Norway’s elevated property prices present risks, though buffers limit sovereign implications

Norway’s house prices are rising again, focusing policy makers’ attention on property market and household debt dynamics. Proactive policies are vital in managing potentially overheated markets, though ample reserves minimise sovereign rating risks.

Scope Ratings believes Norway (AAA/Stable) has the strongest financial buffers among Scope’s rated countries, with the capacity to absorb economic shocks stemming from home or abroad.

This is underpinned by its sovereign wealth fund of USD1.04tn (about 295% of mainland GDP). In addition, according to central bank stress tests from 2017, Norway’s banks could endure a severe downturn without recourse to state aid, having rebuilt substantial capital reserves.

Scope highlighted in its latest rating assessment that house price inflation in Norway remains a risk. Measured relative to per capita disposable income, housing price levels are just under all-time highs. A recent modest correction facilitated by tighter lending regulations and increases in residential construction led to a cumulative 3% drop in prices at their trough, though this correction has reversed on a national basis with annual housing price changes up by 1.5% in June 2018.

“The average cost of a home as a ratio of median household income has risen since the mid-1990s, with the ratio in Oslo amongst the highest of the world’s major cities,” notes Dennis Shen, sovereign analyst on Norway at Scope. “Persistently low interest rates, while bolstering the recovery from the recent oil-price shock, could advance latent financial system imbalances, such as in the housing market.”

Average nominal housing prices have risen by more than 80% since 2008 lows. Moreover, commercial real estate prices have been rising for an extended time, especially in Oslo. Under this context, Scope viewed the recent temporary housing market correction in a constructive light, as a form of counter-cyclical reduction of prevailing imbalances while the Norwegian economy is growing near potential.

Renewed gains in home prices in recent months again raises concern that increases are matched with high and rising levels of household debt, even though mortgage lending standards have been tightened. Household debt stands at 230% of disposable income in Q1 2018, one of the highest ratios in OECD economies. Rising levels of household debt coupled with increases in corporate debt from domestic sources (particularly tied to commercial real estate enterprises) require close monitoring.

“That stated, even in the adverse scenario of a deeper property market correction, in Scope’s view, Norway has the buffers within the financial system and government balance sheet to bridge any such crisis,” adds Shen. “This assumed resilience is a credit strength underpinning Norway’s AAA rating.”

Having substantial reserves to counter downside scenarios does not rule out maintaining, and if needed, strengthening, a proactive policy approach, however. Even if a property bust might not threaten to create significant contingent liabilities from the banking system, it could exacerbate an economic downturn, with negative feed-through effects onto public finances.

Since the start of 2017, temporary measures tightening mortgage lending standards came into force, with borrowing capped at five times pre-tax annual incomes and a loan-to-value limit of 60%, reduced from 70%, for secondary home buyers. Recently, these rules were extended until the end of 2019.

Click here for Scope’s latest sovereign rating announcement on Norway.

Click here for Scope’s research on the sovereign implications of Nordic housing risks.

Norway’s house prices are rising again, focusing policy makers’ attention on property market and household debt dynamics. Proactive policies are vital in managing potentially overheated markets, though ample reserves minimise sovereign rating risks.

Scope Ratings believes Norway (AAA/Stable) has the strongest financial buffers among Scope’s rated countries, with the capacity to absorb economic shocks stemming from home or abroad.

This is underpinned by its sovereign wealth fund of USD1.04tn (about 295% of mainland GDP). In addition, according to central bank stress tests from 2017, Norway’s banks could endure a severe downturn without recourse to state aid, having rebuilt substantial capital reserves.

Scope highlighted in its latest rating assessment that house price inflation in Norway remains a risk. Measured relative to per capita disposable income, housing price levels are just under all-time highs. A recent modest correction facilitated by tighter lending regulations and increases in residential construction led to a cumulative 3% drop in prices at their trough, though this correction has reversed on a national basis with annual housing price changes up by 1.5% in June 2018.

“The average cost of a home as a ratio of median household income has risen since the mid-1990s, with the ratio in Oslo amongst the highest of the world’s major cities,” notes Dennis Shen, sovereign analyst on Norway at Scope. “Persistently low interest rates, while bolstering the recovery from the recent oil-price shock, could advance latent financial system imbalances, such as in the housing market.”

Average nominal housing prices have risen by more than 80% since 2008 lows. Moreover, commercial real estate prices have been rising for an extended time, especially in Oslo. Under this context, Scope viewed the recent temporary housing market correction in a constructive light, as a form of counter-cyclical reduction of prevailing imbalances while the Norwegian economy is growing near potential.

Renewed gains in home prices in recent months again raises concern that increases are matched with high and rising levels of household debt, even though mortgage lending standards have been tightened. Household debt stands at 230% of disposable income in Q1 2018, one of the highest ratios in OECD economies. Rising levels of household debt coupled with increases in corporate debt from domestic sources (particularly tied to commercial real estate enterprises) require close monitoring.

“That stated, even in the adverse scenario of a deeper property market correction, in Scope’s view, Norway has the buffers within the financial system and government balance sheet to bridge any such crisis,” adds Shen. “This assumed resilience is a credit strength underpinning Norway’s AAA rating.”

Having substantial reserves to counter downside scenarios does not rule out maintaining, and if needed, strengthening, a proactive policy approach, however. Even if a property bust might not threaten to create significant contingent liabilities from the banking system, it could exacerbate an economic downturn, with negative feed-through effects onto public finances.

Since the start of 2017, temporary measures tightening mortgage lending standards came into force, with borrowing capped at five times pre-tax annual incomes and a loan-to-value limit of 60%, reduced from 70%, for secondary home buyers. Recently, these rules were extended until the end of 2019.

Click here for Scope’s latest sovereign rating announcement on Norway.

Click here for Scope’s research on the sovereign implications of Nordic housing risks.