Housing markets around the world are shivering as central banks raise interest rates to fight inflation – bringing uneasy memories of the most infamous housing crash of this century – 2008.
But forecasters should not fall into the trap of believing this downturn will be the last, argues Neil Shearing, chief economist at Capital Economics.
The alarming rise in prices, particularly in Canada, Australia and New Zealand during the pandemic, is very similar to the housing bubble in the mid-2000s, but the drivers are different, he said.
At the time, the bubble was created by a rapid expansion of mortgage debt, encouraged by “lax regulation and loose credit standards” – especially in the United States.
“When the bubble burst, homeowners were in negative equity and foreclosures created a self-reinforcing downward spiral,” he wrote.
This time, the housing boom was driven by extremely low interest rates, triggered by the COVID-19 crisis.
Admittedly, if the Bank of Canada and other central banks raise interest rates, they will remove a major mainstay for the housing market.
Shearing said that since the beginning of this year, average interest rates on new mortgages have risen from 2.7% to 5.1% in Canada and from 2.9% to 5.9% in the US.
“There are growing signs that this rise in borrowing costs — and the anticipation of further increases — is already leading to sharp downturns in housing markets in advanced economies,” he said.
Capital describes four phases of a housing shortage. First, housing market sentiment weakens, then buyer traffic declines, third, housing market activity such as mortgage approvals, sales and start-ups decline, and finally house prices fall.
It estimates that Canada, the US, Australia, New Zealand and Sweden are now in the third phase of the decline – and the descent is much faster than it was in the 2000s.
Economists expect house prices to fall 20% in Canada and New Zealand, where markets are particularly overvalued, with smaller declines in the US and other markets.
Nevertheless, banks and households are much better able to weather this downturn than they were in 2008, he said.
“A crisis on the scale of 2008 is unlikely. But a housing shortage will nonetheless hurt developers and the construction industry, and it is possible that this could spill over into problems in the non-bank financial sector. A downturn has a way of exposing vulnerabilities in areas that are hard to anticipate,” he said.
Capital thinks the “shift from boom to bust in housing construction” will shave between 0.5% and 2% of GDP in the coming years in the US, UK, Canada, Australia and New Zealand, with Canada, Australia and New Zealand on the high end of that spectrum.
A falling housing market is unlikely to stop the US Federal Reserve or the Bank of England from raising interest rates next year.
“But in Canada, New Zealand and Sweden, where vulnerabilities are greater, they could mean interest rates will not be raised as far as markets currently expect,” Shearing said.