For a more comprehensive round up of the week, listen to Stephen’s full report here.
Stronger housing activity is a key part of the accelerating Australian economic growth story through 2014 and 2015, helping to provide some direct offset to the negative impact on growth from falling mining investment spending, while also helping to support household consumption down the track as well as the burgeoning number of new homes are completed and equipped. Better housing activity, while mostly good for the economy near-term, can also lead to problems for its longer term health. Rising house prices can lead to expectations that house prices will keep rising sharply causing home buyers to throw caution to the wind, overleveraging and leaving them vulnerable to unexpected changes in financial circumstances or any downturn in house prices.
Lending institutions are not immune to the lure of a booming housing market either, seeing an opportunity to gain a bigger share of growing mortgage lending pie by tweaking their lending standards. Another public policy issue is that a growing proportion of potential first home buyers are priced out of home ownership when rising house prices are being driven by extraordinarily strong investment demand, as appears to be the case at present. Policymakers are likely to be challenged by the prospect of a growing proportion of the young, working population being consigned to rent for life calling in to question the equity of preferential tax rules for housing investors and whether existing rules for foreign investors in Australian housing are being adequately monitored and enforced.
The Reserve Bank too is just starting to think aloud about potential problems arising from rapidly rising house prices driven by mostly investment demand from a financial system stability perspective. The minutes of the 4th March RBA board meeting mention that,
“Members noted that rising house prices were expected results from the monetary easing that had taken place. While these factors were helping to support residential building activity, they also had the potential to encourage speculative activity in the housing market. Lending to housing investors had been increasing for some time in New South Wales, and over the past six months it had also picked up in some other states. While such a pick-up would be unhelpful if it was a result of lenders materially relaxing their lending standards, current evidence indicated that there was little sign of this occurring. Members noted that the recent momentum in households’ risk appetite and borrowing behavior warranted close observation, but agreed that present conditions in the household sector did not pose a near-term risk to the financial system. Members discussed the experience in other countries where macroprudential tools had been utilized to slow demand for established housing and their possible application in Australia”.
The wording of this paragraph is intriguing, implying a potential set of financial stability problems in the making, but not just yet. Nevertheless it is interesting that the RBA board discussed the macroprudential tools used overseas to slow demand for housing and whether they could be used in Australia. Our take on this is that the RBA is reluctant to use the cash rate to try and deal with issues confined to excessive demand for housing, but rather would lean towards other methods to contain demand, perhaps explicit guidance on acceptable loan-to-valuation ratios for investment housing loans. The problem is that the RBA may not find itself with the luxury to choose the appropriate policy tool.
Our view is that it may not be just financial stability issues related to excessive investment housing demand that will be concerning the RBA over the next few months, but probably relatively high CPI inflation too. The housing component of the CPI is likely to be one culprit – higher house purchase costs and rents, but higher prices related to public sector charges, taxes and prices are likely to be a major part too. One irony is that the latter group of higher prices will likely be a direct result of all levels of government trying to contain their budgets.
Relatively high Q1 and Q2 CPI reports after the upside surprises in the Q4 2013 and Q3 CPI reports would mean that the RBA will probably have cause to start lifting the cash around August. Excessive housing investment lending would simply be a secondary reason to lift rates. If our interest rate view is correct, it may mean that RBA never gets to the point of imposing direct controls on investment home loans. Instead, higher interest rates will do the work of containing unduly strong growth in investment housing loans.