Credit growth may pose risk to the economy

Central Bank warnings have gone unheeded and more than €1 billion a month is being extended in new mortgage loans, write Cliff Taylor, Economics Editor.

The louder the warnings on the state of the property market, the more people seem to be borrowing for mortgages.

The Central Bank has weighed into the debate again, warning that if borrowing trends continued, Ireland could become one of the most indebted states in the EU. However, so far its warnings - and those from a host of other august institutions and commentators - have gone unheeded and more than €1 billion a month is being extended in new mortgage loans.

Presenting the bank's annual report yesterday, its governor Mr John Hurley said credit growth continued to be a "worry" and that "the bank remains concerned at the continuing large increases in house prices". The official message is that debt levels are not out of line with the EU average, but will quickly become so if credit continues to grow at four times the EU average.

The danger for house prices is that the current rate of price increase of 12-13 per cent continues, which would mean "the risk of a significant correction would increase". In other words if house price growth does not moderate, we could be heading for a period of falling prices.

Understandably, the bank does not want to be too specific in its warnings and insists that its concern relates to the danger of a continuation of current trends, as opposed to a warning about the current position of the property market.

However, the bank makes no secret of its surprise that the rise in housing supply over the past year and a half has not led to a moderation in the rate of house price growth.

There have been fundamental factors driving prices higher, as the bank points out, including strong economic growth, rising employment, demographic trends and low interest rates. However while there has been some moderation in price growth, most analysts have been taken by surprise that it has not been more marked.

The level of debt associated with high house prices has become a significant focus of debate. Clearly mortgage lending cannot continue to grow at an annual rate of 25 per cent plus ad infinitum. As the bank points out, credit growth here is four times the euro-zone average.

A study it published recently shows that we have moved over the past decade from being a relatively lowly indebted state by EU standards to around or a bit above the average.

The position at the end of last year - measuring personal credit against Gross Domestic Product - is shown in the accompanying graphic. The bank's concern is that if credit continues to grow way above GDP, we could quickly move to well above the average, leaving the economy in an exposed position.

Analysis by the bank - and by some private sector economists - indicates that at the moment overall debt levels here have not climbed into danger territory. However, a minority of borrowers may be exposed as the interest rate cycle turns upwards. Fortunately, for those with heavy borrowings on variable interest rates the first increase in European Central Bank rates could still be some time off.

Mr Hurley said yesterday that despite the threat posed by oil prices and some signs of faster growth, his current assessment is that "the evidence points to inflation in the euro area being in line with price stability over the medium term".

If this view is shared around the ECB board table, then there should be no need for an early increase in ECB rates. US and UK rates are already on the way up, of course, but sluggish growth in a number of the bigger euro-zone countries - particularly Germany - should keep euro rates on hold for some time yet and limit the pace of increase when they do rise.

The bank's new three-year strategy document puts much emphasis on the bank's input to ECB rate policy, where the governor's vote counts equally with the other members of the governing council. However, domestically the bank's role in terms of the housing market now relates mainly to monitoring the overall stability of the financial system, though it does hope to also influence both borrowers and lenders by its views and statements and by discussing prudential issues with the financial institutions.

The job of actually regulating lending practices, however, falls to IFSRA, to which the Central Bank is linked, but which is a separate organisation.

In terms of the stability of the financial system, the bank says that the current state of borrowing does not pose a risk, though director-general Mr Liam Barron says that this assumes no major shock to the economic system.

A report to be published by the Central Bank in September will examine this issue of financial stability in more detail, mapping out how the market would cope in various economic scenarios and what are the risks to the system.

This is at the heart of the borrowing debate: the issue is whether the property market has developed into a risk that could pose a serious danger to the economy in the future. The bank's conclusion is that this risk could become significant, if borrowing growth and house prices do not soon slow.