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Icelandic Financial Market Digest 31. mars

Publisher: Íslandsbanki Research • Resp.Editor: Ingólfur Bender

Housing inflation accelerates still further

The housing market shows numerous signs of overheating at present. First of all, house prices rose by 1.7% in March, according to new figures from Statistics Iceland (SI). The monthly rise has now exceeded a percentage point for eight months in a row, a development not seen since the 2004-2005 housing boom. In the past year, house prices overall have risen by 17.8%, the biggest twelve-month increase since the first half of 2006. 

House prices closing in on historical highs

Real house prices nationwide are now only 4.5% below their all-time high, measured during the last upswing. Given the current housing market situation, prices can be expected to exceed that peak this autumn, thereby setting a new record. Real house prices have now risen by nearly 45% from the trough following the financial crisis. 

 

Few flats for sale and short time-to-sale

In March, 800 flats were advertised for sale, the fewest since measurements began in 2006. In comparison, there were 4,450 flats for sale in mid-2010, the post-crisis peak. In January, the average time-to-sale was 1.2 months, the shortest since measurements began (again, in 2006), whereas in mid-2009 it took an average of 28 months to sell a home. Turnover is rapid in the housing market. In 2016, a total of 7,460 purchase agreements were concluded for flats in the greater Reykjavík area, up from 6,934 in 2015 and 1,870 in 2009, the beginning of the current upswing. These figures were published yesterday by the Central Bank of Iceland (CBI). 

 

House prices rise in excess of building costs, encouraging new construction

House prices have been rising well in excess of construction costs in the recent term. The rise in building costs measured only 1.3% in the past twelve months, while house prices have risen by 17.8%, as is mentioned above. This development encourages new construction, and indeed, new figures from SI indicate that new housing construction has surged after the doldrums of recent years. According to the SI data, residential investment rose by nearly 71% in Q4/2016 and by 33.7% in 2016 as a whole. Furthermore, according to data from the Federation of Icelandic Industries, 3,255 flats were in construction in greater Reykjavík at the end of February, a 10% increase since the last measurement in September 2016. 

Households’ improved financial position a major factor

The improvement in households’ financial position has played a major part in the recent spurt of housing inflation, as real disposable income has risen steeply. A significant contributor to this is the swift rise in real wages, which are now at an all-time high. This is the product of the unusually fortuitous combination of rapidly rising wages and low inflation, which in turn stems from large contractual pay rises, on the one hand, and low imported inflation, which has kept domestic prices down. In this context, it is noteworthy that inflation excluding housing is currently negative and has been so since mid-2016.

 

New credit system lending to households has picked up in the recent term, fuelling increased demand for residential property. This growth in lending is most pronounced among pension funds, which have been gaining a foothold in the mortgage market in the past three years. 

Strong inward migration contributes to housing market developments

The recent surge in immigration to Iceland plays a growing part in housing inflation. Last year, net migration was positive by 4,069. Only twice has it exceeded this number, in 2006 and 2007. This explains why demand for new housing soared last year and pushed house prices upwards. We estimate the need for new flats in 2016 at about 3,100. We believe this factor has weighed heavier in recent developments in house prices than the growth of the sharing economy, for instance, as the latter accounted for about a third of the demand for new flats last year, while net migration accounted for about half of it, as is stated in our recent report on the Icelandic tourism industry. 

Macroprudential tools may be needed 

In his speech at the Central Bank’s (CBI) Annual Meeting yesterday, the Governor mentioned growing concerns about the real estate market and said that it may prove necessary in the near future to activate macroprudential tools in order to mitigate the associated risks. He did not specify which macroprudential tool or tools he had in mind, but it is worth noting that the Act on Mortgage Lending, no. 118/2016, which was passed by Parliament on 20 October 2016 and will be implemented as of 1 April 2017, contains a chapter authorising the Financial Supervisory Authority (FME), upon receiving an opinion from the Financial Stability Council, to impose a maximum loan-to-value ratio (in the 60-90% range) and/or to impose a ceiling on the total mortgage loan amount or debt service amount relative to the buyer’s income. If this is done, it could mitigate demand for housing and curb the rise in house prices. 


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