The RBA's spark won't see house prices rocket

With interest rates at record lows, there are fears that property prices will surge. But there are a few factors that could blunt the impact of the RBA's move.

When the Reserve Bank pulled the trigger on Tuesday, attention immediately shifted to Australia’s property market. Will lower interest rates trigger another round of price rises? Could it make Australia’s housing bubble even worse? Do we even have a property bubble?

The outlook for the property market -- as with the broader economy -- is uncertain. The market faces its fair share of risks and is not immune to the structural forces which shape our growth prospects but lower rates -- and the likelihood of further cuts -- should provide some near-term stimulus.

But moves on the regulatory front -- from both the Australian Prudential Regulation Authority and the Murray inquiry -- suggest that lower interest rates may not provide the singular boost that some analysts expect.

According to RP Data, dwelling prices rose by 1.3 per cent in January -- the fastest pace of growth since July. But it’s worth noting that January has been a seasonally strong month since RP Data introduced its daily house price measure. As a result, I often find it easier to simply assess changes in the rate of annual growth.

Nationally there has been a clear loss of momentum since mid last year -- particularly in Melbourne and Perth -- but there remains a wide divergence in house price outcomes. Obviously, Sydney is leading the pack but price growth remains contained in both Brisbane and Adelaide, with prices in neither city appearing to have benefited a great deal from lower interest rates.

A key characteristic of Australia’s property market right now is that it has become increasingly unbalanced. I’m not just talking about the Sydney versus the rest but also the composition of those buying.

Currently, there’s two clear dynamics at play. First, the number of owner-occupiers looking to upgrade /downgrade has diminished. Second, investor activity continues to surge and now accounts for over half of all new loan approvals.

In the absence of a regulatory response, lower interest rates should boost investor activity further. How much further remains uncertain by virtue of the fact that we are already in uncharted territory. Could investor activity account for 55 or 60 per cent of all property transactions? History suggests that it is only a matter of time.

However, lower interest rates are unlikely to have much effect on the owner-occupier segment. Lower interest rates encourage buyers to bring forward their purchases but there’s only so many people who need to buy a new home at any one point. A lengthy period of elevated activity -- such as that which occurred during 2013 and early-2014 -- will inevitably result in a period of below average activity.

The net effect of lower interest rates remains uncertain. A lot will depend on how Australians interpret the cut. The sharp decline in 10-year government bond yields suggests that many investors expect interest rates to remain at a low level until well into the next decade.

Our experience during the early 1990s -- a period in which interest rates fell structurally and remained there -- indicates that this could boost property prices considerably. In the long term, house prices are determined by income and wealth, the willingness of banks to lend and the short-term and expected cost of money.

If the latter declines considerably then it might be reasonable to expect prices to break out further. But what about the other two variables?

The Australian economy is in the middle of a considerable income shock. The decline in the terms of trade will continue to weigh on domestic income growth over the next few years. Real wages growth remains near historically low levels and with spare capacity rising across the economy that is unlikely to change any time soon.

The regulatory response, however, might be more important. Back in December, APRA said in reference to investor activity that “growth materially above a threshold of 10 per cent will be an important risk indicator for APRA supervisors in considering the need for further activity”.

That threshold has already been breached but the word ‘materially’ clearly indicates that there is scope for discretion. APRA will assess lending activity on a bank-by-bank basis over the next couple of months.

There is also the Murray inquiry, which may in fact have the greatest long-term impact on property prices. The inquiry recommended lifting the risk weights applied to domestic mortgages to between 25 and 30 per cent -- well above the current level of around 18 per cent (Murray’s glaring omission, December 8).

Such reforms, if embraced, would raise the capital reserves at each of the major four banks and reduce the imbalances that currently plague domestic lending. To paraphrase, it would result in fewer mortgages and more business lending, which will likely weigh on land and property prices.

Do we have a bubble though? Despite all the variables at play -- and the uncertainty surrounding those variables -- most people just want to know whether we have a bubble.

‘Bubble’ has certain emotional significance that Australians haven’t fully embraced. Saying the property market is in a bubble is a bit like admitting that you’ve been duped, that the banking sector has tricked you into borrowing and paying too much.

Instead, we prefer to think that Australia is somehow different. Of course, there is nothing fundamentally different about Australian property, it is beholden to the same economic forces that have boosted and destroyed property prices overseas.

What we have benefited from though is two decades of uninterrupted growth. That’s been great for the most part but it has also created a fair few distortions and the Australian property market is no exception. Whether we have a ‘bubble’ or not is almost immaterial; for over a decade now we have happily paid house price multiples that would cause people abroad to wake up at night in a cold sweat.

But that doesn’t mean that property prices can’t take a turn for the worst. The market itself hasn’t truly been tested for two decades and yet we’ve experienced three property downturns in the last decade alone. A recession -- which will eventually happen, it’s just a matter of when -- could prove devastating for thousands of homeowners. That’s precisely why the regulatory response is so important, even if it does weigh on house prices and household wealth in the near term.

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