The era of rising house prices is coming to an end as central banks raise rates. Larry Elliot

it’s all over. An era of soaring home prices driven by cheap money is coming to an end. Central banks created a huge real estate boom and soon they will have to face the consequences of the bubble’s sting.

This is already happening in China. Banks in the world’s second largest economy have been ordered to bail out property developers so that they can complete unfinished projects. Mortgage exclusion is on the rise because people, surprisingly, are unhappy with paying home loans for properties they are unable to occupy.

Sales of new properties have fallen and new housing launches have nearly halved compared to pre-pandemic levels, spelling problems for heavily indebted property companies, the banks they have borrowed from and the broader economy. The property sector accounts for about 20% of China’s GDP. Rising home prices are now a thing of the past.

The US economy contracted for the second consecutive quarter in the three months to June and one factor was the sharply slowing property market. In the two years since the start of the coronavirus pandemic in the spring of 2020, US home prices have soared, up 20% in the year to May. But the market is rapidly cooling down, with the average price of new homes falling sharply in June.

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

The UK appears to be following the trend. According to data 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.

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Last week the Office for National Statistics published data for housing affordability based on the ratio of average earnings to property prices. In Scotland and Wales, the ratio was 5.5 and 6.0 respectively, well below the peak 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.

There were regional variations within England. The average home cost in Newcastle upon Tyne was 12 times the annual income of someone in the lowest 10% income group. In London it was 40 times, and now it is almost certainly higher. The ONS figures cover the period up to March 2021 and since then house prices have comfortably outpaced wages.

There comes a point where housing becomes too expensive for potential buyers, but the long period of ultra-low interest rates means it has taken time to get to this reality check point. Central banks have made affordable by ensuring that monthly mortgage repayments remain low.

This has been true around the world, which is why there has been a steady upward trend in home prices from New York to Vancouver, from Zurich to Sydney, from Stockholm to Paris.

So far, at least. Central banks in the West are aggressively raising interest rates, making mortgages more expensive. Before the US Federal Reserve last week announced a 0.75-point increase in official borrowing costs for the second time in a row, a new borrower taking a 30-year fixed home loan was paying a rate of about 5.5% – up from a year earlier. double in comparison. This increase explains why fewer Americans are buying new homes and why prices are falling.

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The toxic mix for home prices is rising interest rates, falling growth and high unemployment.

In the UK, the Bank of England reduced interest rates to 0.1% at the start of the pandemic and left them at that level for almost two years. This allowed homebuyers to take out fixed-term mortgages at extremely competitive rates, which reached 1.4% last autumn. But since December last year, the bank has been tightening policy, and those mortgages will increase when certain terms expire. 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 either in recession or moving towards that. The toxic mix for home prices is rising interest rates, falling growth and high unemployment. Only the last of them is missing, but if winter is as dire as policymakers hope, it is only a matter of time before the queues get longer.

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

According to the IMF, there have been only five years in the past half century when the global economy has grown less than 2%: 1974, 1981, 1982, 2009 and 2020. A complete freeze on Russian gas supplies to Europe, stubbornly high inflation or a debt crisis were among the factors that could result in 2023 on that list. A global housing crash would guarantee that it does.

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That’s not to say that there aren’t good reasons to purge the property market’s glut. The steep fall in housing prices discriminates between the youth and the poor, leads to mis-allocation of capital into unproductive assets, and adds to demographic pressure by discouraging couples from having children.

However, central banks are trying to manipulate into a soft landing in which the recession is short and shallow, and the rise in unemployment is enough to ease upward pressure on wages but modest nonetheless. The cost of a house is not part of the crash plan as it will ensure a hard landing.

There is no appetite for a repeat of 2007, when the US subprime mortgage crisis led to the near collapse of the global banking system and caused the last major recession caused by the pandemic. This is why the Chinese government is trying to shore up property developers and why western central banks may stop raising interest rates sooner than financial markets expect. We’ve been here before.

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