A world economy already contending with raging inflation, stock-market turmoil and a gruelling war is facing yet another threat: the unravelling of a massive housing boom.
As central banks around the globe rapidly increase interest rates, soaring borrowing costs mean people who were already stretching to buy property are finally reaching their limits. The effects are being seen in countries such as Canada, the United States and New Zealand, where once-hot residential real estate markets have suddenly turned cold.
It's a sharp reversal from years of surging prices fuelled by rock-bottom mortgage rates and government stimulus, along with a pandemic that popularised remote work and sent homebuyers on the hunt for bigger spaces. An analysis by Bloomberg Economics shows that 19 OECD countries have combined price-to-rent and home price-to-income ratios that are higher today than they were ahead of the 2008 financial crisis - an indication that prices have moved out of line with fundamentals.
Taming frothy home prices is a key part of many policymakers' goals as they seek to quell the fastest inflation in decades. But as markets shudder from the prospects of a global recession, a slowdown in housing could create a ripple effect that would deepen an economic slump.
Falling home prices would erode household wealth, dent consumer confidence and potentially curb future development. Animal spirits are typically tamed when people are faced with higher repayment costs on an asset that's losing value. And property construction and sales are huge multipliers of economic activity around the world.
"The danger is business and financial cycles turning down simultaneously, which can lead to longer-lasting recessions," said Rob Subbaraman, head of global markets research at Nomura Holdings. "A decade of QE (quantitative easing) has fuelled frothy housing markets and we could be entering the other side of this soon, as housing affordability is stretched and debt-service ratios could rise sharply."
Such a scenario would gum up bank lending as the risk of bad loans increases, choking the flow of credit that economies thrive on. In the US and Western Europe, the housing crash that precipitated the financial crisis hobbled banking systems, governments and consumers for years.
To be sure, a 2008-style collapse is unlikely. Lenders have tightened standards, household savings are still robust and many countries still have housing shortages. Labour markets are also strong, providing an important buffer.
"Lower prices will have a direct effect on consumer spending and the whole economy, as typically real estate makes up a significant part of households' wealth," said Tuuli McCully, head of Asia-Pacific economics at Scotiabank. "Nevertheless, as household balance sheets in many major markets remain healthy, I am not particularly worried about risks related to house prices and the world economy."
Still, the risk of a sharp drop in prices is clearly greater when there's a synchronised global tightening of monetary policy, said Niraj Shah of Bloomberg Economics in London. More than 50 central banks have raised interest rates by at least 50 basis points at one go this year, with more hikes expected. In the US, the Federal Reserve last week boosted its main interest rate by 75 basis points, its biggest increase since 1994.
Housing markets in New Zealand, the Czech Republic, Australia and Canada rank among the world's bubbliest and are particularly vulnerable to falling prices, according to Bloomberg Economics. Portugal is especially at risk in the euro area, while Austria, Germany and the Netherlands are also looking frothy.
In Asia, South Korea house prices also look vulnerable, according to an analysis by S&P Global Ratings. The report noted risks from household credit relative to nominal GDP, the growth rate of household debt and the speed of house-price gains. Elsewhere in Europe, Sweden has seen a dramatic turnaround in housing demand, sparking concern in a country where debt runs at 200 per cent of household income.
Goldman Sachs Group economists wrote in a report last week that the signals from home sales typically precede prices by about 6 months, indicating that several countries are likely to see further declines in values. A substantial cooling in housing markets is an important reason why developed economies will likely slow, according to the economists, led by Jan Hatzius.
"The very rapid deterioration in affordability and large drops in home sales suggest that a hard landing is a meaningful risk, especially in New Zealand, Canada, and Australia, although that is not our baseline given current tightness," the Goldman economists wrote.
Central banks are issuing warnings of their own. The Bank of Canada said this month in its annual review of the financial system that high levels of mortgage debt are of particular concern as interest rates rise and more borrowers are strained to pay bills. The Reserve Bank of New Zealand's semi-annual Financial Stability Report said that the overall threat to the financial system is limited, but a "sharp" decline in house prices is possible, which could significantly reduce wealth and lead to a contraction in consumer spending.
"As borrowing costs rise, real estate markets face a critical test," Bloomberg's Shah said. "If central bankers act too aggressively, they could sow the seeds of the next crisis." BLOOMBERG