Higher for longer means bottoming out later

About a year ago, the European Central Bank (ECB) engaged in the most aggressive interest rate hike cycle since the start of the monetary union. Interest rates for housing loans have also shot up, financing costs have risen significantly and demand for housing loans dropped sharply. While the economic outlook has weakened lately and there are increasing signs that the monetary policy transmission is working, the fear of pausing too soon is currently greater within the ECB than the fear of doing so too late.

We expect the central bank to raise policy rates by 25 basis points at both its July and September meetings. As a consequence, capital market rates will move up slightly and will only start to stabilise or begin to come down at the end of the year. Demand for housing loans will therefore be dampened for longer and may also follow a similar pattern.

Rising interest rates drive affordability to historically low levels

The recent rise in interest rates has made a significant impact on the affordability of residential real estate, putting a heavier financial burden on prospective homeowners. The sharp rise in energy prices last year exacerbated the situation, leaving families with less money for mortgage payments after paying their energy bills. Consequently, many people chose to postpone their purchase plans, leading to a noticeable drop in demand for credit and downward pressure on house prices. Since interest rates will remain higher for longer, it seems likely that mortgage rates will increase somewhat further in the second half of the year, putting additional pressure on affordability.

Several factors partially mitigated the negative effects of rising interest rates on the housing market. These include a tight labour market, a pick-up in nominal wage growth after a sharp fall in real wages last year, an extension of average loan maturities and the implementation of government support measures. The sharp fall in energy prices also took some pressure off as households had to spend a smaller proportion of their income on their energy bills.

In some eurozone countries, house prices fell significantly from their peak levels. Those positive drivers, however, only offset part of the negative effect of interest rates this year. In our view, housing affordability is expected to remain low throughout 2024, mainly due to a ‘higher for longer’ interest rate environment.