The RBA may need to deal with the ongoing rise in house prices through policy change, shifting the imbalance in the economy away from housing towards a different sector.
At its core, the global financial crisis was driven by a collapse in house prices. As house prices plummeted around much of the industrialised world, various interest rate derivatives that were based on mortgage valuations became worthless, which effectively bankrupted many of the world’s largest banks. Those banks stopped settling transactions with each other and the global financial system all but ground to a halt. It caused mortgage holders in many countries to default on their debt obligations in a way never before seen, meaning consumer spending fell and unemployment skyrocketed. This background of the devastating impact of a house price crash is why many global investors cast an eagle eye over the position of housing in Australia. They are frequently wondering whether Australia has a house price bubble akin to the troubles that dogged the likes of the UK, the US, Ireland and Spain, among others. To be sure, Australian house prices are marching higher – up about 10 percent in the last year alone. Unlike many other parts of the world, house prices in Australia are higher now than ever before. In many other countries, house prices fell 30, 40, 50 percent and more, and are still lower than the level of five or six years ago despite a recent recovery. It is clear that Australia, at least for now, is different. Demand for housing is being driven by a surge in population growth, mainly as a result of a high immigration intake. Whether these extra people buy or rent matters little – demand for housing is robust as a result. At the same time, the amount of new residential construction has been subdued, certainly below the rate required to house the extra population. This is in stark contrast to the housing bubbles in the likes of Spain and even the United States where a house building frenzy accompanied the surge in house prices in the period to 2007 or 2008. Until new housing construction increases in Australia and sustains a pace that firstly houses the population increase but also supplies the current shortfall, house prices will remain supported, simply as a result of the shortage of supply. A further supportive influence is the current low level of interest rates. This has a two-fold effect – investors are attracted to housing given the scant income in the likes of bank deposits and share dividend payments, but low interest rates also lower the threshold for investors to gear-up and bid up house prices. The rise in house prices is an issue for policy makers and the Reserve Bank in particular. While a target for house prices in not within the RBA’s remit, it knows too well the pitfalls for the economy from having an unchecked house price acceleration, even if it is seemingly based on fundamental supply and demand dynamics. This is why the RBA is turning its mind towards ending the interest rate cutting cycle and moving to a period of interest rate increases even as the currency remains overvalued in its assessment. If the Australian dollar were to fall, particularly in the context of the US Federal Reserve ending its incredibly stimulatory monetary policy settings, the RBA would no doubt move rapidly to increase interest rates to crimp the house price lift before it becomes too large a problem. Even if the Australian dollar remains strong, the RBA may still have to deal with the lift in house prices through a policy change and shift the imbalance in the economy away from housing towards a different sector. It would no doubt prefer house price growth to ease of its own accord, even though this rarely happens. Rather, interest rate rises may soon be needed to take the heat out of housing even if this means the Australian dollar stays uncomfortably high. Stephen Koukoulas is Managing Director of Market Economics marketeconomics.com.au