Irma Rosenberg: The property market, the economic situation and monetary
policy
Speech by Ms Irma Rosenberg, Deputy Governor of the Sveriges Riksbank, at a seminar on the
property and rental market, Karlstad, 11 November 2005.
Picture to this speech can be found on the Sveriges Riksbank website, www.riksbank.com.
* * *
Thank you for your invitation to come to Karlstad and participate in this seminar on the property and
rental market. To begin with, I intend to speak about the property market and why it is important for us
at the Riksbank to monitor how it is developing. Then I will discuss the economic situation
internationally and in Sweden and give my view on inflation prospects and monetary policy.
The property market
Developments in the property market are important both in view of the Riksbank's function to promote
financial stability and of the monetary policy objective to maintain price stability. On account of that we
regularly monitor the situation in both the commercial property market and the housing market. That
the property market is significant for the Riksbank's stability analysis is due to the clear linkages that
exist with the financial sector. The most important is that property companies are major borrowers
from the banks. Moreover, a large proportion of bank lending is secured on commercial and residential
property. So if problems were to arise in the property market, they could spill over to the financial
sector. One example of when this happened was during the banking crisis at the start of the 1990s.
During the years 1992-93, fully 40 per cent of the banks' loan losses stemmed from the commercial
property market.
Let me begin by discussing how I view the developments in the commercial property market and then
move on to the analysis of the housing market. Because the two markets have shown completely
different developments in recent years.
The commercial property market
The equity market decline in 2000 was accompanied by a weakening in demand for office premises,
and rents and prices for commercial property began to fall as the number of vacancies rose. In recent
years, turnover of properties has risen again. Presently, the drop in prices seems to have decreased
and in some regions prices have even risen. Even though it is difficult to determine whether there has
been a definite turnaround yet in the price developments for commercial property, such a turnaround
can be expected to come when demand for labour recovers more clearly. Vacancy levels are still high,
though, which means that rents have not yet risen more generally. In the long run, a rise in property
prices should be accompanied by an increase in rental income, since rental income is the underlying
return on property investment.
The situation today differs considerably from the conditions seen at the time of the property crisis in
the early 1990s, when property prices had risen rapidly over a long period without any corresponding
upswing in rental income. At that time the price increases were driven instead by expectations that
prices would continue to rise strongly in the future. When it eventually became evident that these
expectations were not going to materialise, the prices fell quickly. Such speculative elements do not
appear to exist today. At the same time, property companies' earnings and debt-servicing ability are
good. As things stand today, the property sector will hardly cause any large loan losses for the banks
and so it does not constitute a threat either to the stability of the financial system.
Housing prices and household debt
Over the past one to two years we in the Riksbank's Executive Board have devoted quite a bit of
attention to the house market, where a rapid rise in prices has gone hand in hand with an increase in
household debt. But it is important to distinguish between the conclusions we have come to regarding
the significance for financial stability and the discussions we have had in connection with our monetary
policy decisions. I will come back to this.
That house prices have risen rapidly in Sweden and many other countries can hardly have escaped
anyone's attention. In Sweden, house prices in the past ten years have more than doubled, and the
upswing has been especially strong in metropolitan areas. Increasing house prices have been
accompanied by an accumulation of household debt. Due to the fall in interest rates, households'
interest costs have dropped, despite the rise in debt. In historical terms, households' interest costs are
currently very low. That the low interest rates have increased households' ability to take on bigger
loans is one cause of the upturn in house prices. During the summer and autumn, the rate of increase
in house prices appears to have been dampened somewhat in certain areas, but the rate of increase
is still high. Monthly data show that the annual rate of growth for the whole country during the period
July to September was 10 per cent.
The developments in Sweden are by no means exceptional. Internationally, there are examples of
countries which have seen sharper rises in house prices, such as Australia and the UK. But there are
also examples of countries where the rate of increase has been lower, such as Germany. Recently,
however, the international situation has become more mixed in that house price inflation in some
countries, e.g. Australia and the UK, has slackened considerably whereas in others, including the US,
it has continued to pick up. In Australia and the UK, the rate of house price increases dropped when
the central banks there raised key interest rates, although this occurred with a slight lag in Australia. In
the US, the rate of increase has continued upwards in spite of rises in nominal short-term market
interest rates. Longer-term rates, however, have not risen to the same extent since the Federal Funds
rate began to be raised. Because it is more common for US households to fix the interest rate on their
home loans for very long periods, they are mainly affected by changes in long-term interest rates.
Moreover, the pick-up in inflation in the US has meant that real rates of interest have not increased in
line with the rises in the Federal Funds rate.
Estimates at the Riksbank suggest that the upswing in Swedish house prices to date is largely
attributable to rising incomes, low interest rates and low construction activity. Since house prices
began to increase in the mid-1990s, nominal disposable incomes have risen by around 40 per cent
and interest rates have dropped sharply. In 1996 the average nominal mortgage rate for households
was just over 9 per cent. In June this year it was a little less than 4 per cent. Meanwhile, construction
of new homes has been very low, even though low interest rates and rising prices have meant that
construction has picked up relatively well in recent years.
My assessment is that so far there are no indications of any significant overvaluation of house prices
on average in the country at current interest rate levels. Furthermore, Sweden essentially has no
buyto-let market, i.e. a market in which private investors buy homes solely with a view to letting them. That
limits speculation in housing. The apparent absence of any marked overvaluation in the country
overall does not mean of course that house prices in some parts of the country or in some submarkets
have not been driven up more than is justified in the long term.
The fact that the price increases can be explained relatively well by rising incomes, lower nominal
interest rates and low construction activity does not rule out the possibility that the rate of increase
could slow down, or that prices could even fall in the future. The developments in these explanatory
factors normally follow the business cycle. However, the adjustment should be less drastic than in a
situation when prices have soared in a way that cannot be attributed to developments in underlying
factors.
At present, it is especially important to remember that interest rates are low in historical terms and that
they therefore very probably can be expected to rise in the period ahead. To get an idea of what
constitutes a reasonable level for interest rates in the long term, one can look at countries that have
had a floating exchange rate and low inflation for a longer time than Sweden. In the US and Germany,
for instance, key interest rates have normally fluctuated between two and six per cent. When you have
a regime with a successful inflation targeting policy I think that you normally can expect interest rates
in this range. That also makes it clear that today's repo rate of 1.5 per cent is uniquely low. So it is
important that both households and mortgage institutions take account in their estimates of the
possibility that interest rates will be higher in the future than at present. That also means that the rate
of increase in house prices cannot be expected to remain as high in the long term as it is today.
The consequences of this assessment of house price developments differ somewhat depending on
which of the Riksbank's two tasks we are talking about. As regards payment system stability, i.e.
financial stability, I do not believe that house prices and household debt pose any threat at present.
The bulk of lending to households comprises loans secured on housing. A home is part of a
household's wealth and if the value of a home or apartment were to fall, it naturally would mean that
the homeowner's ability to pay would decrease. But the household's income is not tied to the value of
its home, and as long as the household is able to meet its borrowing costs, it does not represent a
threat to the banks and the payment system.
Both higher incomes and lower interest payments have resulted in a good ability to pay in the
household sector at present. Household data estimates that the Riksbank previously has presented in
its Financial Stability Report show that most indebted households have good margins to cope with a
loss of income or rises in interest rates in the future.1 Naturally, that does not mean that individual
households could not run into problems when, for example, interest rates increase. For the banks,
though, it means that credit risk in the household sector as a whole is low. Past experience also shows
that the household sector seldom causes the banks to incur large loan losses. Not even during the
deep crisis at the start of the 1990s, when house prices fell steeply, were losses on loans to the
household sector a significant share of banks' total loan losses.
From the point of view of monetary policy, the consequences of rising house prices and high debt
levels are partly different. House prices influence, via wealth effects, households' decisions regarding
saving and consumption and thereby also demand in the economy overall. For indebted households,
the scope for consumption is also affected if the share of their income used for interest payments
changes. This is something we have to take account of when forecasting economic growth and
inflation.
If interest rates rise, interest expenditure as a share of disposable incomes will increase, which tends
to dampen consumption demand. That is exactly what you want to achieve if monetary policy is
tightened. What happens to house prices is more uncertain. In the UK and Australia, for instance,
house price inflation moderated, as I mentioned, when the central banks there began to raise key
interest rates, but there has not been a general fall in house prices. In a scenario where the central
bank begins to raise key interest rates to slow down a strong economy and market interest rates follow
these upwards, it is plausible that the adjustment in house prices may be relatively soft, with a rate of
increase that is dampened or levels off. But even a moderation of the rate of increase in house prices
could help to reinforce the tightening impact on household consumption. Historically, households'
consumption ratio, i.e. the share of households' disposable incomes that is used for consumption, has
been fairly well-correlated with changes in the value of household wealth (see Figure 1).2 Since the
equity market decline in 2000 this relationship has been somewhat less clear, but it nonetheless
suggests that house price inflation may only need to slow for the consumption ratio to drop.
The risks of a more dramatic downward adjustment in house prices would increase if economic activity
were to weaken relatively sharply and household incomes were to fall as a result. Naturally, this could
make itself particularly hard felt if the developments in house prices and debt beforehand had taken off
far too quickly and households had taken on more debt than they can manage in the long run. In that
case, we could witness a more drastic adjustment that would drive the economy into a deeper and
more protracted slump that would be difficult for economy policy to manage. This is a risk scenario that
the Riksbank's Executive Board has devoted some attention to in recent years. It is also a risk that
individual households have reason to take into account when they are about to take on new loans. So
these mechanisms are something that we have to take into account when we make our monetary
policy decisions.
The current economic situation
International economic activity still firm
International economic growth was high last year. In the latest Inflation Report in October, we noted
that the slowdown in international economic activity earlier this year appeared to have been
temporary. The oil price had turned out considerably higher than we previously expected, however,
prompting us to sharply revise up our oil price forecast. This was expected to contribute to an increase
in international price pressures and to a slight moderation of growth. These effects were forecast to be
relatively limited, however. The picture of relatively firm economic growth abroad in the coming years
was thus broadly unchanged. Consequently, Swedish export markets also were estimated to grow at a
firm pace in the next few years.
In the US, the hurricanes and oil price increases in recent months have contributed to dampening the
economy somewhat. The US Federal Reserve estimates that the rate of increase in industrial
production has been held back a couple of percentage points in August and September overall.
However, preliminary National Accounts data for the third quarter point to continued firm growth.
Households and companies have continued to boost their consumption and investment at a fairly
stable rate. The purchasing managers index for both the manufacturing sector and the services
sectors in October indicate relatively firm developments at the beginning of the fourth quarter as well.
Elsewhere in the world, too, there have been a number of positive economic signals. In October, the
purchasing managers index rose in several European countries and in Japan. The German IFO index
also showed a positive trend in October. In the UK, however, the recent economic slowdown has
continued, as shown, among other things, by preliminary GDP data for the third quarter.
Inflation abroad has turned out somewhat higher recently than we anticipated in the latest Inflation
Report. In the US, inflation rose sharply in September, to almost five per cent. Excluding energy
prices, though, it is still at roughly two per cent. The US Federal Reserve again raised the federal
funds rate at its latest monetary policy meeting, bringing it up to 4 per cent, i.e. 3 percentage points
higher than when the monetary tightening cycle was begun in June 2004.
In the euro area and some other countries, too, inflation has picked up more than anticipated recently.
Here as well the upswing mainly seems to be associated with the direct impact of high energy prices.
However, there are no real signs as yet that the high energy prices are going to have second-round
effects on prices more generally in the economies abroad.
To sum up, recent data suggest that international economic activity is developing in line with the
assessment in the latest Inflation Report. That implies continued firm growth this year and the coming
two years. Meanwhile, it seems that inflation in the OECD area will be somewhat higher than we
previously expected owing to the higher energy prices. Naturally, there are risks associated with the
international economic performance and thus that inflation could deviate from our main scenario.
However, in my opinion the risk outlook, like the main scenario, has not changed to any significant
extent either since we published our latest Inflation Report in October.
New interest rate assumption as basis for forecast
Before I discuss the outlook for the Swedish economy, I would like to make some comments on the
new repo rate assumption that was introduced in the Riksbank's forecast in October. The forecast in
the Inflation Report's main scenario is now based on the assumption that the repo rate will develop in
line with financial market expectations, as reflected in implied forward interest rates. In addition, the
forecast horizon has been lengthened by one year so that the forecasts extend three years ahead.
Such an interest rate assumption has several advantages. One is that it normally gives a more
realistic picture of future monetary policy. That makes it easier to evaluate our forecasts. It also
becomes easier to compare our forecasts with those of other forecasters. The longer forecast horizon
makes it clearer how inflation is being influenced by various temporary shocks. The reasons for the
changes are to provide a more comprehensive set of data for monetary policy and to improve the
pedagogical aspect of the monetary policy message. It is important to point out that the changes in
methods do not entail any fundamental change in the Riksbank's monetary policy strategy. Our
interest rate decisions will continue to be guided by the ambition that inflation normally should be
returned to target within two years.
The new repo rate assumption is a technical forecasting assumption, which should not be interpreted
as the Riksbank's stance regarding which interest rate path it considers to be most desirable. The
interest rate path that underpinned the forecast in the October Inflation Report was judged to imply a
reasonable development of inflation in the coming years. Our conclusion was that if this development
were to continue in line with our assessment at the time, the repo rate would need to be raised in the
period ahead. At the same time, we pointed out that there also were different conceivable paths for the
future repo rate that could give roughly the same outcome for inflation.
Growth in the swedish economy continuing to strengthen
For the Swedish economy, too, it was concluded in the Inflation Report that the economic upswing
appeared to have gained impetus again after the slowdown at the start of the year. Compared with the
previous assessment, GDP growth and resource utilisation were forecast to be somewhat higher in
the years ahead, largely owing to more expansionary economic policy. All in all, the assessment was
that growth would be relatively firm in the Swedish economy in the coming years.
The recent years' high productivity growth has partly laid the foundation for this development.
Companies have been able to boost output with their present workforces, which has improved their
cost situation and held back price increases in the economy. The low inflation rate has enabled
monetary policy to be expansionary for a comparatively long period. In addition, the high productivity
and relatively good profitability is anticipated to create scope for comparatively favourable wage
growth in the period ahead. This means that there are good prospects for firm growth in domestic
demand over the coming years. Expansionary fiscal policy will also help to boost domestic demand,
while more robust growth in Swedish export markets will contribute to stronger exports.
New information broadly supports the picture of a continued improvement in economic activity in
Sweden. The National Institute of Economic Research's (NIER) latest business tendency survey
provides a relatively bright picture of economic conditions in most of the surveyed industries. The
confidence indicator has risen for both the manufacturing and construction industries as well as for
trade and services industries. New orders in manufacturing have picked up, mainly in the export
market but there has also been a clear improvement in the domestic market. Monthly data for foreign
trade in goods also indicate an increasingly bright picture for exports. Like the developments
elsewhere in the world, the Swedish purchasing managers index for October also showed a positive
development. New data for retail sales point to continued relatively strong rises. At the same time, the
NIER's consumer survey for October provides somewhat mixed signals. Households have become
slightly less optimistic about the Swedish economy and unemployment, while their expectations
regarding their own finances have improved.
As regards the labour market, we noted in the October Inflation Report that there were signs of an
improvement in the situation. The strengthening of domestic demand and the announced measures in
the Budget Bill were judged to lay the foundation for a rise in employment in the period ahead.
However, the change in methods in the labour force surveys means that developments in the labour
market are particularly hard to interpret at present. Employment growth appears perhaps to have been
somewhat stronger than we expected in October. Developments in the number of new job vacancies
and redundancy notices also point to an upturn in the labour market. In addition, the NIER's latest
quarterly business tendency survey contained a number of positive signals regarding companies'
hiring plans.
Taken together, the new information that we have received about the Swedish economy also indicates
a development well in line with our forecast in the Inflation Report in October.
Inflation and monetary policy
Inflation in the Swedish economy has been low since the end of 2003. According to the most recent
data, for September, annual inflation in terms of the CPI and UND1X stood at 0.6 per cent and 1.0 per
cent, respectively.3 As we observed in the Inflation Report, the low inflation can be explained in large
measure by favourable supply conditions - strong competition and fast productivity growth - and
relatively low resource utilisation. At the same time, imported inflation has been restrained because
the share of imports coming from low-cost countries has risen. Imported inflation has also been held
back by the previous strengthening of the krona.
Developments in the krona exchange rate are one of all the factors that we have to consider when we
forecast inflation. It is also one of the few areas where the performance since October has deviated
considerably from what we expected at the time. Allow me therefore to comment briefly on the krona
exchange rate. For a succession of years the Riksbank has been predicting that the krona will
strengthen. This forecast has been very accurate up to the beginning of this year even though there
have been some large short-term deviations on the way (see Figure 2). During the current year,
however, the krona has weakened relatively sharply. In the markets, the focus at present seems to be
very much on interest rate differentials in relation to abroad. Personally, I find the weakening of the
krona somewhat surprising given that underlying factors such as the real economy, the relative
inflation rate and so on point to the opposite. For that reason, we also expected in October that there
would be an appreciation in the period ahead. I have difficulty seeing any reason for us now to change
that assessment in our main scenario. But a weaker krona is a risk that we have to take into account.
Were the krona exchange rate to remain weak, it would of course have implications for the inflation
forecast.
In October, as before, we forecast that inflation would rise gradually in the period ahead. Resource
utilisation was expected to pick up both in Sweden and abroad. We predicted that productivity growth
would slacken somewhat and that cost pressures would gradually become higher. Substitution in
favour of cheaper imported goods was expected to continue, but rising global resource utilisation was
estimated to mean that global price pressures nevertheless would increase slightly on the whole.
Against that background, our assessment was that UND1X inflation would rise from today's low level
and be close to the target a couple of years ahead. In my opinion, the information that has been
received since October suggests that our assessment of inflation prospects at that time is holding up
well so far. We in the Executive Board will convene for our next monetary policy meeting at the start of
December. At that time, we will also have to factor in the information that has been released up to
then.