House Prices Continue To Fall As Borrowing Costs Rise – Analysis

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Global housing markets are retreating after years of steady gains. The Chart of the Week shows widespread declines in inflation-adjusted housing prices for two-thirds of the countries with recent data from the Organisation for Economic Co-operation and Development.

On the retreat

Two-thirds of the economies for which the OECD tracks housing prices saw declines for their most recent quarter of available data.

The moves underscore how housing markets are adjusting to rising interest rates as central banks try to contain inflation. Policy rates have increased on average by 4 percentage points across major economies, to levels that prevailed prior to the global financial crisis. 

In the United States for instance, the Federal Reserve has increased the target rate to a range of 4.5–4.75 percent from near zero a year ago, the fastest pace of rate increases in two decades. This in turn led to a sharp increase in the average 30-year fixed mortgage rate, which rose to a two-decade high of 7.1 percent late last year.

Interest rates play a critical role in driving house prices, along with income and population growth on the demand side and various supply factors like construction costs and regulations. A rule of thumb based on cross-country evidence is that every 1 percentage point increase in real interest rates slows the pace of house price growth by about two percentage points. 

Prior to the recent tightening cycle, interest rates had been on a downward trend. Lower rates rationally led to an increase in housing demand by lowering the cost of borrowing to finance the purchase of a house or to build on to existing houses. Now the process has been thrown in reverse. Every percentage point increase in the mortgage rate raises monthly interest payments for the average US homebuyer by $100, and the impacts can be more dire for buyers in countries with a predominance of adjustable rate mortgages.  

How long the decline in housing prices continues will depend on whether the rate hikes by central banks have already curtailed inflationary pressures. The IMF’s latest World Economic Outlook update forecasts inflation to be lower this year than it was in 2022 for about 85 percent of countries. Global inflation is expected to slow from almost 9 percent last year to about 6.5 percent this year and decelerate further next year, driven by the impact that rate hikes have already had on easing supply bottlenecks. 

If central banks slow or pause rate hikes, housing prices should then see greater stability.

*About the authors:

  • Hites Ahir is a senior research officer in the IMF’s Research Department. His areas of research expertise are housing markets and forecast assessment. 
  • Prakash Loungani is Assistant Director and Senior Personnel Manager in the IMF’s Independent Evaluation Office. He is a co-author of Confronting Inequality: How Societies Can Choose Inclusive Growth (Columbia University Press, 2019)
  • Karan Bhasin is a young economist who holds a master’s degree from TERI School of Advanced Studies and a bachelor’s degree in economics from The University of London. He is presently a graduate student and is currently based out of New York

Source: This article was published by IMF Blog

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