Europe's long-awaited economic recovery could be jeopardised if soaring house prices in some member states collapses, the European Commission warned today.
Irish, Greek, and Spanish house prices surged at a double-digit clip in 2002, with substantial, albeit smaller, property price increases also seen in Belgium, France and Italy.
Any sharp increase in interest rates that lifted mortgage repayment costs or a further deterioration in the labour market could trigger a sharp correction in house prices and act as a brake on consumption.
This could pose a key risk to the European economy, which is relying on domestic demand to pick up steam in 2004, the Commission said, echoing warnings issued in September by the International Monetary Fund.
"On the domestic side, one downside risk (to the latest EU forecasts) is represented by the effects on private consumption of a reversal in house prices in member States where valuations are very high," European Monetary Affairs Commissioner Mr Pedro Solbes told a press conference.
The IMF had cited Ireland, the Netherlands and Britain as the EU countries particularly vulnerable to a home price fall. The Commission said mortgage lending growth had been strongest in countries where house prices have risen most.
Prices had begun to decelerate in the Netherlands, whose economy is in recession, and in Ireland but both these countries as well Greece and Spain reported house price increases of more than seven per cent in first two quarters of 2003.
Despite a slight fall in September average Irish house prices have risen by around 13 per cent so far this year.
"Euro area households have continued to accumulate debt in the course of the economic downturn, mostly to finance house purchases," the Commission said.
It said there was only a low risk of households across the euro zone as a whole consuming less because of balance sheet constraints. Still, keeping up with mortgage payments will be harder if mortgage rates start rising sharply.
"The favourable impact of increased real estate prices (on domestic demand) is likely to disappear from the second half of 2003 and might indeed turn negative in case of a strong rise in interest rates," the Commission said.
The ability to repay mortgages will also be impaired if households are hit by job cuts - and the Commission expects the euro zone economy to shed more jobs than it adds for the first time in nearly a decade in 2003.