Charles Kingston, CEO & Editor, REFIRE Ltd.
Things aren’t working out quite as expected on the interest rate front. Expectations are being dampened somewhat of a rate cut by the ECB in June, and the notion of a series of rate cuts by the end of the year is now looking fanciful. Inflationary pressures in the US are now even raising the spectre of possible rate RISES by the Fed to combat a surging economy and full employment, which would really throw the cat among the pigeons here in Europe.
That old mantra of “Stayin’ Alive till Twenty-Five” was firmly based on the premise that, if you could just hold on through ‘24, you’d come out OK at the other end. A normalisation of interest rates, or at least a visible fall of a percent or two, was viewed as a formality, a period of extreme drought until the rains came back and helped to float boats stuck in the dried-up river-bed. Then, thankfully, business could resume, and off we’d go again.
Well, dream on. The Fed has got its estimates of inflation way off several times, and we’ll be lucky to see one rate cut this year, as against the six or seven so confidently predicted just three months ago. This discrepancy in forecasting accuracy has prompted scrutiny from experts like ex-Fed governor and Nobel prize-winner Ben Bernanke, who was recently brought in to evaluate the Bank of England’s performance. His scathing assessment highlighted significant shortcomings in their policymaking process, attributing their underperformance to faulty thinking, outdated software, and ineffective communications. Must do better.
If you think that’s bad, then the European Central Bank, which was so late to recognise looming inflation three years ago, has even less credibility in its pronouncements now as to where inflation and interest rates are headed. REFIRE wrote several times that the dogs in the street could feel inflation building up, but it took another year before the ECB acknowledged what was plain to everybody else. Then rates had to be jacked up so fast that real estate investors and developers were caught on the hop, and the entire real estate industry ground to a halt - from which it is a long way from recovering.
To her credit, Isabel Schnabel, one of two Germans on the ECB’s governing body, wants to do away with the halo of expertise that central bankers have gotten away with for far too long. Her recent proposals involve taking a more holistic view of the causes and peoples’ lived experience of inflation, and of holding the individual 26 members of the ECB’s Governing Council much more strictly to account on their estimations of the inputs that help create official interest rate policy. And to publish this information. Not for her the gnomic utterances of central bankers such as Alan Greenspan or even Mario Draghi, with his “whatever it takes” form of personal myth-making. Much more transparency will be required all round, in recognition of the vastly changed economic environment of the past three years.
Of practical interest to REFIRE readers will be how all this affects developers, lenders and mortgage borrowers. Construction interest rates have risen slightly since the beginning of the year, but are still lower than last autumn, when hopes of rate cuts of 125 basis points in 2024 were widely held. There is no real expectation that, even in the event of a cut in rates by the ECB, this will imminently translate into a lower cost of money all round. True, the banks report a rising level of interest from customers, but this has yet to convert into meaningful action.
What IS of interest in the available data is the pattern of demand. Lending conditions in the market are still higher for five-year and fifteen-year loans than for ten-year fixed rates. This suggests the market expects lower interest rates in five years time, but higher rates in fifteen years time, hence the attraction of committing now for the longer period. German lending rates are less dependent on the ECB’s rates than on the capital markets and the yield on Pfandbriefe than in other countries, and the capital markets have been gradually lowering their expectations for ECB rate cuts. So sideways movements in real estate borrowing and lending rates are the most likely scenario over the coming six months. Nothing too exciting about that.
At REFIRE, we do find it surprising that Germany’s residential housing market has teetered as it has done under the impact of interest rate hikes, given the high rate (75%) of mortgages on fixed interest rates of five or even ten years. But house prices had risen faster in Germany than elsewhere in the preceding years, and construction output has been hit harder, jamming on the brakes and slamming the gears into reverse more brutally than in neighbouring countries, we can only conclude.
At some point the markets will also finally accept that these current rates are actually still quite low, historically. Your editor remembers buying a house in London over thirty years ago, and if memory serves, the interest rate was over 11%. Admittedly property was less expensive then, but the low rate of the last ten years to 2022 has lulled vast swathes of the population - and the real estate industry, it has to be said - into thinking there was something normal about not having to pay much for your money. The painful period of adjustment ahead demands a complete re-think as to how we go about calculating things, which is what Ms. Schnabel at the ECB is on about.
Germany still has lots of strengths, and the country’s not falling apart, despite media reports. But its biggest problems, now and for the next several years, are structural. Its major industries, such as automotive, are under severe threat. Its working-age population is facing a steeper decline than France, Italy or Spain by 2040, and only heavy immigration can counter the fall - a political hot potato, as we’re about to find out, with three state elections this year where the right-wing AfD party is expected to top the polls.
More worrying, in REFIRE’s view, even than the shrinking of the Chinese export market and higher energy costs since the Ukraine invasion, is a certain lack of ... how to put this ... dynamism. This matters, since Germany is still Europe’s locomotive, and we’re all stuck here within one currency bloc and one interest rate for the foreseeable future. Twenty-five years ago Germany put itself on a fiscal and monetary diet which gave it big cost and competitive advantages over its more sluggish and supine eurozone neighbours, and prospered for twenty years with that well-honed edge in productivity. But with much slower growth ahead, across many industries, Germany will have to become very much more nimble if it wants to avoid moving into the relegation zone.
