%.

Central banks say the highest inflation in decades means they have no choice but to tighten policy – but they are doing so at a time when major economies are either in recession or headed for one. The toxic mix for house prices is rising interest rates, collapsing growth and higher unemployment. Of these, only the latter is missing, but if the winter is as bleak as politicians expect, then it is only a matter of time before the aid queues get longer.

Last week, the International Monetary Fund released forecasts for the global economy that were decidedly gloomy. Noting that all three of the main engines of growth – the US, China and the eurozone – are stalling, the fund said risks are heavily skewed to the downside.

According to the IMF, in the last half century there have been only five years when the world economy grew by less than 2%: 1974, 1981, 1982, 2009 and 2020. The complete shutdown of Russian gas supplies to Europe, stubbornly high inflation or debt crisis were among the factors that could lead to 2023 joining this list. A global housing crash would ensure that this is the case.

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That’s not to say there aren’t good reasons to want to purge the excess from the property market. Skyrocketing house prices discriminate against the young and the poor, misallocate capital into unproductive assets, and add to demographic pressures by discouraging couples from having children.

However, central banks are trying to perfect a soft landing, where the downturn is short and shallow and the rise in unemployment is enough to ease upward pressure on wages, but still modest. A collapse in house prices is not part of the plan because it would ensure a hard landing.

There is no appetite for a repeat of 2007, when the US subprime crisis triggered a near-collapse of the global banking system and led to the last major recession before the pandemic. That’s why the Chinese government is trying to support developers and why Western central banks may stop raising interest rates sooner than financial markets expect. We’ve been here before.

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