Contrary to the expectations of many market watchers, the European Central Bank (ECB) remained in wait-and-see mode at its March meeting, not even providing the slightest hint of potential future action.
The lack of activity was most likely due to the ammunition provided by the seemingly endless improvements in economic data and the publication of the ECB’s staff forecasts, which showed a very slight improvement in the region’s growth and inflation outlook out to 2016. The new forecasts really told us what we already know: that the eurozone economy is gaining momentum, albeit very gradually, but that this has not been true so far for every segment of the economy. The housing market, in particular, has lagged the rest of the economy, raising another worry about the region’s path to recovery.
The European economy continues to find firmer footing with each new data release, supporting the ECB’s forecasts of modest growth over the next couple of years. Confidence surveys and business sentiment are at multi-year highs, and the final reading of the eurozone composite PMI for February was revised upwards. At the country level, Germany’s industrial backbone is strengthening and order books are filling up, while unemployment rates in Portugal, Italy and Spain are beginning to fall, even if they are still very high. All this suggests a supportive growth environment in the coming quarters. However, the lack of a significant pickup in the housing market has caused some alarm bells to ring.
This week’s chart shows that there is a casual, if not a little bumpy, relationship between housing activity and economic growth for the eurozone. The annual change in the number of building permits was negative for most of 2013, even though economic activity was increasing over this same period. Using aggregate regional level data nearly always hides the north/south country divide, but even so, this has led to questions about whether the recovery in Europe can mimic the experience of the UK or the US without a pickup in the housing market.
In both the UK and the US, the housing market was an early contributor to the recovery story, feeding through to a more buoyant consumer and increased levels of domestic demand. In the US, households have never been wealthier thanks to last year’s strong run in equity markets and rise in house prices. Existing house prices are up 21 per cent since the bottom in October 2011, while ground broken on new houses has increased 84 per cent. The situation in the UK is very similar, but with the added boost to buyer interest provided by the government’s Help to Buy scheme. Some measures of UK house prices have them back to pre-crisis peaks, and the number of mortgage approvals being agreed each month continues to rise. In January, there were almost 77,000 new mortgages approved, a level not seen since 2007.
Although the European housing market has not demonstrated the strong pickup of its US and UK peers, there are early signs that suggest it has bottomed or is even starting to turn. House prices in the region rose at the fastest pace in over two years in the three months to September last year (the latest data available), increasing by 0.6 per cent compared to the prior three months. Any celebration must be fairly muted as prices are still falling in annual terms (down 1.3 per cent on the prior year), albeit at a slower pace, across the 18 country bloc. However, at a country level, the picture is more promising. While prices are still heading downwards in the more indebted southern economies given the hangover from the property crash that followed the financial crisis, they are on the rise in the north, and especially in Germany, where there are fears that the housing market is overheating.
The potential for declining house prices to undermine the improving economic outlook and hold back the recovery in consumer confidence and domestic demand is therefore limited. While building activity and the number of permits being issued may not be contributing to the current acceleration in economic growth in the eurozone, the fact that they are not detracting from growth is potentially just as important. Moreover, should activity in the housing market increase in the coming year and the number of new houses being built start to rise, this could mean another leg up for the economy.
Kerry Craig is global market strategist of JP Morgan Asset Management
