House-buyers would be prudent to contemplate a doubling of the cost ofborrowing money, writes Colm McCarthy
The Central Bank has again expressed concern that continuing house-price inflation could end in tears. In yesterday's Quarterly Bulletin, Bank staff did not predict that house prices will fall for sure: indeed their analysis did not contain any specific forecast for house prices.
The Bank's argument is that the balance of risk has shifted, and the probability of a disruptive correction in the residential property market has risen, which is not quite the same thing as predicting that it is going to happen.
Three main factors have shifted the balance of risk. The first is the run-up in prices itself. The Central Bank would clearly have been pleased if prices had already reached a plateau, but they have not, and the longer the price surge continues, the greater the risk of a reversal.
Second, interest rates are at, or very close to, the bottom of the cycle. It is, of course, possible that they could fall a little more. But it is highly likely that, the next time the euro zone economy heats up, the European Central Bank will increase its base rate from the current 2 per cent to 5 per cent or even 6 per cent.
That was the pattern when the German Bundesbank led European rate-setting in the pre-euro period and it has tended to be the pattern in the United States also. It is worth recalling that less than three years ago the base rate in the US was 6.5 per cent, versus today's 1 per cent.
Retail mortgage money costs about 3.5 per cent to the borrower in Ireland today. At some stage through the next cycle, it would be prudent to contemplate retail money at about double this cost, allowing for the lenders' margin. That would mean sharply higher repayments, and quite likely a heavier incidence of mortgage arrears.
Hence the lectures from the Central Bank about prudence in lending. My guess is that European interest rates are not going up any time soon, given the weakness in the main continental economies, but in 2005 or 2006 a run-up in rates is certainly possible.
Finally, the Irish economy is still looking rather flat, redundancies and the unemployment rate have risen and the labour market is off the boil. So household incomes are not as buoyant as they were, and consumer confidence has weakened. A weak labour market is invariably associated with softer house prices.
Aside from wishing that the price surge abates quickly, all the Central Bank can do is urge caution on lenders, and this it has been doing. But the Government can do more, particularly in regard to the cost of building land. Because interest rates are currently so low, high house prices have not translated into a really acute affordability problem.
A couple with two incomes totalling €50,000 do not face insuperable difficulties in servicing a loan of, say, €150,000, where the annual interest bill is now about €5,250. But if rates increased a few per cent, things would be a lot tighter. This is likely to happen at some stage through the next cycle, and affordability will be a hotter political potato than it is at present.
What Government can and ought to do is loosen the very restrictive zoning laws. It is a myth that development land prices are determined in a free market. The market is heavily regulated through the planning system, and a wholly artificial scarcity is created. In many US cities which are growing at Dublin-style rates, land prices (and hence new house prices) tend to be lower, because there is permissive zoning.
It is interesting to speculate on the shape our cities and towns would have taken, and on the housing market which would have emerged, if the 1963 Planning and Development Act had never been passed.
It is arguable that cities and towns would be more compact, that houses would be cheaper, that long-distance commuting would be far less prevalent, and that public transport would be more cost-effective.
The town planners would no doubt argue that the built environment would be uglier, and perhaps it would. But it is not tenable to maintain that Irish-style restrictive zoning is costless.