By Mathias Pleissner, Director, Covered Bonds

House prices continued to be fuelled by ultra-low interest rates, a lack of investment opportunities, historically high household savings, and a desire among consumers to move into a more spacious homes fostered by government dispensations around working from home.

European house prices have been a hot topic ever since they started recovering in the wake of the financial crisis. In some countries, bubble risks were identified by some as early as 2010 but the consensus that emerged was that the primary indicators, such as household debt and debt-to-income ratios, did not indicate housing had entered bubble territory.

In fact, current levels of 4% growth in household debt are far from the 8%-9% annual growth rates seen in 2004-2008. But the trend has been rising since 2014. Strong economies such as France, Germany, Austria and Belgium have all showed debt growth well above 5%, before and during the pandemic. The debt-to-income argument seems to be gaining ground, demonstrated by the strong increase in 2020. That said, some attribute spike to short term unemployment. However, by the end of 2020, unemployment had almost moved back to pre-pandemic levels.

Inflation could stress house prices. But given the European Central Bank’s reluctance to touch rates, debt-financed house purchases will continue to be attractive, as there are few real investment alternatives. Politicians as well as European and national regulators are trapped. In the medium term, the most obvious tool to fight inflation – interest-rate rises – is not viable to countries in the euro area (and those with a currency peg). Rates will remain broadly untouched in 2022.

Fiscal policy may soften the housing boom. Higher taxation could help fight inflation but will be widely condemned, especially in light of the pandemic. Politicians may further decide to halt public investment in infrastructure as long as inflation is hot. But this does not sound like a sustainable or popular action, among other things because public investment creates jobs.

Finally, after their usage was dialled down in recent years, national supervisors may increase or re-introduce macroprudential measures. Germany had been slow to activate such measures but in its first action of 2022, BaFin asked banks to build back buffers as the property market heats up. It intends to increase the countercyclical buffer to 0.75% from February 2023 from 0% and introduce a supplementary 2% buffer for residential mortgages. We do not expect this to be a game changer but a first step to making German mortgages less attractive as long as the ECB keeps to its ultra-low rate policy. Other national regulators will likely follow.