Experts Warn of Potential Disarray in Euro Zone Home Prices as Mortgage Rates Soar

The European Central Bank (ECB) recently released a report raising concerns about a potential "disorderly" drop in home prices across the euro zone. Experts are worried about the impact of soaring mortgage rates, which are making homes unaffordable for households and unattractive for investors. This, coupled with higher borrowing costs and slower economic growth, poses risks to companies, households, traditional lenders, and shadow banks.

Since July, the ECB has been steadily increasing interest rates to combat inflation. The effects of these rate hikes are starting to ripple through the property market, which experienced significant growth in the past decade due to easy credit. The report warns that as interest rates on new mortgages rise, affordability becomes compromised, and existing mortgage holders face a heavier interest burden. This situation is particularly precarious in countries where variable-rate mortgages, like Portugal, Spain, and the Baltic countries, are prevalent.

Furthermore, the ECB highlights potential challenges for regions heavily influenced by institutional investors in the residential real estate market if capital is withdrawn. Berlin, certain parts of western Germany, and capital cities such as Paris, Madrid, Lisbon, and Dublin are among the areas at risk. On a positive note, the report acknowledges that robust labor markets currently benefit households, reducing the likelihood of mortgage defaults due to unemployment.

The COVID-19 pandemic has significantly impacted housing prices globally, especially in advanced economies. Initially, low interest rates and limited property supplies drove prices to record highs. However, in recent months, many countries have witnessed price declines or slower growth. Advanced economies, in particular, have experienced a notable deterioration, exacerbated by stretched valuations before and during the pandemic.

Central banks have responded to curb inflation by raising interest rates, causing the average mortgage rate in advanced economies to more than double to 6.8 percent by late 2022 compared to the previous year's start. Continued high borrowing costs are expected to further weaken demand and prices. According to the Organisation for Economic Co-operation and Development (OECD), Canada, Australia, Norway, and Sweden are particularly vulnerable to higher mortgage payments and increased default risks due to their high household debt levels and reliance on floating-rate borrowing.

While declining housing prices are unlikely to trigger a financial crisis, they could adversely affect the economic outlook in affected countries. Notably, the current situation differs from the global financial crisis of 2008, as banks are better capitalized, and underwriting standards are generally stricter. However, the average household debt-to-income ratio remains similar to 2007, primarily driven by borrowing in economies that largely avoided the brunt of the previous crisis.

Policymakers are closely monitoring these vulnerabilities and may need to intervene in the future to mitigate potential risks. The report emphasizes the importance of continued vigilance while recognizing the potential benefits of increased affordability in countries where housing prices experienced rapid growth prior to the current monetary tightening cycle.

In conclusion, the euro zone and several advanced economies face the potential for a disorderly decline in home prices due to surging mortgage rates and rising borrowing costs. Experts caution against the consequences for households, investors, and the broader economy, highlighting the need for policymakers to manage these risks carefully. By ensuring stability in the housing market and minimizing adverse effects on financial stability, policymakers can navigate these challenges successfully.