Strong recovery in Irish house prices in recent months.

Our expectation for the Irish housing market in 2023 was for a slowdown in annual price inflation rather than an outright fall in prices, based on the view that employment growth would continue to boost demand , albeit dampened by higher mortgage rates and the impact of inflation of real incomes, alongside a continuation of steady bank lending, supported by the easing of mortgage controls. That forecast has proved broadly right, although the last few months has actually seen a sharp pick up in prices, in Dublin and across the country.

The national price index, as published by the CSO, had shown modest monthly price increases over the summer but that changed in the final quarter, with prices rising by 3.6% in the three months to December. As a result the annual change in prices has accelerated again, ending the year at 4.4% . This is weaker than the 7.7% recorded in 2022 but represents a recovery from the 1.1% seen in August.

The Dublin market has been softer than elsewhere in the country, perhaps due to the interest rate impact on higher mortgage loans , and prices in the capital fell for seven straight months to May last year, with the annual inflation rate also turning negative. Again, though, prices picked up markedly from the autumn, rising by 3.8% in the final quarter, so pulling the annual change back into positive territory at 2.7% in December. House prices in Dublin City had suffered most, down by over 4% at one point, but again ended the year positive, at 2.9%.

The market excluding the capital proved more resilient, with prices still generally rising on a monthly basis, albeit at a slower pace than the previous year. The final quarter also saw stronger price growth, at 3.4%, and the annual inflation rate in December rose to 5.7% from a low of 3.3% in August. The Midlands (Laois, Offaly, Westmeath and Longford) saw the strongest price gains over the year( 7.9%) marginally outpacing the Mid West (Clare Limerick and Tipperary) with 7.6%.

Why the pickup of late? A key factor may be interest rate expectations. New mortgage rates in Ireland peaked in September and more borrowers are opting for floating rates on the belief that ECB rates will fall this year, Most borrowers still fix of course, but the prospect of lower rates no doubt helps boost buyer sentiment and Builder confidence. Consumer price inflation has also slowed , which means real incomes are now rising again after a significant hit over the second half of 2022 and the first six months of last year. Finally, the supply of new housing did rise last year , by some 3,000 to 32,700 but the housing stock per head of population is still falling,so absent a big employment shock demand will continue to outstrip supply.

Irish housing market Update December 2023

With a few months data still to emerge for 2023 it appears that the Irish housing market has performed broadly as we expected earlier in the year, with housing supply the main exception. We had shared the consensus view that completions would fall , following some weak commencement data in late 2022, but in the event the published completion figures have held up well, exceeding 22,000 in the first three quarters of the year, and we now expect a figure around 31,000 for 2023 as a whole , which would be the strongest since 2008.

Housing and mortgage demand in our model is strongly influenced by real income growth, with the change in employment a key driver. On that score the labour market proved very resilient, with employment growth likely to have averaged over 90,000 in 2023 or 3.7%. As a result household income growth was an estimated 7.5%, hence outpacing CPI inflation (6.3%) to give a modest rise in real incomes.

The strength of employment also supported mortgage demand despite a rise in new mortgage rates rates, to 4.22% at end -October from 2.60% a year earlier, with lenders finally passing on higher market rates after initially using the huge volume of excess deposits to absorb the ECB’s monetary tightening. We expect the number of mortgages for house purchase to emerge at 35.650, or 3% down on the 2022 outturn, with the average new loan rising by over 5% to €290,000 so giving total lending for house purchase of €10.3bn, marginally ahead of the previous year. Total mortgage lending, in contrast, is estimated to have fallen by €2bn, to €12bn, as a result of a collapse in switching.

The weaker growth in real incomes allied to higher mortgage rates was expected to lead to a fall in house price inflation, rather than an outright fall in prices, and that duly emerged; national house price inflation slowed to 1.1% in August, while Dublin prices were down 1.8% at that point. However prices have picked up momentum in the last few months and we expect Dublin prices to end the year in marginally positive territory, with the national index up 3%, against a 7.7% rise in 2022.

Expectations also play a role in the housing market and the perception that the next ECB rate change will be a cut may well be supporting the market now- it is noticeable that over 15% of new mortgage loans in October were at variable rates rather than the 5% or so seen in recent years. Policy measures also remain supportive, notably the Help to Buy scheme, while the Central Bank effectively admitted to a policy error by increasing the Loan to Income limit from 3.5 to 4. We also expect the supply of new housing to pick up further in 2024, to 33,000, and that should help to boost new lending for house purchase to 38,000, with a value of €11.5bn. Overall mortgage lending is forecast at €13.5bn.

Employment growth is expected to slow next year , which impacts housing demand, and with increasing supply we expect prices to remain subdued, rising by around 4% by end-2024. As noted , employment is a key driver in our model and if that were to fall the price and mortgage outlook would be very different.

Irish Mortgages and ECB rates

The ECB largely controls short term interest rates in the euro money markets, but the feed through from there to retail rates in each member state is also influenced by a range of other factors, including local banking conditions and competition. That country effect is clear from the latest figures on new mortgage rates at end-March, with a range from 2.3% to 5.4% around the average of 3.52%.

That average figure is 206bp up on the year and only reflects the change in ECB rates to February, which at that time was 300bp. Rates rose by a further 50bp in late March and by 25bp last week , so the full impact of monetary policy changes has yet to be felt.

In Ireland, the ECB tightening cycle has not to date had a major impact. New mortgage rates actually fell for most of 2022, and although rising sharply in March, by 62bp to 3.54%, still left the annual change at only 76bp, well below the norm elsewhere, with rates here now the third lowest in the EA, having been for years the highest.

Why the muted rate response here, which is all the more surprising given that two of the five main bank mortgage lenders have left the market?. The answer is twofold. One relates to the cost of funding for the remaining Irish banks, which has been dampened by huge amounts of household deposits in the banking system, standing at €151bn from under €100bn five years ago.Most are in current accounts, classed as overnight deposits, and pay virtually zero interest (0.03%). Of course the banks could have raised those deposit rates (and rates on longer term deposits are starting to inch higher) but deemed it unnecessary given the scale of excess deposits in the system( deposits exceed loans by €74b). Banks had also lost some market share to non-bank lenders, largely dependent on market funding, so utilised the competitive advantage on deposits to undercut the non-banks and regain market share. In effect, households with deposits have been subsidising new mortgage borrowers.

The ECB impact on existing loans has also been muted. The average mortgage rate on outstanding PDH loans was 3.20% in March, having risen by 74bp over the past year. Again that is low relative to the change in ECB rates, reflecting the high and growing share of fixed rates; 65% of outstanding PDH mortgage are on a fixed rate, a far cry from the position a decade ago, with less than 10% fixed.

Standard variable rates have risen , albeit modestly to 3.54%, but the biggest impact was felt in Tracker rates, linked to the ECB refinancing rate, with the average in March at 3.47% . The Tracker spread is around 1.1% so the current refi rate of 3.75% implies a Tracker rate of 4.85% over the next few months and a possible cycle high of 5.35% if current market expectations are borne out.

The Tracker mortgage share is falling steadily as new fixed loans replace maturing Trackers,and now amounts to 22% of outstanding PDH loans, which in round numbers equates to 130,000 mortgages with Irish banks. These borrowers have benefited from low ECB rates for the past decade, paying only around 1.1% for most of that time.

These published mortgage rates from the central bank relate to bank loans only, and 114,000 or 16% of mortgages are held by non-banks, where monthly reporting is not available. The central bank has just published an update, however, showing the average rate is 3.97%, so well above the 3.20% bank average. The percentage of fixed loans is much lower than the bank equivalent, at 31%, and this largely explains the differential, with standard variable rates much higher, at 5.12%% versus 3.64%. A third of non-bank mortgages are Tracker, again well above the Bank figure, or some 37,000, although the rate is actually slightly lower , at 4.25%, than the 4.37% paid by bank Tracker holders.

A very diverse picture then on mortgage rates, both across countries and within Ireland. New borrowers here have been sheltered from the full impact of tighter ECB policy by the scale of household deposits, while the impact on existing borrowers has been dampened by the high percentage of fixed loans. The losers have been those on Tracker rates, with more pain to come, albeit having benefited for years ,but the relatively low numbers involved ( 140,000 out of a total PDH figure of over 700,000) means that to date higher ECB rates have not had a big impact on the Irish economy,or indeed on underlying inflation, which is in theory the rationale behind the ECB’s actions.

Irish GDP grew by 27% over last two years

Irish GDP grew by 12% in real terms last year, following a 13.6% increase in 2021, and the average figure over the past six years is an extraordinary 9.1%. The spike in inflation in 2022 also boosted nominal GDP, which rose by 17.9% , to €502bn, from under €300bn as recently as 2017.

Exports have been the key driver of that stellar growth although the net export contribution in 2022 was more modest, boosting GDP by 2.5%, with investment spending the main engine last year, contributing 7.5%. Capital formation in total grew by 26%, including a strong performance from construction ( 10%) with a 45% surge in housebuilding. Spending on machinery and equipment also had a strong year, up 29%, with Intangibles rising by 34%. The latter is extremely volatile (it fell 57% in 2021) as it is strongly influenced by multinational spending on intellectual property and R&D, and also captured as a service import, and therefore broadly GDP neutral.

Despite the rise in inflation last year (the CPI increased by 7.8%) real consumer spending rose by 6.6%, which was the strongest increase since 2007. Real government spending growth was a modest 0.7% , following the pandemic related increase over the previous two years, while stock building was very strong, adding over 2% to GDP. GNP, which adjusts for the net international flow of profits and interest, grew by 6.7%, following a big rise in multinational profit outflows, although again over the past two years the increase in GNP is over 20%.

The CSO also produce an estimate of final domestic spending (i.e excluding all foreign trade and stock building) adjusted for the impact of aircraft leasing and multinational spending on intellectual property, and this modified domestic demand figure grew by 8.2%.

The quarterly breakdown shows the economy slowing in the second half of the year, with GDP growing by just 0.3% in the final quarter. Export growth eased substantially, to 0.4%, but the main factor dampening the GDP figure was a 46% plunge in investment sending. This also depressed imports,so avoiding a fall in GDP, and reflected declines in construction , spending on machinery and equipment and intangibles, the latter extremely large at 62%. As noted this component is volatile (it rose by 91% in q3 for example) and is likely to be the main factor behind the large revision to the q4 data, as the CSO had initially announced that GDP had risen by 3.5% in q4.

That estimate captured international attention because it added 0.1% to the overall euro GDP estimate but that now disappears, which alongside a downward revision to the German data for q4 (now put at -0.4%) means that the euro area may well have contracted after all in q4. From an Irish perspective the softer than expected final quarter will impact growth estimates for 2023, although the carryover effect is still very strong, with annual growth in q4 at 12%.

Housing Market Update: softer tone

Rising interest rate, falling real incomes and tighter credit standards have led to a turn in the international housing cycle, with the long boom now giving way to a slowdown, most notably in the US, although in most countries that as yet has not translated into large nominal price falls.

In Ireland, prices nationally are still rising but at a much slower pace; by 0.8% in the three months to December, compared to 3.4% in the same period of 2021. As a consequence the annual increase in December slowed to 7.8%, compared to 15% in the early months of the year.The trend has not been uniform across the country, however, as prices in Dublin actually fell in the final quarter, albeit by a modest 0.6%, leaving the annual change at 6%, against a figure of 9.3% elsewhere in the country, although double digit gains were recorded in the West ( 14.9%) and the Border counties ( 11.5%). .

One factor in the softer price tone was a marked increase in housing supply, with completions emerging at just shy of 30,000 in 2022, a substantial rise from the 20,000-21,000 totals seen in recent years.This also helped to boost mortgage draw downs for house purchase, increasing to 36,800 from 34,500 in 2021.The average purchase mortgage rose by 10% , to €276,000 , so boosting the total value of purchase mortgages to €10.2bn from €8.6bn the previous year. Headline new mortgage lending came in at €14.1bn , inflated by a very significant rise in switching, although the latter has no impact on housing demand nor indeed net mortgage debt. In fact the latter fell in 2022 by €700m or 0.9%, and the absence of credit growth perhaps best explains why the Central Bank eased its mortgage controls, increasing the LTI for FTB’s to 4 from 3.5.

That credit contraction alongside the huge level of household savings in Ireland left the domestic banks here with deposits exceeding loans by €89bn. As a consequence new mortgage rates only started to rise in December, five months after the first ECB rate increase, leaving Irish rates well below the EA average ( 2.69% versus 2.95%) and now the third lowest in the euro area.

The average rise in house prices in 2022 (as opposed to year-end) was 14.2% which was reasonably close to our model forecast rise of 12%. The biggest demand factor for housing is real household income and that fell last year, albeit by not as much as many anticipated it would seem (the final quarter figure has yet to be published) boosted by strong employment growth. This year will probably see a big fall in inflation so we expect a broadly flat income figure. which would be more supportive of demand. On interest rates most models tend to use the real mortgage rate , which fell sharply last year given the surge in CPI inflation, but we find the nominal rate is better supported empirically. On that basis the market is currently priced for another 1.25% from the ECB which may not all feed through to retail here but the likely increase is a negative factor for demand.

Affordability on our model deteriorated in 2022, reflecting the rise in the average mortgage, but was still below the long run average due to the offsetting impact of rising nominal incomes and lower interest rates. That changes this year, given the rate outlook, and affordability is forecast to be worse than the long run average for the first time since 2009.

Housing supply enters our model with a lag so the 2022 increase acts to dampen price growth in 2023, although we expect house completions to fall back to around 26,000 through the year, which would be supportive in 2024. That anticipated fall in supply also affects our mortgage forecasts, with new purchase loans falling to 32,500, with the value figure also falling to €9.4bn, although switching may boost the headline figure to €14.4bn, marginally above the 2022 out turn.

Expectations also play an important role in the housing market, both from buyers and developers, and that is difficult to capture in a formal way. We prefer adaptive expectations (ie. the recent price trend determines current expectations) but shocks to the economic or political outlook can materialise ( another sharp rise energy prices for example, or a larger rise in unemployment than we expect) but absent shocks we expect an average price rise in 2023 of 5%, implying a continued slowdown through the year to around 2% by December.

Double digit growth again for Ireland in 2022, 5% next year

Following the release of National Accounts for Q3 Ireland looks on course to record double digit real growth for 2022 as a whole: the annual average year to date is 11.7% and we now expect a figure of 12.4% for the full year.Moreover, thanks to higher inflation nominal GDP is likely to rise by 17% to over €500bn, from €175bn a decade ago.

Real GDP grew by 2.3% in the third quarter, following modest upward revisions to growth in the first half of the year, now put at 2.2% in q2 and 7% in the first quarter. Exports again performed strongly,. increasing by 4.8%, although this was dwarfed by a 27% surge in imports., albeit largely due to a massive increase in service imports, in turn captured by capital investment in intangible assets by the multinational sector. As such this is broadly neutral for GDP (the investment boost offset by higher imports) but is extremely volatile, not only quarterly but also in the annual data.

Capital formation actually fell in the quarter when adjusted for this multinational effect, declining by 4.6%; construction spending fell marginally but there was a 7.2% fall in investment in machinery and equipment. This was the main factor behind a 1.1% contraction in modified final domestic demand, with personal consumption barely rising (0.3%) and government consumption recorded a modest 0.3% fall.

In fact personal consumption looks to have held up well through the year , despite the hit to real incomes caused by much higher CPI inflation , largely due to robust growth in nominal disposable income, which may average over 7% in 2022, boosted by strong employment growth. We expect 6% consumption growth in 2022 and the savings ratio , although moderating, is higher (over 19% average ytd) than most expected as a result of the income growth.

We have revised up our capital formation estimate for the year as a result of the q3 outcome and now expect a rise of 23%, with a 9% increase in construction spending and a 28% rise in machinery , equipment and intangibles. The latter is also reflected in an upward revision to our import estimate, but exports too are stronger than we initially envisaged, and we now forecast a 14% increase in that component. Consequently the external sector is again the main driver of Irish GDP growth , with that export performance offset to some degree by higher multinational profits outflows, so reducing GNP growth to a forecast 8%. Modified final domestic demand is estimated to rise by 6.5%, with the recent slowdown offset by a strong carryover impact earlier in the year.

GDP growth is much stronger than earlier consensus estimates and Ireland’s fiscal position is also much more robust than initially envisaged by the Government; the 2022 Budget projected a €7.7bn Exchequer deficit , predicated on 2.6% growth in tax receipts, but by end-November the Exchequer had recorded a €14bn surplus, with receipts up 25%, with all the major tax headings well ahead of expectations. In response, the Government has put €2bn into the Reserve Fund, so reducing the surplus to €12bn. Corporation tax was expected to fall but is over 50% up on the previous year, maintaining a pattern of underestimation evident for the past decade. Ireland’s debt to GDP ratio will probably end the year below 45% and 10-yr bond yields have been trading around 45bp over Germany and as such below France and Belgium.

Inflation in Ireland may have peaked at 9.2% on the CPI measure in October, with falling fuel prices the main disinflationary factor, although the average for the year is likely to be around 8%. We expect a steady decline through 2023 with the average next year at 4.6%. This will again dampen real income growth , particularly as employment and labour force growth is slowing given the scarcity of labour, which has pushed the unemployment rate below 4.5%. We expect very modest employment growth next year and a modest rise in the unemployment rate to over 5%, and as a result project only 2% growth in real consumer spending for 2023.

House completions may surprise to the upside this year (we expect 29,000) but look on course to decline in 2023 given some of the forward indicators and we also expect total construction spending to fall by 8%, contributing to an overall 4.5% fall in capital formation, although the intangibles component can always spring a surprise. Consequently we expect modified final domestic demand to grow only marginally, by o.5%. GDP growth as a whole will again be largely determined by the export performance, which in truth seems impervious to global demand ; the annual change in exports is still strongly in double digit territory so even even with little growth through the year the average export figure for 2023 is still likely to be 8%. That assumption helps deliver GDP growth of 5%, with GNP increasing by 4%.

Housing Market Update

Following the release of recent data on housing supply, mortgage lending and residential prices we have updated our models and forecasts for the Irish housing market, including projections for 2023, summarised on the website.

We are revising up our estimate of house completions this year, and now expect a figure around 29,000, which if broadly right will be the strongest supply figure since 2008. Annual completions have been in a 20,ooo-21,000 range for the past three years and as such well below the 33,000 figure deemed by the Government to represent annual demand. Completions this year have picked up and the 7,500 figure for q3 brought the four-quarter total to just shy of 28,000, prompting our upward revision. Some analysts had reduced their completions forecasts earlier in the year, in response to the surge in housing construction costs, but that is more likely to impact supply next year.

We have also revised up our estimate for new mortgage lending. For house purchase we expect 36,500 new loans, 6% above the 2021 figure,and again another 14-year high. The double-digit rise in house prices is reflected in much higher average mortgages, and we expect that figure to be around €279,000, up from €250,000 in 2021. The resulting total figure for house purchase is €10.2bn against €8.6bn last year. Total new lending has been boosted by very strong growth in switching, which amounted to a third of mortgage loans in the third quarter. This has no effect on net lending, nor on the housing market , but is substantial now, and we expect total lending this year to rise by €4bn, to €14.3bn.

House prices are still rising but at a slower monthly pace than last year, so the annual inflation rate in residential prices is slowing, to 12.1% on the latest CSO figure (for August) from a high of 15.0% in February. We expect this trend to continue, with a December forecast of 8.0%. This would give an average figure for the year of 12.5% which is in line with our model forecast- falling real incomes act to dampen prices but offset by strong price momentum, low interest rates and the lagged impact of weak supply,as the growth in the housing stock has not kept pace with the growth in population.

The interest rate impact this year has been surprising, in that the average new mortgage rate has actually fallen since the turn of the year, despite the significant rise in market rates, which has led to significant increases elsewhere; the average new rate in the EA in September was 2.40%, 111bp higher in the year, against 2.58% in Ireland, which is 11bp lower.Consequently, although affordability has deteriorated in response to the rise in the average new mortgage it is still below the long run average on our affordability model.

Expectations play an important part in short term house price movements, albeit hard to adequately capture in modelling, and there is a risk that prices weaken more than we expect if potential buyers decide to postpone purchases given uncertainty about the outlook for inflation, employment and interest rates. On the latter we expect new mortgage rates to start to climb soon and so affordability deteriorates in 2023, to above the long run average. However, inflation is expected to slow and absent a big employment shock real household incomes will be broadly unchanged after a fall this year. On the supply side the recent commencement data points to a weaker supply total next year, and we expect completions of 25,000. This is supportive of prices but we still expect a further slowdown, with a 2% annual end-year rise expected in 2023 .New purchase mortgage lending will also slow, to €9.5bn, with the total figure ( i.e. including switching) marginally higher than 2022, at €14.5bn.

Irish mortgage rates and ECB rates

The ECB began to raise its main lending rates in July , followed by another round of increases in September with a further set expected at the October 27th meeting.The impact on Irish mortgage borrowers has not been as straight forward as many anticipated ; existing borrowers with Tracker rates have seen a significant rise but the average new mortgage rate has actually fallen this year, reflecting both specific Irish liquidity issues and an unusual set of factors affecting the pass through of ECB rates to the Euro money market as a whole.

Half of the outstanding mortgage loans of Irish banks are at a fixed rate so those borrowers will be unaffected by money market changes, at least in the short term. In terms of variable rates 60% of those borrowers (and so 30% of all borrowers) are on Tracker rates, directly linked to the ECB refinancing rate, with an average spread of 1.05%. The refinancing rate was cut to zero in 2016 , meaning that those on Tracker rates have paid extraordinarily low borrowing costs for over six years, but that has changed; the refinancing rate has risen to 1.25% and will probably hit 2% by month end, so pushing the average Tracker rate to 3.05%.

Higher ECB rates have also pushed up rates on new mortgage loans across the zone, with the average in August rising to 2.21% from 1.29% at end-2021. Irish rates actually fell over the same period, to 2.64% from 2.69%, and are now below that of Germany, illustrating that local conditions can play a significant role.

There are two specific Irish factors at work. One is the scale of excess deposits in the banking system here, reflecting a longer term upward move in the household savings ratio, the impact of the various Lockdowns on spending and the low rate of house building, with a concomitant impact on mortgage lending, the main driver of Irish bank assets. In August, Irish household deposits amounted to €147bn (from €109bn three years earlier) while in Irish headquartered banks deposits exceeded loans by €83bn (which is probably the main reason the Central Bank has eased the controls on mortgage lending)

The average interest rate on most of these deposits is virtually zero (0.02%) so domestic banks here have a significant funding advantage over the main non-bank mortgage lenders. The latter have made significant inroads in the market of late (accounting for 13% of all new mortgage lending in 2021) but are more dependent on market rates , so offering Irish banks the opportunity to regain some market share.

Ultimately higher market rates will have an impact of course but the pass through from ECB rates to money market rates is not 100%. A huge factor is the amount of excess liquidity in the euro system, which currently stands at €4,500bn, in turn reflecting the impact of ECB long term loans to EA banks (TLTRO III) and QE .Short term money market rates would therefore be determined by the ECB’s deposit facility rate, which in theory should set a floor for rates, but that is not happening; both the overnight rate (0.658%) and the one week rate (0.67%) are well below the the 0.75% deposit rate.

How to reduce that excess liquidity? For the moment the ECB is reinvesting all its maturing bond holdings under QE and so could start to reduce the amount it reinvests , as per the US Fed. Yet that might clash with their desire to prevent any further widening of the spread in long term borrowing costs between Germany and Italy or Greece. The TLTRO has a three year maturity and can be repaid earlier by banks but that too has thrown up problems for the ECB, as the terms are such that banks are unlikely to do that; the average rate paid by banks for the loans will be substantially below the rate they can earn by simply depositing the money back at the ECB (Irish banks drew down €21bn, which has been a significant boost to their profits, with French and German banks the main beneficiaries).

Modifications to the TLTRO are widely expected at the upcoming meeting, but retrospectively changing the terms of a three year loan would not be a good look for the ECB. Changing the rate charged on excess reserves may also be on the table.

The pass through from ECB rates to the market may not be 100% but its still pretty high, so further monetary tightening from Frankfurt will have an impact on retail rates. Market expectations as to the peak in rates this cycle are volatile, shifting in response to the latest inflation release (still surprising to the upside) and indicators on the real economy(pointing to a probable recession) . Longer term fixed mortgage rates will be influenced by the 5-year swap rate in the market, and although that has fallen back to 3% from 3.25% earlier this month it was below 1.5% in August. Shorter term,one-month rates are priced to rise to 3% next year. Remember that reflects expectations about the ECB deposit rate and implies a refinancing rate of 3.5% and therefore a Tracker rate of 4.55%. These market expectations may not be fulfilled of course but we probably need some short term downside surprise in the inflation figures to placate ECB hawks and not just weak economic data.

Irish Housing Market Update

House prices in the US, the Euro Area(EA) and the UK have seen strong and persistent growth in recent years, driven by similar factors- low supply relative to past experience, very low interest rates by historical standards and significant monetary and fiscal stimuli in response to the Pandemic. Monetary policy has now changed and signs of a slowdown in the housing cycle have appeared although as yet this has precipitated a softening in price momentum rather than any significant price falls.

The latest Irish residential price index illustrates the point; prices rose by 2.3% nationally in the three months to June, but at a slower pace than seen in the same period a year earlier so the annual change in prices slowed, albeit not dramatically, to 14.1% from 15.0% in March.In Dublin price inflation slowed to 11.7% from 12.5%, while the figure excluding the capital was 16% from 17.1%.

June also saw the index climb back up to the previous cycle peak recorded in April 2007, although house prices are now 2.4% above the previous high after reaching that level in March, while apartment prices are still 14% below their 2007 peak. Prices remain supported by limited supply and a big fall in the real interest rate (nominal mortgage rates on new loans have not risen year to date while the CPI has spiked) although real incomes are falling and hence acting as a negative for house prices. Prices did rise strongly in the latter half of 2021 and that base effect alongside slower monthly increases for the rest of this year may result in and end-year house price appreciation figure of around 8%.

On supply , annual completions have been around 21,000 over the past three years and the 2022 total may well pick up to around 26,000 given that the figure for the first half of the year was over 13,000, although some analysts have paired back their initial forecasts in response to the surge in construction costs. This may dampen housebuilding in the coming year rather than impact supply already under construction however.

Transactions have also picked up this year which is consistent with an increase in completions, amounting to 32,615 in the first six months of the year, against 31,405 in the same period of 2021. For the full year we expect 72,000 from 68,000 last year and 67,000 in 2019.

The number of new mortgages relative to market transactions has risen in recent years to 59% from a low of 50% in 2015 and looks on course for a similar share this year. New lending for house purchase rose to €4.4bn in the first half of 2022, from €3.5bn in the same period last year, reflecting a strong rise (10%) in the average new mortgage, to €267,000 , and a similar percentage increase in the number of new loans for house purchase, taking that total to over 16,000. For the full year we expect the latter to rise to 34,000 with a value of €9.9bn. The headline new mortgage lending figures include tops ups and switching, and the latter has risen sharply over the past few years and we expect a figure of €2.5bn in that category this year, up from €1.6bn in 2021. Overall mortgage lending is forecast at €12.6bn from €10.5bn in 2021.

As noted above new Irish mortgage rates in June were unchanged from the end-2021 figure, at 2.68%, in contrast to experience elsewhere in the EA, where rates rose fro 1.31% to 1.94%. This reflects the high level of deposits relative to loans in Ireland, allowing the main lenders to absorb the rise seen in longer term market rates. That is unlikely to continue particularly as July saw the first of what is likely to be a series of ECB rate increases. The share of fixed rates in new lending has been well over 80% in recent years and so the share of variable rates in terms of outstanding loans has now fallen below 50% so lessening the impact of ECB actions.

Finally, rents are also rising very strongly, with the CPI in July recording a 12.9% annual increase in rents actually paid by tenants. In our view employment is the key driver for rents, alongside the housing stock, and the former will probably rise by over 100,000 this year or 5%. The housing stock per head is still falling, exacerbated by a dwindling supply of properties for rent, so it is not surprising to see double digit rental increases. Employment growth may slow somewhat in 2023 as workers are scarce and on that basis we may see some easing in rent inflation, back to single digits, but absent an employment shock rents are unlikely to slow appreciably.

ECB rate rise will hurt but not as much as in the past

The first ECB rate rise in over a decade was universally expected later this year and it is now likely to be announced on the 21st July. The most recent data has led to the capitulation of the more dovish Council members, with its combination of record low euro area unemployment, another fresh high in the headline inflation rate , at 7.5%, and a big jump in the core rate, to 3.5%.

The market has been pricing in higher rates for some time although expectations are volatile and at the time of writing longer term rates have fallen from the recent highs, albeit with 1-month euribor still priced at 1.25% by end 2023, or over 1.75% above the current level. For this year, three quarter point increases are fully priced in, taking rates well into positive territory by Christmas.

Higher money market rates will eventually feed through into retail rates but the impact on Irish households may well be less painful than in the past. First, rates are much lower than at the beginning of previous tightening cycles – the average rate on outstanding mortgages is currently 2.45%, including a variable rate average of 2.16%. Second, household debt here has been falling for 14 years and is now down to 98% of household disposable income, against well over 200% at the peak of the Tiger era. Third, in the aggregate households now have far more cash and deposits than debt, with the gap widening to €54bn in the final quarter of 2021.

A fourth factor relates to the mortgage market itself which in the past was largely based on variable (floating) rate debt, meaning a relatively quick pass-through from wholesale rates to most borrowers. In recent years that has changed as around 85% of new loans are fixed, with the majority over three years. Over time, the proportion of outstanding mortgages on variable rates has fallen and is now down to 50%, against over 90% when the ECB last raised rates in 2011.

Irish fixed rates are generally on a shorter term than the EA norm and so over the next few years many will have to revert to a new fixed rate or to a variable and both are likely to be higher, although given the hit to real incomes from inflation (now 7%) a few years respite will be welcome.

Although an ECB rate increase looks inevitable now, the impact on Ireland, at least initially, will also depend on which rates the ECB choose to adjust. Short- term money market rates are currently tied closely to the ECB deposit rate, at -0.5%, and that will move up in order to push up market rates. The refinancing rate is zero and the spread between the two rates has varied historically, from 0.25% to as wide as 1%, so it is not a given that the refinancing rate will also move up in July, although on balance that appears most likely.

When the refinancing rate moves may be open to debate but not the impact here as 30% of outstanding mortgages are on Tracker rates i.e. at a fixed spread over the refinancing rate. That percentage has been falling steadily as mortgages mature (it was still as high as 50% in 2015) and the average rate has been extraordinarily low for some time (1.05%) but if the refinancing rate does rise by 0.75% by year-end that will increase Tracker rates by the same amount.

One final point . Two major mortgage lenders are leaving the market which all things equal will reduce competition for loans, although a number of new niche lenders appear to be picking up market share in terms of new lending. How mortgages are funded is key though, and the remaining banks have a huge pool of excess deposits, paying zero or even negative rates , to call upon, against other lenders who are solely reliant on market rates .Ultimately higher market rates will be passed through but the timing may vary depending on that funding mix; new Irish mortgage rates rose in March, as across the EA, but with a difference in that here new fixed rates were unchanged and the increase was in variable rates.