Europe’s overvalued property market may fall if rates rise

The euro zone’s overvalued property market may collapse if mortgage rates rise faster than inflation, exposing debt-fueled bubbles in some countries, the European Central Bank said today.

In its Financial Stability Review, the ECB also warned of further declines in asset prices if the economic outlook deteriorates as a result of the war in Ukraine or if inflation turns out to be much higher than expected.

House prices in the euro zone have been on the rise for years, even accelerating during the coronavirus pandemic as the ECB’s own ultra-loose policy pushed mortgage rates below zero after removing inflation.

The ECB, which is set to raise its main interest rate in July for the first time in a decade, estimated that homes in the euro zone were now overvalued by nearly 15% on average and as much as 60% in some countries, according to the ratio between prices and income.

It warned that home prices could fall between 0.83% and 1.17% for every 10 basis point increase in mortgage rates after adjusting for inflation.

“A sharp rise in real interest rates could induce house price corrections in the short term, and the current low level of interest rates makes substantial house price reversals more likely.” “, the ECB said in its semi-annual FSR.

He warned of a “price lending spiral” in some countries’ residential real estate markets.

Slovakia, Estonia and Lithuania showed the fastest growth in both residential property prices and mortgage loans.

The highest household debt relative to GDP was recorded in the Netherlands, Cyprus and Greece.

However, homeowners are not the only potential victims of higher rates, as the ECB also flags indebted governments and companies, as well as low-income households, as vulnerable.

The ECB repeated its call for restrictions, such as telling banks to hold more capital against their property exposure, but warned any move must be weighed against headwinds from a growing Russian invasion of Ukraine, which fuel became more expensive.

He said the conflict had worsened financial stability conditions and further declines in asset prices could be at stake.

“Further corrections in financial markets could be triggered by the escalation of the war, including by weaker global growth or if monetary policy needs to be tightened faster than expected,” the ECB said.

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