By Dimitris Kontogiannis – Kathimerini English Edition The Greek residential market has been supportive of economic activity in the last few years but this may change from the first quarter of 2007 onward as the European Central Bank (ECB) interest rate hikes start biting and the new supply of houses built on permits issued before the introduction of VAT begins to come into the market. The ECB has raised its key interest rates to 3 percent from 2 percent in early December 2005 and is likely to move it one notch higher to 3.25 percent by early October according to consensus. The market expects the ECB official rate to peak at 3.75 percent at some point next year. Despite the increases, the ECB rate remains low by historical standards, much more so if one considers consumer price growth and looks at the level of real interest rates in relatively high-inflation countries such as Greece. However, this theoretical approach masks a more sober reality. Despite a consistent effort by local banks to entice borrowers into fixed-rate mortgages, the vast majority of Greeks continue to take out floating-rate loans to buy a house or other real estate property. Some 90 percent of all Greek mortgage loans are in variable-rate form and this means their holders have already seen their monthly installments go up although Greek bankers are fast to point out that the extra burden is not unbearable. The latter may be due to the fact that tighter spreads on new floating-rate mortgage loans have partly offset the ECB rate hikes. But this process appears to be slowing down considerably for two reasons. First, mortgage growth continues to be robust so the pressure to tighten them fast further has not been great. Second, banks have seen their shares battered by the perception of investors that their fat spreads are converging to average eurozone levels too fast, following the announcement of the first-quarter financial results. So, they are more willing to protect their spreads even if this means shedding a bit of a market share to competitors with a lower cost of funding. It is noted that mortgages have been growing by more than 25 percent on average per annum since the mid-1990s. Even the widely held view at the end of 2005 – that there would be a considerable slowdown this year – had not materialized by the end of the first half, based on figures released by the major Greek banks. The strong growth rates exhibited since the middle of the last decade have not completely closed the gap with the rest of the eurozone countries. The mortgage loan-to-GDP ratio is estimated around 28 percent in Greece compared to about 42 percent on average in the eurozone. But as the ECB official rate approaches the 3.5 percent to 4 percent range, which is viewed by many bankers as pivotal for the demand for mortgages in Greece, the residential real estate market is expected to feel the pinch. In addition to the additional cost of servicing variable-cost loans, the second-biggest challenge for the Greek residential real estate market is the supply of new houses to hit the market starting at the end of the fourth quarter and the first quarter of 2007. The introduction of value-added tax (VAT) on the construction of new houses, for which permits were issued this year, convinced many contractors and individuals to rush to get the building permits last year before the new tax came into effect. The supply of the new houses will start coming into the market late this year and next year, adding an extra hurdle for residential property. The Greek residential real estate market may not be overstretched despite the sizeable prices increases in the last 10 years, as some research reports by EFG Eurobank and others suggest, and is therefore less prone to a severe correction. However, the combination of buyers’ fatigue due to higher interest rates on one side and a significant supply of new houses to come on stream starting in the next few months means the residential real estate sector may not be as supportive to the Greek economy as it used to be in the last decade or so.