ECB pays lip service to worries about inflating a housing bubble

The European Central Bank (ECB) raised its inflation target last week, at the same time going to great lengths to try to persuade people that it did not.

In the process, the central bank also stated that it will find a way to deal with an issue that is increasingly pressing: that of runaway house price inflation.

The ECB used to aim to keep consumer price inflation (CPI) close to, but below 2%, without looking at house price inflation. On July 8, it announced that its new CPI target is a “symmetric 2% over the medium term”.

In a statement, the central bank said that “negative and positive deviations of inflation from the target are equally undesirable.”

What this means in practice is that the ECB will tolerate periods of above-target inflation in order to keep the economy afloat.

This in fact only formalises a policy that has been in place since Mario Draghi’s famous July 2012 pledge to do “whatever it takes” to save the euro as the eurozone debt crisis was in full swing.

That promise calmed investors and marked an important shift in the ECB’s policy: the euro area’s central bank shifted course to adopt the same kind of policies that the Federal Reserve, Bank of England and Bank of Japan had been implementing for a while. 

While it is true that the ECB was the last of the major central banks to start printing money after the financial crisis of 2007-2008, it has sure made up for the lost time.

Between December 31, 2013 and December 31, 2020, the entry marked “Securities held for monetary policy purposes” on the ECB’s balance sheet increased from €235.9 billion to €3.69 trillion.

But since 2020 was a special year when the central bank ramped up its asset purchases to deal with the effects of the pandemic, let’s take 2019 for comparison.

At the end of 2019, the ECB’s balance sheet showed €2.63 trillion worth of “Securities held for monetary policy purposes”. That’s an annual growth rate of close to 50% from the end of 2013.

House price inflation

House prices in the euro area have not increased at the same pace, but they have taken flight, in particular in Germany and France, the eurozone’s main economies.

An advertisment for loans in Frankfurt.

The compound annual growth in Germany’s house prices in the period was 6%. But that is a misleading figure, as house price growth only turned positive in Germany at the end of 2015, according to Eurostat data.  

Between end-2015 and end-2019, compound annual growth in house prices in Germany was almost 7%.

More and more people in the Western world are being pushed into housing poverty, and some market observers have blamed central banks’ easy money policies at least partly for the jump in home prices.

While not exactly admitting any blame, the ECB did try to address the issue. But the way it did it suggests that it only wants to be seen as tackling this challenge, rather than actually doing something about it.

“The Governing Council recognises that the inclusion of the costs related to owner-occupied housing in the HICP would better represent the inflation rate that is relevant for households,” the central bank said in a statement.

The ECB did not give details in its statement about how it would calculate the cost of occupying a home as an owner, saying that it will take years to develop a method.

However, this measure may not be the most relevant. The cost of occupying the home as an owner is likely to be low, since interest rates on mortgages have been depressed by the central bank’s purchases of bonds and negative interest rates.

But this is precisely why homes have become unaffordable: With mortgage rates so low, house prices have jumped up.

Central banks should include the rise in house prices, not the cost of owning one, in their inflation targets.