The euro zone is heading for a turnaround in interest rates. The ECB is now pointing out noticeable consequences for the housing market. In the common currency area, real estate is already overvalued by a sixth, sometimes even by half

The European Central Bank (ECB) is warning of a price correction on the overheated housing market if mortgage interest rates rise abruptly. This emerges from the latest Financial Stability Report. According to this, houses in the euro zone are now overvalued by almost 15 percent on average and by as much as 60 percent in some countries.

The boom in the real estate market has been fueled for many years by the low interest rate policy of the ECB, as this has also kept construction financing costs low. With inflation soaring, however, the central bank is facing a turnaround in interest rates, which is likely to come in July.

According to their March forecast, the ECB’s economists expect an average inflation rate of 5.1 percent in the euro area for the current year. In 2023 it should be 2.1 percent and then drop to 1.9 percent in 2024. According to ECB boss Christine Lagarde, negative interest rates should be history by the end of the third quarter and further hikes are likely to follow. Mortgage interest rates are therefore likely to continue to rise. The ECB now calculated that inflation-adjusted house prices should fall by 0.83 to 1.17 percent for every tenth of a percentage point of mortgage rate increases.

According to the ECB, in some countries there is currently a risk that real estate prices and mortgage lending will boost each other if a bubble forms on the housing market. In Slovakia, Estonia and Lithuania there has been a sharp increase in real estate prices and a significant increase in mortgage loans at the same time. At the same time, household debt is high in relation to economic output in some countries – above all in the Netherlands, Cyprus and Greece.

The ECB reiterated its request that banks should hold more capital commensurate with their exposure to the real estate sector. The Ukraine war has worsened the conditions for financial stability. Falling asset prices cannot therefore be ruled out. If the conflict in Eastern Europe continues to escalate or the global economy falters, or if interest rates have to be tightened more than expected, there could be further corrections on the financial markets.