Rate cuts don't spark prices anymore
What does this mean for property investors? According to economists, it suggests they should probably prepare for softer capital gains than in the past.
Each period of Reserve Bank interest-rate cuts since late 1990s has been followed by a strong increase in house prices, as you can see in this week's graph. The latest cutting cycle, however, has been different. Since late 2011, the Reserve has cut the cash rate by 2 percentage points to 2.75 per cent. Most of this reduction has been passed on to typical mortgage rates - which, at about 5.3 per cent, are low by historical standards.
House prices have responded, but it's been relatively muted, with home values rising by annual rates of 4.6 per cent in Sydney and 2.1 per cent in Melbourne. This has occurred despite auction clearance rates building for the past year or two, a sign of stronger confidence. So why the relatively soft bounce in prices? For one, it's worth noting that auction clearance rates tell only part of the story. The fact that more homes are being sold at auctions suggests there's life in the market, but it could also mean more sellers are happy to settle at realistic prices.
Another big part of every house price boom has been debt - which tends to amplify price growth. And that's the key area where things are very different today.
Recent research from Bank of America Merrill Lynch found the typical loan size had increased by about 5 per cent in the past year, and this increase was probably the main reason house prices had also risen.
But it also argued that households would remain reluctant to take on more debt, because they are a much more cautious bunch today than they used to be.
"We expect this caution to continue and therefore do not expect average loan size to rise markedly ... and this will weigh on house prices," the research said.
A key reason households are unlikely to take on more debt, it argued, was that many people remained nervous about their employment prospects. Even though unemployment has not jumped too dramatically, the reports of wide-scale job cuts are understandably alarming.
And with the economy going through a weaker period of "transition" after a mining bonanza, most think the labour market will remain patchy for a while yet.
The bottom line?
We are far more reluctant to bid up house prices today than we have been in the past, even though debt is very cheap. Therefore, economists say, don't bank on blockbuster capital gains of years gone by.
House price lag
Frequently Asked Questions about this Article…
Historically rate cuts have kick-started house price booms, but this latest cutting cycle has been different. Since late 2011 the Reserve Bank has cut the cash rate by about 2 percentage points to 2.75%, and most of that has been passed on to typical mortgage rates (around 5.3%). House prices have risen, but only modestly compared with past cycles.
Economists warn not to count on blockbuster capital gains. Even though borrowing is relatively cheap, households are more cautious today and are less likely to bid up prices the way they did in past rate-cutting cycles, so investors should prepare for softer capital gains.
Rising auction clearance rates signal more transactions and confidence, but they don't tell the whole story. Higher clearance rates can also reflect sellers accepting realistic prices, so sales volumes can improve without large upward pressure on prices.
Debt has historically amplified price growth. Recent research from Bank of America Merrill Lynch found typical loan sizes rose about 5% in the past year and helped push prices up. But researchers expect households to remain cautious about taking on more debt, which will limit future price growth.
Mortgage rates are low by historical standards—typical rates are around 5.3%—and most of the RBA's cuts have been passed on. However, low rates alone have not produced the same strong bounce in prices seen in earlier cutting cycles, because other forces (like household caution) are weighing on demand.
Uncertainty about job prospects makes households reluctant to increase borrowing. Even if official unemployment hasn’t spiked, high-profile job cuts and a weaker economic transition after the mining boom mean many people remain nervous, which dampens willingness to take on larger loans.
House values have risen but at relatively modest annual rates: about 4.6% in Sydney and 2.1% in Melbourne, according to the article. Those gains are smaller than past post-rate-cut booms.
The bottom line from economists is to be realistic: cheap debt no longer guarantees a big housing rally. Everyday investors should not bank on past-style blockbuster capital gains and should factor in household caution, loan-size trends and labour-market uncertainty when setting expectations.
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