[Lee Jong-woo's Economic Insights] Global Real Estate Market 'Warning Lights'... Time to Raise Interest Rates to Curb Asset Price Increases

Major Countries' Average Housing Price Increase Over Past Year More Than Tripled
South Korea's Rise at 21.4%... 8 Times Last Year's Average Annual Increase
Need for Interest Rate Hikes and Liquidity Reduction
Bank of Korea Likely to Raise Rates as Early as August

'UK 13.4%, US 14.6%, Germany 15.3%, Canada 12.5%, New Zealand 28.8%'

These are the housing price increase rates in major countries over the past year. Although there are some differences, it is clear that many countries recorded double-digit increases. The significance of these figures can be easily understood by comparing them with the average annual increase rates over the past 10 years since 2010. The increase rate over the past year exceeds three times the previous average increase rate. In the case of Canada, it is as much as five times. This shows that real estate prices surged worldwide over the past year. The situation is even more severe in Korea. According to a survey by the Korea Real Estate Board, the actual transaction price of apartments nationwide rose by 21.4% over the past year. This is eight times the average annual increase rate of 2.6% over the past 10 years since 2010. It means that apartment prices expected to rise over eight years have all risen within the past year.

As housing prices surged, many governments found themselves in a dilemma. When the economy is weak, rising real estate prices play a positive role in the economy. The recovery of the construction sector drives the overall economy, and the increase in housing prices increases assets, which in turn boosts consumption. Therefore, when trying to stimulate the economy, governments tend to target housing prices first. The US Federal Reserve (Fed) did the same last year. One-third of the $120 billion monthly bond purchase quantitative easing program was allocated to mortgage-backed securities related to housing. This policy was introduced assuming that the housing market would shrink due to COVID-19. Contrary to expectations, housing prices surged, and in countries where housing prices rose nearly 15% in a year, the central bank ended up providing funds to invest in real estate.

Going forward, real estate prices are likely to become a key criterion for government and central bank policies. There are two reasons why central banks raise interest rates. One is inflation: interest rates are raised to calm prices and reduce the amount of money circulating in the market. The other is asset prices. If asset prices rise and there is a risk of a bubble expanding, interest rates are raised to prevent it. Real estate is particularly problematic among assets. Stocks or bonds are smaller in scale compared to real estate and involve fewer stakeholders, so problems tend to be limited to specific sectors. Real estate is different. In any country, real estate is the largest asset and involves many people. A lot of debt is used when purchasing. If problems arise, the impact inevitably spreads throughout the economy. The difference between the unprecedented IT bubble burst in the US stock market in 2000, which had little economic impact, and the 2008 real estate bubble burst that led to a financial crisis, illustrates this well.

In the future, inflation will be an important criterion when the Fed decides whether to raise interest rates. The Fed's decision to maintain an accommodative policy for the time being is based on confidence that inflation is temporary and will return to normal in the fourth quarter. Over the past decade, the global economy was in a deflationary structure to the extent that even a slight economic downturn caused price declines, so the Fed believes there is no chance that inflation will become a problem suddenly. Considering that economic structures do not change overnight, this seems a reasonable judgment.

The problem lies in real estate. Asset prices tend to move on their own once they enter a certain trajectory. Because prices rise, people think they must join the trend and buy, which pushes prices even higher. To calm this, prices must become so high that buyers give up on their own, or the driving force behind price increases must disappear. Currently, the driving forces behind rising housing prices worldwide are low interest rates and liquidity. Therefore, raising interest rates and reducing liquidity can somewhat curb real estate price increases. The decision is not easy. Several rate hikes are needed to affect real estate prices, and the economy may worsen during this process. For this reason, despite rising housing prices over the past year, advanced countries have not implemented policies.

The situation is different now. First, the economy has recovered to pre-COVID-19 levels, and many countries are suffering from high housing prices. Political pressure resulting from this is also significant, making asset prices an important factor in determining interest rates. In 2004, the Fed raised the benchmark interest rate from 1.0% to 5.25% over two years. This was to curb housing prices that were rising by double digits annually. As a result, problems arose in mortgage loans in 2008. The rush to burst the bubble was the cause, and to avoid repeating this mistake, advanced country central banks may raise interest rates faster than expected.

The Bank of Korea has already begun responding to this change. At the July Monetary Policy Committee meeting, the Bank of Korea mentioned the side effects of excessive debt and leveraged investment. It emphasized the need to adjust the current accommodative policy. This was a stronger statement than expected. Initially, it was thought that interest rate hikes would be discussed only after the fourth wave of COVID-19 subsided. Considering the Bank of Korea's remarks, interest rate hikes could occur as early as August, with two hikes possible within the year. Although consumption has not yet recovered, this issue was left to be resolved through economic recovery and fiscal support such as disaster relief funds. Despite the negative impact on the overall economy, it is considered important to curb asset price increases.

Several emerging countries have already raised interest rates for various reasons. Some aim to induce currency appreciation to prevent capital outflows, while others intend to curb high inflation. Although not explicitly stated, some, like the Bank of Korea, also aim to defend against asset price bubbles. The number of countries considering asset prices as a factor in financial policy decisions will continue to increase. Most advanced countries are likely to recover to pre-COVID-19 economic levels within this year. While other economic variables have returned to normal, there is no reason for financial policies, including interest rates, to remain in a crisis state. Changes in asset prices should be observed as carefully as inflation.