July 21, 2024

Housing Finance Development

It's Your Housing Finance Development

House Prices Continue to Fall as Borrowing Costs Rise

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.

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 the imbalances between demand and supply.

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