Fears of property price bubble grow in eurozone

FRANKFURT - While fears of a property price bubble seem to be abating in Britain, they appear to be on the increase on mainland Europe, with central banks, and the ECB in particular, sounding the alarm as house prices surge in countries such as France, Spain and Italy.

Earlier this month in its January monthly bulletin, the European Central Bank warned for the first time in relatively strong terms about the possible emergence of a property price bubble in some eurozone countries. And the bank's concerns were reiterated by ECB President Jean-Claude Trichet. "The combination of high excess liquidity and strong credit growth could in some countries become a source of unsustainable price increases in property markets," Trichet told the guardian of the euro's regular monthly news conference.

Such remarks suggest that alarm bells are beginning to ring in the ECB's Eurotower headquarters in Frankfurt, analysts said. "It is clear that the ECB is increasingly watching" the property market, said Bank of America economist Lorenzo Codogno. And with house prices already driving policy changes at central banks such as the Bank of England and the Norwegian central bank or Norges Bank, the ECB could also take housing prices more into account in future, economists said.

"Rising house prices and the associated indebtedness have already had an appreciable influence on monetary policy at the Bank of England and the Norges Bank," said said UBS economist Edward Teather. "Moreover, housing market developments are beginning to feature more strongly in ECB rhetoric." Indeed, "house price inflation and the credit growth behind it may be about to influence the direction of ECB policy rates," Teather suggested. Spain, the Netherlands and Ireland were the main focus of concern, since house prices there have doubled between 1995 and 2003. But France and Italy are also a worry, since property prices in those two countries have also risen by 50 percent, UBS calculated.

Low interest rates are behind the development, since they persuade consumers to borrow to become owners of their own homes. But as house prices become increasingly speculative and disconnected from the economic fundamentals, some economists are worried that a property price bubble could be emerging. And if that bubble bursts, it could trigger a property crash, which would have dire consequences both for households, which would be saddled with negative equity, and banks which use the properties as security for loans. Bank of America economist Codogno insisted that there was no danger yet of a euro-area wide bubble. The property market in Germany, for example, has been depressed for a number of years.

In Spain, on the other hand, the government announced last week it was seeking to put the brake on house prices by putting on the market a total nine million square metres in real estate belonging to the army which would then be used to build new housing. In Ireland, the central bank is concerned about the high level of household debt, with property loans accounting for 80 percent of overall indebtedness, double the ratio 10 years ago.

Last autumn, Bank of Ireland chief John Hurley warned that if prices continued to notch up double-digit growth rates "there will be an increased risk of a big correction." And the Bank of France, too, found in a study published Monday that the rate of growth of price prices was "barely sustainable", even if the national real estate federation thought a soft-landing in the sector was more likely. By contrast, house price inflation in the Netherlands has slowed substantially since 2001.

Given the divergent trends, the ECB would have little room to act, said Codogno at Bank of America. It would continue a course of verbal intervention, rather than raise interest rates to put the brakes on prices, since tighter monetary policy could run the risk of choking off the fragile economic recovery. But UBS economist Teather argued that runaway property prices would prevent the ECB from lowering its key rates to kick-start economic activity. "House market developments will be a key reason why ECB policy rates will remain on hold rather than be lowered in the periods ahead," he said.

Article by: By Aurelia End - www.bday.co.za