BIS Review 66/2004  5  The concern relates in particular to the likelihood that some households may be underestimating the risks they face. These risks are associated first, with the higher sensitivity of households to changes in interest rates. In this regard, we have seen a tendency in some euro area countries to increasingly focus on borrowing at conditions which are linked to short-term interest rates. For many households this seems to be an attractive option as it implies a rather low interest rate burden notably at the beginning of the contract. What is often overlooked, however, is the fact that the currently low interest rates could well change over time. A second risk relates to future house price changes. Some valuation measures for property prices, such as the price-to-rent ratio, are now 10-15% higher than their average levels during the period 1995-2003 in the euro area as a whole. These valuation measures have even reached levels as high as 17%. Against this background, concerns have been expressed that substantial house price increases in some countries entail risks of a reversal of this trend that may currently be underestimated. It is not the first time we have been confronted with pronounced movements in asset prices in the euro area. Indeed, current movements in house prices are small when compared to some swings in stock market prices over the last six years. We have witnessed rather substantial share price fluctuations resulting from the new economy euphoria and the subsequent disillusionment.
In real terms, this corresponds to growth rates of 4-5%, which is relatively high by historic standards. Differences across euro area countries have been considerable: while in Spain, France, Ireland and Italy, residential property prices were rising on an annual basis by between 11% and 17% in 2002 and 2003, they have been falling slightly in Germany and Austria in the last four years. The dynamism of property prices in several euro area countries is very much related to the very low levels of interest rates brought about by the introduction of the euro. For several euro area countries, the adoption of the euro marked a significant fall in real interest rates, as it implied a “regime change” towards a more stable macroeconomic environment. The fall in interest rates, in turn, allowed households to borrow more and accumulate more debt. As a consequence, household indebtedness in the euro area has increased significantly in recent years. In 2004 it is estimated at 54% of GDP, up from 46.5% in 1998 and 43% in 1995. The rise in household debt has not, however, been accompanied by higher interest payments as a ratio of disposable income in the euro area as a whole. This ratio amounted to 4.6% in 2003, similar to the 4.8% observed in 1998. However, the strong rise in house prices and the substantial increase in household indebtedness have raised some concerns. Given the differentiated path of house price increases across countries, this concern is obviously more relevant and stronger in some countries than in others.