Irish house price inflation still building


February’s annual property price increase of 13% the fastest in nearly three years

Momentum in house prices remains broadly based

With supply improving if still inadequate, price pick-up suggests demand still strengthening

Booming demand seems to reflect buoyant economy and backlog of transactions rather than accelerating wage growth or looser credit

Irish house price inflation remained strong in February, with the annual rate of increase accelerating again to 13%. It is 34 months since house prices increased at a faster rate (May 2015 +13.7%). The pick-up in the annual rate compared to January’s 12% increase reflected strong monthly gains in the capital and across the rest of the country. As such, the momentum in Irish house price inflation remains broadly based.
The persistent upward pressure on Irish house prices reflects a continuing imbalance between buoyant demand and inadequate supply.  While a notable increase in new building and transactions will be required to stabilise prices, the nature and length of this process will also be substantially influenced by developments in demand that tend to receive notably less attention.
As diagram 1 below indicates, a sustained if modest increase in property transactions (and also in new building) in recent years has failed to dampen the pace of Irish house price inflation. In circumstances where supply and prices are both increasing, increasing homebuyer demand must be exerting a significant influence.

To assess the sustainability of current conditions in the Irish housing market and the nature of difficulties it might present, it is worth considering the relative importance of various possible drivers of the current increase in homebuyer demand. Is it largely a reflection of rapidly rising wages, looser credit conditions or a more fundamental strengthening of the demand for homes?  In the paragraphs below we look at some key indicators in this regard.  
In light of emerging concerns, it is important to note that the current strength of Irish house prices is not a symptom of a wage-price spiral. In fact, sectoral accounts data published yesterday (April 11th) by the CSO suggest some easing in the underlying pace of wage growth in late 2017 and, as diagram 2 illustrates, the correlation between  the respective trends in house prices and individual employees compensation has been very low in recent years (0.20 on an annual basis since 2006).  The diagram also suggests the gap between the pace of increase in Irish house prices and wages has widened of late in spite of a marked strengthening of the jobs market.

It is unlikely that the pace of growth in Irish wages and house prices could diverge indefinitely. The strength of house prices could generate demand for compensating wage Increases in the future, particularly as the recovery in the jobs market brings us closer towards full employment. However, the lessons of the recent crisis should still be reasonably fresh in the minds of domestic wage bargainers and evidence from abroad suggests pay growth has remained notably weaker than expected even at historically low level of unemployment, suggesting some structural constraints on pay growth. In such circumstances, it might also be expected that subdued wage growth will eventually act as a limiting force on Irish house price inflation
Of course, the effect of buoyant demand on Irish house prices could be a product of a marked loosening of domestic credit conditions. In such circumstances, larger loan amounts would simply chase Irish house prices higher. However, this doesn’t offer an adequate explanation of recent developments in Irish house prices. As diagram 3 indicates, mortgage approvals data show the average loan size for house purchase increasing at a slower pace than Irish house prices for the past ten months and has increased at a slower pace than house prices for most of the past five years.

These considerations and the particular strength of house price inflation suggest we need to consider broader drivers of demand that reflect the improving Irish economic environment as the comparison of house price inflation and consumer sentiment shown in diagram 4 below suggests.

An important consideration is that the current strength of demand reflects a logjam that has been created by the lack of housing transactions through the past seven or eight years. As the Irish recovery strengthens and spreads, this pent-up demand has now re-emerged and in light of inadequate supply is putting significant upward pressure on prices. Our upcoming spring 2018 KBC homebuyer sentiment survey will attempt to shed some light on the range of influences now contributing to this ‘bulge’ in demand.

This non-exhaustive information is based on short-term forecasts for expected developments in the economy and financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalised investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a judgment as of the date of the report and are subject to change without notice.