The era of sky-high house prices is ending as central banks raise rates | larry eliott

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

In China it is already happening. Banks in the world’s second-largest economy are under orders to bail out property developers so they can complete unfinished projects. Mortgage boycotts are on the rise because, unsurprisingly, people are unhappy paying home loans for properties they can’t occupy.

New property sales have plummeted and new home starts are down nearly in half compared to pre-pandemic levels, spelling trouble for heavily indebted real estate companies, the banks they’ve borrowed from and the economy in general. The real estate sector accounts for about 20% of China’s gross domestic product. Rising house prices are now a thing of the past.

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

The housing market is cooling down in the US. Photograph: Mike Blake/Reuters

Britain appears to be bucking the trend. According to figures from Halifax, the nation’s largest mortgage lender, home prices are rising at an annual rate of 13%, the highest in nearly two decades. Here, too, the picture is changing.

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

Within England there were regional variations. In Newcastle upon Tyne, the cost of an average house was 12 times the annual income of someone in the bottom 10% income. In London it was 40 times, and it is almost certainly higher now. The ONS figures cover the period 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 an extended period of ultra-low interest rates means it has taken time to reach this reality checkpoint. Central banks have made the unaffordable affordable by ensuring that monthly mortgage payments are kept low.

That has been true all over the world, so from New York to Vancouver, from Zurich to Sydney, from Stockholm to Paris, the trend in house prices has been relentlessly upward.

Until now, at least. Central banks in the west are aggressively raising interest rates, making mortgages more expensive. Even before the US Federal Reserve announced a second consecutive 0.75 point increase in official borrowing costs last week, a new borrower taking out a 30-year fixed-rate home loan was paying a rate of around 5.5%, double that of the previous year. That increase explains why fewer Americans are buying new homes and why prices are falling.

In the UK, the Bank of England lowered interest rates to 0.1% at the start of the pandemic and left them at that level for nearly two years. That allowed homebuyers to obtain term mortgages at extremely competitive rates, which hit a low of 1.4% last fall. But since December of last year, the Bank has been tightening the policy, and those mortgages will go up when the fixed terms are exhausted. Average home loan rates 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 slipping into or heading toward recession. The toxic mix of house prices is driving up interest rates, collapsing growth and driving up unemployment. Of those, only the last one is missing, but if the winter is as bleak as politicians expect, then it is only a matter of time before the unemployment lines lengthen.

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

According to the IMF, there have only been five years in the last half century in which the global economy has grown less than 2%: 1974, 1981, 1982, 2009 and 2020. A complete stoppage of Russian gas supplies to Europe, stubbornly high inflation or a debt crisis were some of the factors that could result in 2023 joining that list. A global housing collapse would ensure that it does.

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That’s not to say there aren’t good reasons to want a purge of the excess from the housing market. Skyrocketing house prices discriminate against the young and the poor, lead to misallocation of capital in non-performing assets, and add to demographic pressures by discouraging couples from having children.

However, central banks are trying to hone in on a soft landing where the recession is brief and shallow, and rising unemployment is enough to ease upward pressure on wages, but still modest. A fall in house prices is not part of the plan because it would guarantee a hard landing.

There is no desire to repeat what happened in 2007, when the subprime crisis in the US triggered the near collapse of the global banking system and led to the last great recession before the one caused by the pandemic. This is why the Chinese government is trying to prop up property developers and why Western central banks may stop raising interest rates sooner than financial markets expect. We have been here before.

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