A chill is falling over housing markets around the world as central banks raise interest rates to battle inflation — rousing uncomfortable memories of the most notorious housing crash this century — 2008.
But forecasters shouldn’t fall into the trap of believing this downturn will be like the last, argues Neil Shearing, chief economist of Capital Economics.
The alarming run-up in prices, particularly in Canada, Australia and New Zealand seen during the pandemic looks very similar to the housing bubble in the mid-2000s, but the drivers are different, he said.
Back then the bubble was created by a rapid expansion in mortgage debt encouraged by “lax regulation and loose lending standards” — especially in the United States.
“When the bubble burst, homeowners found themselves in negative equity and forced selling created a self-reinforcing downward spiral,” he wrote.
This time the housing boom was driven by extremely low interest rates, brought on by the COVID-19 crisis.
Granted, as the Bank of Canada and other central banks raise interest rates they will be removing a key prop to the housing market.
Shearing said since the start of this year average rates on new mortgages have risen from 2.7% to 5.1% in Canada and from 2.9% to 5.9% in the U.S.
“There are growing signs that this rise in borrowing costs – and the anticipation of further increases to come – is already fuelling sharp downturns in housing markets across advanced economies,” he said.
Capital describes four stages to a housing downturn. First, housing market sentiment weakens, then buyer traffic declines, third, housing market activity such as mortgage approvals, sales and starts drop, and finally home prices fall.
It reckons Canada, the U.S., Australia, New Zealand, and Sweden are now in the third stage of the downturn — and the descent is happening much more quickly than it did in the 2000s.
The economists expect home prices to fall by 20% in Canada and New Zealand, whose markets are particularly overvalued, with smaller declines in the U.S. and other markets.
Nonetheless, banks and households are in much better shape to weather this downturn than they were in 2008, he said.
“A crisis on the scale of 2008 is unlikely. But a housing downturn will nonetheless cause pain for developers and the construction sector, and it’s possible that this could spill over into problems in the non-bank financial sector. Downturns have a way of uncovering vulnerabilities in areas that are difficult to anticipate,” he said.
Capital thinks the “shift from boom to bust in housing” will shave between 0.5% and 2% off GDP in the U.S., UK, Canada, Australia and New Zealand over the next couple of years, with Canada, Australia and New Zealand at the high end of that spectrum.
A declining housing market is unlikely to stop the U.S. Federal Reserve or the Bank of England from raising rates over the next year.
“But in Canada, New Zealand, and Sweden, where vulnerabilities are greater, they could mean that interest rates are not raised by as far as the markets currently anticipate,” said Shearing.
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DANCING IN THE STREET Students of the Ballet Manguinhos School practice dance movements at the Manguinhos favela in Rio de Janeiro, Brazil. About 400 students between six and 29 years old take free dance classes in Ballet Manguinhos — a kind of oasis in a neighbourhood that lives under the sway of drug trafficking and where classes are regularly interrupted by shootings. The dance school is now facing the possibility of closure due to financial difficulties. Photo by Mauro Pimentel/AFP via Getty Images
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More evidence has emerged building a case for a jumbo rate hike from the Bank of Canada later this month and this time it came from the central bank itself. The Bank’s business and consumer outlook surveys Monday showed the number of Canadians who think inflation is going to stay high for a long time has increased.
Short-term expectations of inflation climbed to the highest since the central bank began polling consumers in 2014, writes Financial Post editor-in-chief Kevin Carmichael. The median result of the survey was for inflation of 7% a year from now, about 5% in two years, and about 4% in five years.
This latest sign that inflation expectations are becoming unanchored could prod the Bank into an oversized move to prove it is serious about bringing inflation down.
Three-quarters of a percentage point is almost certain, but even a one percentage point hike is possible now, wrote Carmichael.
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