A slowdown in the global housing construction sector poses risks to the economy's growth

- New building permits in Germany also below 2008 trends: 23 percent drop from peak in Canada

In recent times, the pace of housing construction in the world's major markets has slowed significantly. Which poses a threat to global growth. The housing market is an important and vital channel for the transmission of monetary policy. Lower demand for housing due to higher interest rates reduces overall economic activity. This is especially true in developed markets where real estate business is planned.

Housing is not only an important source of economic demand, contributing 10 to 24 percent to GDP, but it is also an asset for most households. Being a long-term asset, its value is highly sensitive to interest rates.

In the 1980s, real estate investment fell 40 percent between 1979 and 1982 when then-Fed Chairman Paul Volcker sharply raised interest rates to curb inflation, triggering the recession. On the other hand, a large portion of venture capital is competitive in nature and short-term. As such, the cost of credit is a relatively minor factor in making investment decisions.

Earlier discussed the risks posed to developed countries' real estate markets in the post-Covid low interest rate environment. Consolidated savings and the desire for larger homes pushed prices to their highest levels in 30 to 50 years. When prices eased again, two risks emerged: slower growth and stress in financial markets. A 20 percent drop in prices means debt becomes distressed.

The primary concern at this stage is the impact on global growth. A recession can deepen or expose defects. For example a situation like the corporate bond market. It is estimated that if housing construction in the US, China, Germany, Canada and Australia returns to the old trend, the impact on global growth will be 0.9 percent. Many of these markets have seen sharp slowdowns in recent days, suggesting that global growth may be worse than we previously estimated.

The US$2.7 trillion in mortgage-backed securities held by the Fed should be seen as an example of direct capital in the housing market. The end of these purchases pushed the spread between mortgage rates and government bond yields to the highest level since 1985. As such, mortgage rates are unlikely to return to 2021 levels, even if government bond yields fall to this level, unless quantitative easing resumes.

Currently, there are no systemic risks to mortgages because borrowers' credit scores are much higher than in 2007, the share of credit-based services in income is lower, and the share of homebuyers is at multi-decade highs.

However, new housing starts are 20 percent below their October 2022 peak and will decline further if trends over the past five decades are any indication. Assuming that it takes an average of seven months to build a house, the number of houses under construction, which determines the contribution of house construction to GDP, is now falling from record levels.

New building permits in Germany are also below trends since 2008, and the value of orders for real estate construction in January 2023 is 28 percent below a year-ago high. Germany's population has barely changed over the past two decades. Migrants are compensating for the natural decline in population there. Housing prices did not change much between 1970 and 2015. The sharp increase since then and the recent drop in nominal prices may bring forward difficulties that have not been tested.

Despite a 23 percent drop from the peak in Canada, new building permits are still on trend and are expected to decline further. The price-earnings ratio has declined for most of the past two decades and is now at a half-century low.

Australia has also seen unabated real house price growth over the past 25 years and housing loan commitments have halved from their 2021 peak. Since they're around 2014 levels, they don't appear to be declining much, especially given the tight rental market. In such a situation, construction will receive relatively little funding in the coming months.

When it comes to monetary policy, the trend in Australia also reflects the characteristics of real estate markets in developed countries. A tightening of the rental market can also keep consumer price inflation high because rent is important for consumption. However, the rental market can tighten when higher interest rates slow sales and then production. This cycle will end only when demand weakens.

It is important to look separately at current (nominal) and actual house price trends. High inflation, especially rising rents, means modest house prices will fall. However, rental yields in major developed countries are 20 to 30 percent lower than in 2015 due to low interest rates.

The macroeconomic impact depends on the speed and size of the decline in housing prices. If they decline gradually and most of the decline is in real terms, financial stability should prevail despite the weakness in growth. However, we estimate that if house prices decline by more than 15 percent in nominal terms, financial stability concerns may arise in some major markets as well.

These concerns are not as relevant in India. The market here is coming out of a decade-long slump. The housing sector is not fully funded. Rental yields are not that significant and mortgages account for barely one-sixth of total financial assets. However, India will not be immune to the risk of weak global growth and financial instability.