Cooling housing markets will prevent interest rate rises

Housing markets in certain developed economies are beginning to lose steam, prompting worries that house prices might see corrections, especially in countries where they had been overheating.

“Secret” contributors to the rise in house prices in big cities in the West were the Chinese investors. A couple of years ago, I wrote an article arguing that the relaxation of Chinese capital controls for companies three years before had led to increased investment in Western housing markets by Chinese investors.

It is difficult to say exactly how badly these markets rely on Chinese investors, but we could be about to find out. These investors may be individuals buying a couple of flats here, a couple there, or they may be companies investing in other companies investing in property markets.

The relaxation of capital controls in 2013, which I mentioned in the article about Chinese investors blowing up a gigantic housing bubble in the West, allowed companies to lend money in renminbi to their offshore branches, without any limit and without an obligation to first notify regulators.

This started a flight of capital out of China and into Western property that Chinese authorities tried to slow down last year, when they put limits on the investments in offshore property that Chinese entities are allowed to make.

The consequences are beginning to show. Chinese real estate investment in the first quarter of 2018 was the lowest in three years, according to the Financial Times, which wrote that outflows fell 27% year on year to $5.6 billion in that period.

This has been reciprocated by house prices, which have peaked in many former global hotspots. In London, for instance, for the sixth consecutive month, significantly more real estate agents reported falling prices than rising ones, according to the Royal Institution of Chartered Surveyors’ monthly poll.

Other cities face the same problem. Sales of homes costing more than C$1 million ($760,000) declined by 46% in Toronto and by 19% in Vancouver from a year earlier, according to a recent Bloomberg report. Manhattan, one of the biggest property hotspots three years ago, has seen the average home price fall 8.1% in the first quarter of this year from the fourth quarter of 2017.

Stockholm house prices were down 0.1% in the first quarter of this year, according to a Knight Frank report quoted by various media. House prices in Sweden have seen tremendous growth, helped by underinvestment in the housing sector and exceptionally low interest rates.

And this is where the risks lie. If the house price bubbles in various advanced economies had been caused only by the Chinese investors’ eagerness to invest, the danger would be smaller than it currently is. But right now, besides the retreat of important foreign investment, former property hotspots will also have to face the consequences of a decade of lax monetary policies.

Interest rates have been so low for so long, that a whole generation is growing up without ever having experienced a 5% rate. Even 4% looks too high to many people. In the UK, the Bank of England still keeps interest rates at 0.5%, despite inflation exceeding 2% — this is a real negative interest rate of 1.5%.

It has been clear for a long time that central banks can ill afford to “normalize” monetary policy. Debt has become so prevalent (and a lot of it because of the rise in house prices caused by their use as investment and by low interest rates) that to increase rates now would be economic suicide. So many people would find themselves unable to pay back their mortgages, that the housing market would collapse, taking the economy with it.

The Bank of England has finally admitted this in comments made by Jon Cunliffe, Bank of England deputy governor for financial stability, during an event at the Cumbria Chambers of Commerce.

“If, as seems likely, we are and will continue to be in a lower natural interest rate environment, policy rates will not approach levels seen before the financial crisis. The average level of Bank rate was around 5% for the 20 years preceding the crisis. The current yield curve sees bank rate rising slowly over three years and levelling off at under 2% for the next 30 years,” he said, according to “Mortgage Solutions.”

The big question, in this case, is what will happen if, or rather when, inflation increases so much that keeping interest rates low is no longer an option. The central banks will probably still keep rates deep in negative territory, trying to keep the housing market afloat. But it will be an increasingly risky policy.

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