10 minute read
Property markets for ever?
Klas Eklund, Senior Economist, Mannheimer Swartling
A year ago, the global outlook was bleak. All regions were slowing down and geopolitical uncertainty was on the rise. But central banks saved the day. New monetary expansion put a cushion under most economies, and over the past few months, signs of a trough and possible upturn have been visible. Property markets have continued to climb, in the Nordic countries as well as worldwide. Yet there are uncertainties: Is there a risk of new bubbles? And what will the effects of the Corona virus be? However, rates remaining low for long will constitute a strong force which will continue to support property markets.
Global economy bottoming out In the autumn of 2019 and the beginning of 2020, most economic forecasters lowered their global growth forecasts for 2020. But none projected an outright recession. The consensus has rather been that the global economy would gradually start to pick up by the end of 2020, albeit slowly. One important reason is the renewed strong expansionary policy from big central banks. In 2019, first the Federal Reserve and then a number of other central banks cut their key rates and increased the size of their liquidity injections. The ECB even launched an open-ended new phase of quantitative easing – the liquidity injections were to continue as long as needed. Given that the ECB’s own inflation forecast says inflation will remain below target for another two years at least, that means aggressive easing for the foreseeable future. As a result, market rates fell to record-low levels. After recession fears receded, they rose slightly but remain historically low.
In the US, GDP growth has gradually slowed to around 2 per cent. Not bad, after the longest expansion in American history. Unemployment is now the lowest for over half a century. But it must be conceded that the expansion has been supported not only
by monetary policy, but also by a very loose fiscal stance, resulting in a large government debt.
The Eurozone is stagnating, with German manufacturing in recession. The automotive industry is struggling with the effects of the trade war and new environmental regulations. Japan is suffering from zero growth, with zero rates and booming debt. Inflation has been low in most places, although China has experienced temporary bouts of pork price hikes.
Risks That was the situation in January, when the Corona virus struck. So far, the virus has been mainly confined to China, but it is still too early to put specific numbers to the economic effects. What is clear, though, is that Chinese growth during H1 2020 will take a hit. The quarterly numbers will probably look abysmal. Since China is the shop-floor of the world as well as the largest consumer market, global supply chains will be negatively affected. Several neighbor countries will also suffer, but direct effects on Europe and the US will be small. Production may rebound during H2, unless virus contagion will continue to spread outside China. But at the time of writing, it is impossible to quantify such effects.
Other geopolitical risks are, of course, also present. The first step in the Brexit process has been taken, and in that sense, uncertainty has diminished. However, the negotiations over the future trade agreement are likely to be messy. There are obvious conflicts between the UK position on the one hand, and the EU’s unwillingness to allow the UK to cherry-pick. The UK also wants a special relation with the
US, but American and European regulations and standards differ, which may cause problems. The American presidential election may cause even stronger polarization with accusations of a rigged outcome. Should President Trump be elected for a second term, we may well see a further dismantling of the global governance system.
The trade war may seem as though it has been put on hold, courtesy of the “First phase” agreement between the US and China. However, from an economic point of view the deal is a disaster. Bilateral talks are disrupting the multilateral global trade system; China will not be able to reach the import targets without blows to other exporters; and the impasse in the tariff war is less important than the strong escalation of the technological rivalry over 5G standards and the development of AI. A “decoupling” of standards is taking place, breaking up global supply chains and putting pressure on European companies to pick sides. As a result, productivity will suffer.
Low inflation, low rates – and booming real estate Unemployment has fallen in most Western countries. However, wages and inflation have not responded. The old inverted relation between unemployment and inflation – the Phillips curve – has turned flat. This could be because of a number of structural supply shocks – globalization, digitalization, weakening unions – which have made inflation permanently low; or it could be that these shocks are temporary, and that further demand stimulus actually would revive inflation. Here, the jury is still out. But most, if not all, forecasters now believe that low inflation will persist, at least for the foreseeable future.
Financial markets obviously are believers. Bond yields, both real and nominal, are historically low. As a result, the past year has been good to stocks and real estate. With stock market valuations starting to look stretched, asset managers have loaded up on property, and real estate is now the world economy’s biggest asset class. Property prices have picked up again.
This is what we should expect in a low-inflation, low-rate environment. And most strategists have interpreted recent moves from central bankers as though monetary policy will remain expansionary for a long time. Should any recessionary threats arise, e.g from the Corona virus, they expect key rates to be lowered even more.
That could indeed happen. But low or negative interest rates are not very effective as a weapon against supply side shocks. The main tool used for stabilisation thus remains fiscal policy. Here, the US and Japan have been pushing the envelope; and as long as rates are low, rising government debt does not seem to be a problem. The Eurozone – in particular, Germany – is, however, much more hesitant to really use fiscal stimulus. Europe will continue to be parsimonious.
After so many years of record-low rates and booming markets, a word of caution from the grumpy economist is in order. Markets are hooked on cheap money. The hunt for yield in an environment of low returns may once again cause asset bubbles. At the same time, central banks are gradually moving from strict inflation-targeting
to a broader interpretation of their goals. So, even if the risk of tighter monetary policy and bursting bubbles is low, it certainly is not zero.
The Nordics are doing rather well… As usual, Norway is the best-performing economy in the Nordic region. Petroleum investment is pushing total GDP (including the oil and gas sector) towards a growth rate of above 3 per cent this year. The mainland economy, however, is slowing, and growth in
2020 will remain around 2 per cent. Expectations are for investments in the petroleum sector to gradually soften, which will also have repercussions for the mainland. Thus, both these GDP measures will slow down over the course of this year and 2021.
Unemployment is low, and disposable income has grown. Nonetheless, households have remained cautious, and the savings ratio has risen. A strong domestic economy plus rising imported inflation (because of a weak currency) has made Norwegian inflation the highest in the Nordic region; it remains slightly above target. This caused Norges Bank to hike its key rate last year – it is now clearly the highest among the neighboring countries. Mortgage rates rose. Still, home prices increased, while the rental market also benefited from the sound macro fundamentals. Demand for property is strong. The benign macro situation will persist this year,
resulting in another good year for property.
The Danish economy also looks fundamentally sound. GDP growth is hovering around 2 per cent, slowing gently. Inflation is low, and because of the fixed-currency regime, the Danish central bank is carrying out an ultra-loose monetary policy with negative rates. Danish banks are actually charging negative interest rates on large household deposits. Employment growth has been fairly strong, but inflation remains far below target.
In this situation of easy money, mortgage rates fell last year. That also freed up liquidity for consumers, who could refinance into cheaper loans. The combination of low rates and strong liquidity is supporting the property market. Consequently, strong transaction volumes are expected to persist.
Finland is a member of the Eurozone and largely follows the economic trends in the monetary union, Germany being its most important trading partner. Economic growth is around 1.5 per cent, gradually slowing down. Manufacturing is gloomy, and investments are weak. Unemployment is high compared to Norway and Denmark, and sentiment among households has deteriorated. A government crisis at the end of 2019 was resolved, and the new government will probably re-establish political stability.
Inflation is below target, and since Finland is part of the EMU, the ECB’s loose monetary policy will also remain in place and affect the Finnish market. Low rates support the property markets. Lack of supply is pushing up prices while holding back the transaction volume.
… but Sweden’s macro performance is worst in class Economically, Sweden is the worst performer in the Nordic area. In 2019, growth slowed to a paltry 1,1 percent (meaning just about zero growth per capita). The trough of the downturn is expected this year, which means that the annual growth rate will be as low as last year, not visibly moving up until 2021.
Swedish manufacturing and exports have been negatively affected by the European slowdown. Sentiment indicators point to continued weakness in industry, while domestic sectors such as retail and construction show signs of stabilisation. Construction is particularly important, since it has large “multiplier effects” on the rest of the economy. Household consumption weakened in 2019 but is expected to gradually recover as disposable income rises.
The labour market has cooled. Unemployment is rising. At 7 per cent, it is the highest among the Nordic countries, and actually one of the highest in Europe – somewhat surprising, given Sweden’s traditionally strong showing in this area, and the government’s pledge that Sweden this year would have Europe’s lowest unemployment rate. One reason is poor integration of new immigrants.
Inflation is clearly below the Riksbank target of 2 per cent and is likely to remain there. Even so, the central bank is not expected to cut its repo rate. After five years of negative rates, it hiked to zero by year-end. The reasons given were somewhat vague, but the market interpretation was that the side effects of negative rates were getting worse. Consequently, the Riksbank does not want to move back into negative territory. This means that now that the zero rate has been reintroduced, it will probably remain in place for the remainder of this year, and probably also most of 2021.
In this environment, the property market is thriving. Construction is recovering. House prices have recovered what they lost two years ago. Transaction volumes have risen sharply. Lack of supply will continue to hold up prices. The coalition government has stated it wants to loosen rent control, but political tensions and waning popular support makes this unlikely.
All in all, even though the Nordic countries differ in several respects, the area as a whole is performing decently, and property markets will be strong in all countries for the remainder of 2020.
