House prices have regained fresh upward momentum in recent months, which looks set to be extended into the early part of 2015, but price gains will likely stabilize around 4%, according to a client note from Capital Economics.

The reason, analysts say, is because existing homeowners and homebuilders will respond to higher prices by increasing supply.

“The outlook for real economic growth was looking up even before the collapse in energy prices,” says Paul Diggle, property economist for Capital Economics. “The boost from easing credit constraints and the fading fiscal tightening is more than offsetting any drag from slower economic growth overseas. While inflation is not rising as quickly as we expected, employment growth has outpaced our earlier expectations.”

Besides increased employment, there is the issue of likely interest rate hikes in the first part of 2015.

“A March rate hike is not out of the question. Thereafter, we expect the Fed to continue raising rates more aggressively than the markets expect, with the Fed funds rate reaching 3% by the end of 2016,” he says. “In turn, that means that 30-year mortgage rates will increase from 4.1% now to 5.5% by the
end of 2015 and 5.8% by the end of 2016. Housing affordability will deteriorate, but even by end-2016 affordability will be more favorable than the historical norm.”

Capital Economics doesn't think that rising interest rates will affect home sales.

“With credit conditions loosening, negative equity falling and buyer confidence increasing, we expect total home sales to rise from 5.4m this year to 5.8m next year and 6.0m in 2016,” Diggle says. “New home sales will provide the bulk of the impetus for this gain.”

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