Last week brought some news which caught my eye. On Thursday, Bloomberg told us this:

Germany’s housing boom is over as prices for residential properties dropped for the first time in over a decade.

For newer readers the significance of this is that central banking policy has been driven in the credit crunch era by house prices. Or, more specifically, they want house prices higher so they can claim wealth effects for them. In the euro area they are aided by the fact that the official inflation measure, or HICP, ignores owner-occupied housing entirely. So in theory any house price rise is officially pure gravy, as it is a real increase or wealth effect. Of course, in the real word things are different because first-time buyers face inflation, for example. But the credit crunch has taught us that central banks are not very good at telling the difference between theory and inflation. Otherwise we would not be where we are.

What were the numbers?

Bloomberg told us this:

A measure of home valuations fell in December by 0.8% from the same month a year ago, according to data released by the mortgage technology provider Europace AG on Thursday. That’s the first decline in the company’s EPX index for the month since 2009.

Their chart shows that post credit crunch house price growth was of the order of 5% per annum. Then the advent of negative interest rates and mass QE saw it rise to more like 10% and 2021 saw it push towards 15%.

What is causing this?

The drop in housing prices highlights how much the situation in the German real estate market has changed since the European Central Bank started last year to reverse a decade of low and even negative interest rates. The move has doubled or even tripled the cost of mortgages, pricing many consumers out of the once red-hot market for homes. ( Bloomberg)

That is interesting because as the ECB only raised interest rates in July we have apparently a very fast reaction function. What that fails to take account of is the fact that mortgage rates were already rising due to what was happening in the rest of the world influencing German bond yields and hence mortgage rates. The ECB has a composite mortgage rate measure which was 1.31% in December 2021, but by July 2022 it had already risen to 2.82% so more than double. So as Nelly reminded us:

It’s gettin’ hot in here (So hot)

So, in essence, we learn that there are quite a few fixed-rate mortgages in Germany and that they were impacting well before the ECB moved variable ones.

We can bring that more up to date because in the latest figures ( November) we see that the composite mortgage rate was 3.62%. So the pressure continued. Oh and there is something one might not expect which is that Germany was a fair bit above the Euro area average of 2.98%. whilst having one of the lower bond yields. I rather suspect this is telling us that it has more fixed-rate mortgages than Italy at 3.4%. As we stand those borrowing for a mortgage in Italy have been able to do so more cheaply than their government!

What happens next?

We get a fair clue from the rhetoric of the ECB itself:

ECB‘S REHN: I SEE SIGNIFICANT RATE HIKES AT THE NEXT MEETINGS. ( @financialjuice )

That was from this morning as the ECB continues its open-mouth operations. Bloomberg has summarised what the market thinks about this:

The deposit rate will be raised to a peak of 3.25% — from its current level of 2% in three steps. The survey shows two half-point hikes at the February and March meetings, followed by a 25 basis-point increase in May or June.

ECB policymaker Isabel Schnabel spoke on the 10th of January and is relevant on several counts. First she is a good weather vane for ECB opinion and second she is German. She starts with some outright hype:

Over the past year, we have moved forcefully to contain inflation by first stopping net asset purchases and then by raising our key policy rates by a cumulative two and a half percentage points.

So forcefully in fact that the deposit rate is 2% while inflation has been over 10 %. But the crucial issue is here:

We judge that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to our 2% medium-term target.

This is another confirmation (steady pace) that they intend to raise by 0.5% at the next two meetings. She takes an unusual route to this, but as central bankers have gone green it shows that she really means it:

Therefore, the green transition would not thrive in a high inflation environment. Price stability is a precondition for the sustainable transformation of our economy.

Tucked away there is, I think, a direct hint for mortgage rates:

To resolve today’s inflation problem, financing conditions will need to become restrictive. Tighter financing conditions will slow growth in aggregate demand,

We can take that forward because one of the lessons of the credit crunch was that the ECB could get some sort of control over shorter-term bond yields. Now, it took a lot of bond buying or QE, but it forced German ones in particular into especially negative territory. We see that has continued on the rise with the German two-year yield at 2.6%. So, it will presumably follow the planned  0.5% rises at the next couple of meetings with a clear implication for mortgage rates.

Comment

Actually, for once, the official series was ahead of the game:

WIESBADEN – The prices of residential property (house price index) in Germany rose an average 4.9% in the third quarter of 2022 on the same quarter a year earlier…… The Federal Statistical Office (Destatis) also reports that the prices of dwellings and of single-family and two-family houses were down by an average 0.4% compared with the previous quarter.

So we see that the price signal is now clear as in lower. As for prospects, there is the issue of the supply of mortgage finance as well. According to Bloomberg that is pretty clear as well:

The amount of new loans for house purchases in Germany dropped 30% in the four months following the decision last July to raise interest rates for the first time since 2011, according to ECB data.

Thus the overall situation looks very bearish for house prices in Germany as we start 2023. Both mortgage finance supply and price is applying a squeeze and the ECB plans to increase both. But while I welcome lower house prices as first-time buyers deserve some relief, I expect that central bankers will start to get itchy short collars as soon as we get a series of reports of house price falls. After all, higher house prices are one of the few concrete things they can claim as a response to their policies.

Thus by the summer I am expecting the ECB to be mulling the words of Tears for Fears.

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Originally published by Notayesmanseconomics’s Blog and reprinted here with permission.