Author: Vicente Nieves

Source: El Economista

Luis de Guindos, Vice President of the European Central Bank (ECB), has warned about the potential shift in the real estate market trends in the Eurozone following years of strong price growth and increased mortgage credit. Guindos has acknowledged that certain changes (expectations, interest rates, and demand) could lead to a decline in housing prices.

Interest rate hikes are pushing up the Euribor, which has now reached around 2%, rapidly increasing the cost of mortgage credit (both fixed and variable rates). This trend could dampen housing demand, which has perhaps grown disproportionately in recent years, driving up property prices. In the new financial environment, the trends of recent years in the real estate market seem vulnerable, Guindos stated in a speech in Lisbon.

Contrary to initial expectations, the COVID-19 crisis had a positive impact on housing demand and prices. On one hand, households increased the value they place on properties as housing became even more relevant due to mobility restrictions.

On the other hand, lower interest rates and liquidity injections from central banks made housing one of the few assets with high returns (deposits, bonds, etc. offered almost no return). Additionally, the savings accumulated by families during the pandemic were partly channeled into housing investments.

Now, these trends could reverse. Guindos believes that housing might be affected by the new situation: “Vulnerabilities in the residential real estate markets in the Eurozone are also increasing in light of the ongoing price increases and vigorous growth in mortgage lending,” said the Spanish economist, who also provided data. In the first quarter of 2022, housing price growth in the Eurozone was 9.8%, the highest growth rate since the early 1990s.

“However, since the beginning of the year, survey responses from households about the intention to buy a home have decreased, and banks have lowered their expectations for mortgage demand, which points to a greater potential for housing price correction,” Guindos concluded.

Although a correction in housing prices may occur, both families and banks are in a better position than in 2007 to handle this ‘shock’. Banks’ balance sheets are stronger than in the past and are less exposed to real estate credit. Meanwhile, household debt, at least in Spain, is much lower than in 2007. Thus, the economy seems better prepared to handle a possible housing correction.

More Interest Rate Hikes

Additionally, Guindos emphasized during his speech the prioritization of interest rate hikes and inflation control over the risk of a recession. It is evident that tightening monetary conditions is accelerating the arrival of a new recession, but in the current situation, it is more important to bring inflation back to the target (2% annually) and maintain the central bank’s credibility.

The path to normalization (achieving the neutral interest rate) is long, so the ECB will continue raising interest rates in upcoming meetings. Despite last week’s historic rate hike (75 basis points in the three key rates), monetary policy remains accommodative, meaning it still stimulates aggregate demand.

Therefore, Guindos insisted that “with inflation at record levels, such an accommodative monetary policy stance is no longer appropriate… In this context, we decided to raise interest rates by 0.75 percentage points at our Governing Council meeting last week. This significant step anticipated the transition from a highly accommodative level of interest rates to levels that will ensure the return of inflation to our medium-term target of 2%,” Guindos stated.

The Vice President prepared the ground for further interest rate hikes even in the event of a recession. Guindos stressed the importance of returning inflation to 2% even in a context of economic slowdown.

“It is true that we are not in a classic overheating episode driven by demand, and that energy remains the main factor behind inflation and the slowdown in growth. But with the current low level of interest rates, monetary policy remains accommodative, which supports demand and ultimately also contributes to price pressures,” the Vice President said.

“With inflation at record levels, such an accommodative monetary policy stance is no longer appropriate. Additionally, we must ensure that inflation expectations remain well-anchored until the current shocks pass to facilitate the return of inflation to our medium-term target,” Guindos concluded.