Low rates infuse a bubbly atmosphere in the established housing market

There’s an ongoing discussion between our politicians as to whether low interest rates indicate ‘good’ or ‘bad’ economic management, with Joe Hockey warning – correctly – that a further cut indicates a slowing, if not, “struggling,” economy, and Kevin Rudd shoring up his corner with the backhanded comment that this merely implies the opposition think ‘high interest rates’ must be a ‘good’ thing.

The last time the RBA moved interest rates so close to an election was back in August 2007 just prior to John Howard’s demise from office – except of course, at that point, the cash rate was lifted +0.25 per cent to 6.75 per cent with the comment from Governor Glenn Steven’s that;

“The world economy is still expected to grow at an above-average pace..” and noting the need to contain medium term inflation.

After Kevin Rudd entered office, house prices were at a peak, and two further increases in both February and March took cash rate to 7.25 per cent, after which the contagion of the GFC resulted in a swift ‘six’ consecutive rate cut cycle as we felt the worldly repercussions of a highly interconnected financial system regulated by fear and greed, teetering on the brink of economic collapse.

The swift reversal which sent us right back into a rate ‘hike’ cycle occurred in line with the Rudd stimulus packages, including the first home owner ‘boost’ which applied to contracts entered into between 14^th October 2008 and 31^st December 2009 and consequently, swathes of easy credit entered the housing market creating a short term price multiplier effect across all ranges and arresting the downward decline in household ‘debt’ growth.

The party could only last so long, and in response to the high Aussie dollar, subdued credit growth, declining asset prices and continued underperformance in the construction sector, the current rate easing cycle, which commenced 2^nd November 2011, has been going on for 18 months.

The resulting eight cuts which leave us with the lowest cash rate in at least 50 years have been successful in taking some of the air out the Aussie dollar, albeit newly revised forecasts from Government indicate a worrying trend in rising unemployment, and cautionary words are emerging from the RBA as Governor Glenn Steven’s evaluates that;

“One's assessment of prospects for consumption will be driven mainly by one's assessment of the outlook for income, but will also be affected by expectations about asset values and in particular one's view on whether housing prices are overvalued..”

Job ads fell by 1.1 per cent in July – the 5^th consecutive monthly decline, and a cumulative 19 per cent over the past 12 months. Business confidence is waning with conditions at a 4-year low, household income dynamics worsening, and considering we have a tightly contested Federal election on the door step, there is little prospect of improvement in the near-term.

With the above in mind, it ‘seems’ a sensible move to pull the one economic lever the RBA have to hand, and provide ‘relief’ to “interest-sensitive spending and asset values.”

However, since the global economic crisis; the world’s banks have been concentrated on lowering rates in order to boost growth. The textbook model indicates the atmosphere will motivate an increase in lending for such items as homes, goods and services; however as we know, monetary policy is at best, a blunt instrument and whilst Governments can allocate at their discretion where to spend our tax dollars and pressure the banks to ‘pay forward’ the rate cuts gifted,  they have limited influence on where cheap credit is spent (or for which asset it is lent) into the economy or to direct it into areas where it’s needed most – which in terms of housing, would principally be construction.

In this sense, relying on interest rates to stimulate demand in new home building is akin to banging your head against a brick wall and hoping the pain will subside.

I happened to catch the Sunday morning “Financial Review” show on Channel 9 last week to witness and interview with Harry Triguboff – chief of Merriton – who happily concluded that the reason demand from Australian buyers for his high rise apartment blocks was so low, was directly correlated to the RBA’s monetary policy.

To paraphrase, his comments "They should have dropped rates earlier.. I don't know how many more drops they need to do....they just need to keep dropping till Australian's start buying my high rise apartments again"

Albeit, whilst a drop in rates may assist the construction industry to some extent, unless it goes hand in hand with policies to sustainably finance the provision of essential infrastructure, such as public transport arterials to ease the cost of commuting to fringe localities, tackling planning constraints, reducing hefty tax overlays, or assisting finance for development of ‘quality’ accommodation - to name but a few - consumer demand will remain subdued – nothing will change outside of intermittent First Home Buyer ‘new build’ incentives, and the issue will remain a topic of discussion.

The other problem with a long-term low interest rate environment is the air of dependency it creates as economies struggle to ‘repair’ whilst desperately trying to encourage consumers back into a spend/borrow mentality.

This is never more evident that the current circumstance in the UK.  Whilst a proportion of home owners will take advantage of lower rates to pay down outstanding debt, there is no shortage of borrowers living week to week who would topple over if rates were to moderately rise.

In the south east of England where, not unlike Australia, rates of home ownership are elevated, house prices haven’t ‘corrected’ perhaps quite as far as they should have done considering the underlying and ‘high unemployment’ economic challenges the UK faces.

This is partly related to foreign ownership of prime London real estate – which makes over 50 per cent of the buyer market – but also a dramatic increase in investor activity, which now accounts for more than one in ten mortgages.

Add to this the newly introduced ‘Help to Buy’ scheme allowing first timers to purchase houses with as little as a 5 per cent deposit, whilst the tax payer foots an underwritten Government guarantee for 15 per cent of the capital value should the buyer default, and you have an inevitably bubbly environment devised and costed on the assumption interest rates will remain close to zero for the foreseeable future.

The UK is far more interconnected with the US than we are in Australia, and therefore the hint a few weeks ago from Ben Bernanke indicating FED may begin to slowly unwind its era of quantitative easing which would inevitably put upward pressure on rates, provoked a response from the new Governor of the Bank of England who swiftly inaugurated what’s been termed a new ‘policymaking revolution‘ of ‘forward guidance’ guaranteeing to keep interest rates at their low of 0.5 per cent until the unemployment rate falls to ‘at least’ 7 per cent.

Understandably savers are up in arms – which isn’t so different to the atmosphere we’re now experiencing in Australia – albeit, our economic prospectus differs considerably.

However, pushing interest rates lower, discourages saving and predictably forces people to seek out any area of speculation that can provide a better return on their dollar as cost of living pressures slowly inflate it away.

And in our ‘all things property’ obsessed culture, coupled with policies such as negative gearing and the increasing trend to buy real estate as part of a self managed super fund, a large proportion of ‘mum and dad’ investors are pooling their funds into the second hand housing market usually with a budget that competes directly against the slow decline of our “first home buying” sector.

Break the data down and as pointed out here it’s clear that the larger share of mortgage demand is investor lead “ Since March 2009, the average FHB mortgage has grown by only 1.8 per cent, whereas the average mortgage for the market as a whole has grown by 9.6 per cent.”

The pent up demand and as we suffer the consequence of another interest rate cut, and the supply of easy cash bubbles the air, comes with a warning from UBS analyst Jonathan Mott indicating;

 the “ingredients are now in place for another bout of sustained house price inflation in Australia and Sydney in particular” remarking “Given Aussie housing is already expensive by most metrics we see this as undesirable and dangerous.”

Housing finance approvals rose solidly in June ahead of expectation, with ABS figures showing a seasonally adjusted 2.7 per cent increase in owner-occupied finance commitments which are now tracking 7 per cent above the five year moving average with the series up +14.2 per cent on the same time last year.

Loan sizes also increased – up 0.7 per cent for the month and 0.9 per cent for the year (a marked improvement from the beginning of the year) with the value of investor finance commitments up 18 per cent over the year.

ABS housing data shows nationally, prices have exceeded their 2010 peak – primarily lead by Darwin, Perth and Sydney, with the other states still playing a game of catch up in median terms. And as I explained last week, for those of us who work ‘on the ground’ assisting purchasers, to describe the atmosphere as ‘challenging’ would be an understatement of terms.

In a recent conversation with a contact of mine, who runs a buyer advocacy agency in Sydney, he spelt out clearly the difficulties purchasers are now facing with the comment;

“Definitely already a seller's market here in Sydney. Auction clearance over 80 per cent in many suburbs. Saw a property where after just 2 Opens, the agent had 25+ contracts out. Price guide revised immediately after first open from 1.2m-1.3m to now 1.4m-1.5m. Tough market to buy in!”

And although Victoria faces stronger headwinds - as I explained last week, it’s not so anecdotally different in Melbourne.

As property once again ramps up in capital value, becoming more expensive in a domain riddled with speculative behaviour - supply side constraints prevent any sustainable recovery in the construction sector and - as commented in a discussion on housing affordability during last week’s ABC1 ‘Question and Answer’ - political parties refuse to touch negative gearing or make the tough decisions that might just prevent an increase of ‘cheap’ credit being fed directly into boosting second-hand home prices  - (instead trying to solve with their right hand, problems created with their left) we’re effectively washing away any efforts to assist our young home buying generation.

In this respect, Australia is remarkably similar to the UK and Canada, and also parts of the USA. House prices rising against the gravity of the broader macro environment, with all who have a hand in manipulating the situation, imagining the story will somehow have a happy ending.

Catherine Cashmore