ESRI: ‘House prices are above where we would predict them to be’

The Economic and Social Research Institute (ESRI) is predicting a significant slowdown in house price growth as interest rates start to rise in response to higher inflation.

The European Central Bank has already signalled that it will begin a sequence of interest rate rises from next month, beginning with a quarter-point increase in July. Markets are, however, pricing in up to 135 basis points of increases between now and the end of the year while more hawkish elements within the bank’s governing council are pushing for bigger rate hikes, up to 2 per cent in total, in a bid to rein in record high euro-zone inflation.

In its latest economic commentary, the ESRI modelled the impact of these higher interest rates on house prices here, noting that interest rates were “regarded as being an important determinant of the demand for housing”.

The ESRI said it still expected house prices to rise in the coming months as support factors such as population growth and sluggish supply persist, but said the rate of growth would be significantly slower. It estimated that a half point rise in interest rates, in the absence of these support factors, would trigger a 2 per cent decline in property values, while warning the impact could be greater if people anticipated having to absorb further increases in the future.

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“There is some element of froth or overvaluation in the market at present,” the ESRI’s Kieran McQuinn said, noting that the pandemic had led to an unexpected surge in prices, fuelled by increased savings and restrictions on construction. “House prices are above where we would predict them to be and that by definition is what we would call an overvaluation,” he said.

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House price inflation in the Republic remains red hot at more than 14 per cent but the rate of increase slowed for the first time in almost two years in March, a sign perhaps that the current cost-of-living squeeze may be dampening demand.

In its report, the ESRI said the Irish economy – despite the challenges of greater inflation, a tighter labour market and rising interest rates – would continue to grow strongly this year, by nearly 7 per cent in gross domestic product (GDP) terms and by 4.8 per cent next year on the back of strong exports from the multinational sector. It estimated that inflation – currently at 7.8 per cent – would peak at 8-9 per cent in the summer months and average 7.1 per cent for the year as a whole.

With earnings expected to grow by just 3 per cent, real incomes will therefore decline by up to 4 per cent, placing significant financial strain on households, it said. On the upside, the institute said buoyant taxes and strong growth would deliver a budget surplus this year of about €1.6 billion, considerably more than previously envisaged, giving the Government some fiscal headroom for cost-of-living measures in the upcoming budget. However, it warned its forecasts were subject to significant downside risks with the United States and the UK threatened by recession.