ECONOMIC RESEARCH REPORTS – In recent years, there was a broad-based recovery in Europe’s housing markets. Since the second half of 2016, a majority of EU countries are again recording annual house price increases of above 5%. The rally in prices has prompted increasing public debate as to whether EU property markets are overvalued. In general, fundamental factors, such as disposable income, interest rates and demographics, can explain much of the recent price rally seen in the EU28. The upturn can, in particular, be linked to the prevailing low interest-rate environment and, more notably, to the economic recovery that started early 2013.
Looked at from a longer perspective, house prices across Europe have shown significantly different developments before, during and after the financial crisis. Although the general trends were broadly similar, the intensity of the price movements varied strongly across the 28 countries. The explanation for this divergence is twofold. First, despite the economic and monetary integration in Europe, the performances of individual countries’ economies have varied, sometimes drastically, with sustained and often substantial differences in GDP growth figures and unemployment rates. Second, property price developments have been strongly determined by country-specific demand and supply features of the countries’ housing markets.
The main risks now facing Europe’s housing markets are likely to emerge in circumstances where there is: (1) a severe GDP growth slowdown combined with increasing unemployment, (2) an unexpectedly strong and sudden increase in interest rates, and (3) a decline in popularity of residential real estate as an investment. Based on our assessment of various valuation metrics and indicators for household indebtedness, vulnerabilities to such shocks seem the largest in Sweden, Luxembourg and Austria. The risk of an eventual price correction is the biggest in these countries, but (slight) price corrections in a number of other EU countries cannot be entirely excluded. In our view, the sustained positive growth environment will, however, provide sufficient counterweight to rising interest rates. Therefore, further house price increases, albeit at a notably more modest pace than of late, remains the most likely scenario for the coming years.
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