ECB’s Historic High Rates Cause Epic Home-Price Plunge Since 2000!

Home prices. It’s a topic that often drives conversations at dinner tables, social gatherings, or even business meetings. Especially, when it comes to talking about price changes. One of the swinging factors that work behind these changes is the interest rate. Currently, Germany is witnessing a significant drop in home prices after the largest quantitative tightening (QT) and the highest rates in the history of the European Central Bank (ECB).

So let’s dive right into what’s happening in Germany’s real estate market.

The Impact of ECB Policy

The first thing to know is the relation between the ECB’s deposit rate, its balance sheet, and home prices. Since summer 2022, ECB’s deposit rate has landed at 4.0%. A stark rise from the negative 0.5% recorded in June 2022. The ECB balance sheet has also experienced a contraction. The bank has shed a whopping €1.85 trillion from its balance sheet since its peak in summer 2022. That means it has unwound approximately 40% of the assets piled up during the pandemic, which equals 21% of its total assets.

But what does this mean?

Well, essentially, when the deposit rates rise and the balance sheet decreases, the cost of borrowing goes up for consumers. Banks have less money to loan out and the cost of borrowing that money increases. When this change seeps into the home loans segment, potential home buyers pull back, triggering a decrease in demand and making sellers lower their prices.

The Steepest Drops in Home Prices in Recent History

The result of all these changes?

Germany’s existing home prices have dipped by another 1.5% in Q3 from Q2. This marks the fifth consecutive quarter of declining home prices in Germany. If we look at this on a year-to-year scale, the prices fell by an eye-watering 11.2%. The year-over-year dips in Q1, Q2, and Q3 turned out to be the steepest since 2000.

Looking back from the peak in Q2 2022, prices have dropped by 12.0%. To put this further into perspective, between 2010 and its peak in Q2 2022, the home prices in Germany ascended by a notable 104%.

The Role of Larger Economic Environment

Let’s move on to understanding the contributing factors to this decline.

In the wake of the 2008 Global Financial Crisis and the Eurozone Debt Crisis, the ECB’s policies started spinning out of control. To combat the economic downturn, the ECB manipulated its deposit rate and balance sheet, leading to low longer-term interest rates including mortgage rates. As a result, home prices in Germany more than doubled in 12 years, while the ECB’s balance sheet experienced a staggering nine times increase.

As you can see, central banks’ policies play a huge role in the fluctuation of home prices. The ultra-low interest rates and large-scale QE activities whip the home prices into a frenzy, while on the contrary, rate hikes and QT tend to tank the prices.

Although the current scenario might seem alarming to some, it’s important to remember that financial markets, including real estate, are cyclical. Ups and downs are part of any investment. During these trying times, investors need to stay informed, adhere to their investment strategy, and practice patience. After all, the greatest asset an investor can have is endurance.

Happy Investing!

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