Irish house prices could fall if the UK crashes out of the European Union, the Central Bank has said, as it warned that a disorderly Brexit may hit employment levels, incomes and the financial standing of the banking sector.

A Financial Stability Review, published on Thursday, said that while house prices in the Republic “on average are around what would be expected” given the state of the economy, they “exceed historical averages” when looked at from the perspective of average house prices compared with average rent levels and price-to-income ratios.

A negative shock, such as Brexit or “some unforeseen geopolitical event, has the potential to cause these currently ‘high’ house prices to fall in the period ahead,” it said, adding that this could be as a result of incomes falling, or a changed view among overseas investors that have been increasingly involved in the Irish property market in recent times.

House prices relative to rent are currently 12 per cent above what they have averaged since 1980, a Central Bank spokesman told The Irish Times. The price-to-income ratio is 26 per cent higher than the long-term average, he said.

“Higher positive deviations from long-run averages of price-to-income are typically associated with higher probabilities of house price declines,” the report said.

House price inflation

Figures released on Wednesday by the Central Statistics Office showed that house price inflation had cooled to an annual rate of 2.8 per cent in May – the lowest since July 2013 – from 12.4 per cent for the same month last year. Much of the easing in prices has been put down to Central Bank mortgage-lending limits introduced in 2015.

Home values in the State have surged by almost 83 per cent from their lows six years ago, but remain 18 per cent off their peak in 2007.

While the rise in residential prices in recent years has not been fuelled by bank lending, factors such as interest rates and disposable income which drive prices are sensitive to economic developments, which are, in turn, highly sensitive to global factors, the Financial Stability Review said.

Uncertainty around the eventual Brexit outcome “remains elevated”, which has been reflected by sterling’s recent falls against other major currencies, it added.

“The extension of the UK’s departure from the EU to October 31st has allowed further time for households and businesses – including in the financial sector – to continue contingency planning,” the report said.

“The main outstanding source of risk to financial stability in Ireland stems from a worse-than-expected macroeconomic shock. This could arise if the expected negative impact through trade channels is compounded by a sharp increase in uncertainty and a fall in confidence, with knock-on effects to Irish employment, incomes and investment.”

The Central Bank estimated earlier this year that a no-deal Brexit would shave 6 per cent off the size of the Irish economy over two years. However, the State’s banks were stress-tested by European authorities against the threat of a 9 per cent hit. They found that AIB and Bank of Ireland would be able to maintain their capital levels above minimum regulatory requirements under this scenario.