May 29, 2022

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Columnist on the housing market: Would you dare to bet that interest rates will be lower than what Norges announced?

Columnist on the housing market: Would you dare to bet that interest rates will be lower than what Norges announced?

The Bank of Norway recently raised the interest rate to 0.75 percent and announced a number of new rate increases. The new interest rate path means that the key policy rate will be set at 1.50 percent by the end of this year, and then reach 2.50 percent in 2023.

The fixed income market believes that the key policy rate will be higher.

Marius Gunsholt Hof

Marius Gunsholt Hof (Photo: Thomas T. Klevin)

For a mortgage client, the options are very simple:

  • Put your head in the sand and take comfort in the fact that the market and Norges Bank have made mistakes before.
  • Keep in mind that the rise in interest rates will be at least as steep as Norges now estimates.

The first option is tempting. The Bank of Norway had rattled its swords before – only that it was surprised by the new shocks and turmoil, which in turn ensured that interest rates were lower than the central bank had originally envisaged. But history shows that the hypothesis does not always hold.

We’ve seen this recently in the wake of the pandemic, as Norges Bank’s interest rate plans have been quite systematically adjusted, as Terje Erikstad from DN that day.

At the same time, we can assume that at some point in the future there will be new disruptions, which in turn will lead to a key interest rate lower than what Norges Bank is now targeting. But in the long run, as we know, we’re all dead.

Meanwhile, we pay the interest and premiums.

Norges Bank is not alone in a hurry. The power and persistence of the inflation shock created during the pandemic have been underestimated by major central banks, first. It turns out that supply-side challenges are not temporary. With massive monetary and fiscal stimulus on the demand side, this has led to imbalances causing the general price level to rise.

Russia’s aggressive war on Ukraine may have done even worse damage, but it’s just an additional explanation for rising inflation.

Central banks’ reassessment is that overcoming this inflation trend is becoming more and more urgent. In order to restore a better balance between demand and productive capacity in the economy, interest rates must be set high enough to have a direct tightening effect on demand.

This tightening could also affect the housing market.

So far, we in Handelsbanken have a fairly sober and positive view of future housing prices. We assumed that the rise in wages would offset the effect of higher lending rates, with the net effect that house prices would continue to rise at a moderate pace.

If we now prefer a situation where interest rates have to be charged more, the probability of a fall in home prices increases as well.

Below, I’ve looked closely at the impact of a rapid rise in interest rates, as Norges Bank now estimates. The analysis is based on a simple model, where home prices are explained by known variables such as lending rates, population and income growth, and the supply side. rentals isolated effect Strong, see also descriptions of André Kallåk Anundsen (DN March 8).

I find that Norges’ latest interest rate path cut home prices by four to five percent, compared to the scenario in which Norges committed to its original interest rate plans from December (shown in the figure). If the market is correct that the Norges Bank will receive more than is now indicated, the negative impulse for the housing market may be stronger.

It is important to distinguish between net and aggregate effects in the housing market, Anundsen has also well argued. The calculation I just referred to only gives a picture of the isolated house price effect that follows from the Norges Bank upward adjustment of interest rate plans. But there are clearly other factors at play as well, which make me believe in a softer landing for the housing market: household wage incomes are on the rise, as well as the fact that housing construction remains low, to name just a few of the obvious candidates.

However, the risks of falling home prices should not be ignored.

At Norges Bank, they themselves believe they are raising interest rates at a slower pace than they would otherwise. But we note that they still assume that house prices will fall next year. If we do see a decline in the housing market, it is not inconceivable that the Norges Bank will slow the rate hike.

If we get a situation where interest rates have to be charged more, the probability of a fall in house prices also increases


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