CityLivingRecent survey results point to property prices rising at a gradual pace in the short to medium term, writes Jane Suiter

Potential property investors have been cheering a raft of new reports suggesting that house prices will continue to rise, albeit at a slower pace than heretofore.

In the last week Bank of Ireland and IIB in conjunction with the ESRI have brought out upbeat assessments of the market for the years ahead. Overall, the survey found that prices are expected to rise by 6.5 per cent over the next 12 months, representing a slight slowdown from the current pace of property inflation of around 8 per cent.

Over the next five years, consumers will see prices rising by around 5 per cent per annum. This is broadly in line with predictions from Bank of Ireland where chief economist Dr Dan McLaughlin is predicting house price growth of around 5 per cent this year.

According to the IIB and ESRI survey, seven out of 10 Irish people believe that house prices will increase over the next year. Only one in five expect house prices to remain flat and as few as one in 15 expect prices to fall.

Of course, just because people expect something does not guarantee it is going to happen. After all, the classic signal to sell in an equity bubble is when the shoeshine boy recommends a stock tip. But with property one of the key drivers is expectations. If this situation were reversed and only one in 15 expected prices to rise, few would be willing to pay high prices and thus they would also certainly fall.

But in this latest survey only one in 500 expects a major decline in Irish property values in the coming 12 months. But this is not foolproof, a surprise or, in the jargon, a shock, to the economic system could leave people reassessing their expectations very quickly. One of the most common types of shock is a larger than expected rise in interest rates.

The survey found that low interest rates and income growth are seen as the key drivers of the near-term outlook for Irish house prices. And with interest rates destined to increase this year, this should undermine many people's enthusiasm.

Nevertheless, over a five-year period, underlying economic trends and population growth are expected to be more critical to market prospects than rates. Expectations are also positive for the other key driver of house prices - incomes.

In his quarterly housing report, Dr McLaughlin predicted that incomes would grow by 6 per cent this year and more next year as the next round of benchmarking kicks in.

But higher mortgage costs on the back of rate increases will cancel out any benefits before the end of the year. According to Dr McLaughlin, the European Central Bank will start raising rates coming into the summer as the European economies pick up a little steam. He is expecting a half point rise this year and two further quarter point rises in 2006.

This would mean variable rates around 4 per cent by the end of the year and 4.5 per cent by summer 2006. This will mean home loans costs rising from 28.4 per cent to 31 per cent of average earnings, according to the study. This scale of rate rise should still be reasonably affordable for many people. The repayment on a €250,000 loan over 20 years would rise from €1,450 to €1,515. A steeper interest rate rise would obviously have far worse consequences. A variable rate of 6 per cent, for example, on the €250,000 loan would mean repayments of €1,791. Rapidly increasing rates on this scale would eat into mortgage demand and, ultimately, house prices.

The future of the Irish housing market may thus rest with the president of the ECB Jean-Claude Trichet. Earlier this month the ECB sent the clearest signal yet that its next interest rate move would be upwards when Mr Trichet said "everyone knows" that rates would have to rise.

However, the extent and the timing of any rate rises will be determined by the growth outlook for Europe as a whole. And that is still looking rather bleak, as Europe feels the effect of higher oil prices and a stronger euro. Pressure for higher rates also comes from the renegotiated Stability and Growth Pact as well as credit and mortgage lending across the Continent.

The ECB is particularly concerned about house price booms in France and Spain. The one problem is still Germany - its growth reached only 0.2 per cent in the last quarter of 2004 - compared with 0.8 per cent increases in Spain and France. In addition, new budget rules which will allow Germany run a large deficit may also push up rates, the ECB has warned.

Events in the US are also key for the future of European interest rates. Long term US rates are already rising and productivity is slowing in the US as labour market conditions tighten. This leads to inflationary pressures as wages rise while the weak dollar is also inflationary.

IIB and the ESRI argue that, if low interest rates were pivotal to the outlook for property values into the medium term, this might raise questions about the persistence of a rising price trend.

However, consumers feel there is a broad range of supportive factors that are driving the property market. "No single factor dominates, with fewer than one in four consumers citing low interest rates as the single most important factor supporting the market."

In addition, the five-year outlook for property prices suggests that in the medium term they expect underlying economic and population trends to be more critical to housing market prospects than interest rates.

And, if CSO population statistics are to believed, these will prove to be supportive.

jsuiter@eircom.net