Why French Housing May Be Next Bubble to Burst

The French housing market would be the next bubble to pop if the European Central Bank increases interest rates, or if markets begin to perceive the same fundamental weaknesses in France as they currently do in Spain, analysts at Danske Bank wrote in a market note.

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French President Nicolas Sarkozy will fight for re-election on May 6, and many observers were taken by surprise by the fast ascension of far-right candidate Marine Le Pen, who pledged "economic patriotism" to fend off the effects of the euro zone's debt crisis on France.

House prices saw only a minor fall during the financial crisis, and in 2009 they started rising again, to reach new all-time highs in the third quarter of 2011 – up 121 percent since 2000, with prices in Paris rising at the fastest pace, according to the Danske analysis.

"We see signs of a bubble in the French housing market and would not be surprised to see French house prices declining 10-20 percent in coming years," Danske analyst Frank Oland Hansen wrote .

In the fourth quarter of last year, house prices stabilized in Paris and fell slightly in the rest of France, in cities with a population of more than 10,000, according to the analysis.

"The big question is whether this is the beginning of a larger correction in the French housing market. There are several indications that it might be," Hansen wrote.

Among the signs that a correction is coming, Hansen cites a sharp fall in demand for loans for house purchase, contracting housing starts and housing permits in the first few months of the year, the tightening of credit standards for loans for house purchases and the fact provisions for doubtful loans to households have increased sharply since 2008, although they are still only 1.8 percent of all loans to households.

"There is little doubt in our minds that the French housing market at the current juncture is vulnerable to a sharp rise in interest rates," he wrote.

However, Hansen does not believe that the ECBwill raise interest rates before 2014 and thinks that French house prices might be able "to rise strongly on an unsustainable path" for a couple of years before losing momentum, in which case "the 'pop' would just be larger."

"We find that several indicators, including demand for house loans and credit conditions, signal that the French housing market could be at a turning point," he wrote.

"Under normal circumstances, this should not cause too much alarm. However, we are in the middle of a European confidence crisis. If focus moves from Spain to France, the crisis could escalate."