The role of interest rates in influencing housing prices

This paper investigates the role of interest rates on housing prices from the perspective of homeowners’ expectations. Using quarterly data on interest rates and housing prices for Hong Kong in 1981-2001, it identifies a structural shift in housing prices coinciding with a move from inflation to deflation around 1997. The results indicate a moderately high correlation between housing prices and nominal interest rates in 1998-2001, as opposed to a negative correlation during the earlier period. The same pattern again holds in linear regression with both interest and inflation as explanatory variables. The Granger causality test indicates that interest rates do not significantly determine housing prices. The study suggests that the interaction between interest rates and expectations of capital gains or losses plays a critical role in the short-run housing price fluctuations in Hong Kong.