Various indicators suggest that house prices are not much out of line with fundamentals in most markets. However, the critical question is whether interest rates will remain close to their historical lows. If they rise steeply, real house prices would come under downward pressure, with a risk of sharp drops.
While real house prices have levelled off in Australia since 2003, and to a lesser extent in the UK, in most countries they have kept growing or even accelerated. What are the chances of peaks being reached in these countries? OECD economists have looked at this question and have identified two scenarios. Their work shows that, except for Denmark and New Zealand, most housing markets would withstand a 1 or 2 percentage point hike in long-term interest rates at 2005 real house price levels, with a limited risk of a sharp downturn.
Actually, long-term interest rates are already up by some 50 basis points since late 2005, the reference period for these calculations. If real prices continue to rise for another year at their 2005 pace, then interest rate increases of the magnitudes considered would raise the probability of nearing a peak to 50% or more in France, Ireland, Spain, Sweden and the US.
©OECD Observer No 256, July 2006