IMF Warns of ‘Chaotic’ Corrections in Real Estate Prices in Europe

The International Monetary Fund (IMF) warned on Friday of possible ‘chaotic’ corrections in residential real estate prices in Europe, at a time when the region is grappling with high inflation containment.

In its latest regional economic outlook for Europe, the IMF stated that a downward price correction is already underway in some European real estate markets, but that their decline could accelerate as central banks raise interest rates further.

– Disorderly corrections in real estate markets could occur even if broader financial difficulties are avoided. A correction in real estate markets is already underway in some European countries, such as the Czech Republic, Denmark, and Sweden, where residential property prices fell by more than six percent in 2022 – the IMF noted.

– The decline in property prices could accelerate if markets factor in inflation risks, and financial conditions tighten more than expected. Such a price drop would have negative effects on households and bank balances – they added.

Mortgage repayment rates could also rise as central banks increase interest rates in an effort to reduce inflation. Consequently, mortgage holders could have less disposable income to spend, and in some cases, even reach a point where they could not repay those loans. Banks could also face problems in an environment where loans are not being repaid.

– Empirical models linking residential property prices to their underlying drivers indicate overvaluation of 15-20 percent in most European countries. Therefore, as mortgage interest rates continue to rise and real incomes are eroded by inflation, residential property prices have recently been falling in many markets – the IMF stated.

‘We Need to Use Monetary Policy Instruments’

Data from the European statistical office Eurostat shows a decline in residential property prices for the first time since 2015. In the fourth quarter of 2022, residential property prices in the EU fell by 1.5 percent compared to the previous three months.

– General issues with residential property prices are present in all areas, not just in high-debt countries, and they need to be addressed through oversight. They should be addressed through stress tests, and they need to be monitored very carefully – said Alfred Kammer, director of the IMF’s European department, to CNBC in Sweden.

At the same time, the IMF called on the European Central Bank (ECB) on Friday to continue raising interest rates until mid-2024, and for EU finance ministers to tighten fiscal policy in a coordinated effort to reduce high inflation.

The head of the IMF’s European department, Kammer, stated at a press conference ahead of the EU finance ministers’ and central bank governors’ meeting that inflation is the biggest concern.

– Our main recommendation is to defeat inflation, which means we need to use monetary policy instruments. For the ECB, this means further tightening, tightening for a longer period, we estimate until mid-2024, in order to bring inflation down to the targeted level somewhere in 2025 – said Kammer.

– Inflation is a tax, especially for the poor, and this needs to be addressed – said Kammer.

In March, annual inflation in 20 eurozone countries was 6.9 percent, but core inflation, which excludes large fluctuations in energy and food prices, was even higher at 7.5 percent.

To bring inflation down to the targeted level of 2 percent, the ECB is aggressively raising interest rates, having increased them from zero in mid-2022 to 3.5 percent at the March meeting, but few in the markets expect tightening to continue after 2023, Reuters notes.