Housing recovery complicates the RBA’s war on inflation
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The housing market seems to have wrong-footed the experts yet again. Over the past month, the country’s four biggest banks have dumped their more pessimistic forecasts for house prices and declared the correction is largely over.
The resilience of bricks and mortar surprised many economists because most had assumed the sharp rise in interest rates, which has slashed the maximum amounts banks will lend, would spark a deeper drop in prices.
Australia’s four biggest banks think the house price correction is largely over.Credit: Peter Rae
But while many home owners may be breathing a sigh of relief, the tentative signs of recovery in housing are likely to be causing some discomfort at the Reserve Bank.
RBA governor Philip Lowe explained this week’s surprise move to jack up interest rates to 3.85 per cent as being targeted mainly at containing inflation, but some observers believe Lowe may have also been influenced by recent rises in house prices.
In a speech explaining the rate rise on Tuesday night, Lowe noted that since he paused interest rates in April, asset prices, including those of houses, had responded to the market’s more dovish outlook for rates. Lowe has also previously raised concerns that the extreme tightness in rental markets could fuel inflation.
While the RBA has not explicitly raised concerns about house prices, AMP chief economist Shane Oliver says it’s likely recent trends in real estate were one influence on Lowe’s latest rate rise.
“The RBA is probably a little bit concerned about the early signs of a pick-up in the property market, and I would suggest they probably don’t want to see it go too far at this stage,” Oliver says.
CoreLogic research director Tim Lawless says housing conditions supported the RBA’s decision to raise rates, though he doesn’t think the rate rise will send prices falling again.
“The lift in interest rates could act to dampen some of the recent housing exuberance, although a range of other factors are likely to support the continued stabilisation in home values, including low available supply, extremely tight rental conditions and higher demand via net overseas migration,” Lawless says.
Others are not convinced house prices have really bottomed. Morgan Stanley analysts this week said they expected further price falls this year, as higher interest rates and weaker employment conditions hit the market. This weekend’s auctions, following a rate rise, will be an important test for the market.
‘The RBA is probably a little bit concerned about the early signs of a pick-up in the property market, and I would suggest they probably don’t want to see it go too far at this stage.’
But whatever your view, there is no doubt changes in house prices can have big economic implications, through the impact on household balance sheets, and high-employing industries, such as construction and retail.
So, which sectors in corporate Australia have most at stake in a housing market that’s still absorbing the impact of rapid rate rises? And how could the stabilisation in housing influence the wider economy and the RBA’s war on inflation?
Residential real estate is the biggest asset class in the country. It is worth $9.3 trillion, CoreLogic says, and it’s the largest sector for bank lending. This means a host of industries are watching closely for signs of a rebound, after capital city prices dropped by about 10 per cent in 10 months.
Tribeca Investment Partners portfolio manager Jun Bei Liu thinks this week’s rate rise has simply pushed out the time frame for the recovery in house prices and that as they increase, there will be widespread benefits for consumers and businesses.
NAB chief Ross McEwan believes house prices are more likely to go sideways than down.Credit: Elke Meitzel
“In the near term, we might have a bit of weakness, but we’re very close to the bottom,” she says. “Ultimately, house prices rising is very good for the Australian economy because it’s such a big component that underpins consumer confidence, business confidence and economic activity, and flows through to salaries, employment and everything else. Most things will benefit from it.”
National Australia Bank’s chief executive Ross McEwan was more cautious in his remarks on housing this week, but he highlighted the tight supply of homes and argued prices had bottomed.
“House prices we think bottom out from there, from a decline that’s been happening over the last six to 12 months. So I think you’re seeing more and more prices going sideways as opposed to down,” McEwan said.
Despite very low listing numbers, Liu predicts an increase in the number of homes for sale in months ahead, with positive impacts for home builders, which have come under pressure recently.
“The likes of Boral, Stockland and Mirvac are going to see quite a bit of demand,” she says. “It doesn’t mean earnings will return quickly, but the share price will move ahead of earnings for those builders.”
Markets appear to be pricing in some of these potential benefits for property developers. Macquarie’s equity strategists this week noted real estate shares outperformed in April, probably helped by house price trends; Stockland shares were up 13.5 per cent and Mirvac gained 14.8 per cent.
Industrial companies, such as CSR, which manufacture and supply building products, will also benefit from increased demand for homes, Liu says, along with consumer sentiment.
The banks also have plenty at stake in the property market: the $2.1 trillion mortgage market is the biggest source of loans for the big four – and a potential source of bad debt charges.
If house prices have bottomed, as Commonwealth Bank, ANZ, National Australia Bank and Westpac expect, it lowers the risk of a major wave of loan losses for banks. Any pick-up in housing could also strengthen housing credit growth, which has slowed sharply as interest rates have risen.
Property listings businesses, such as REA Group and Domain (60 per cent owned by this masthead’s owner, Nine), are also highly exposed to the ups and downs in the property market. Generally, however, analysts say the volume of listings is critical for these businesses – and unlike prices, the number of listings has yet to pick up.
But it’s not only businesses that directly clip the ticket on property transactions that have plenty at stake in the housing market.
Retailers – especially those selling bigger ticket items, such as Harvey Norman or JB Hi-Fi – can also benefit from a recovery in house prices through what economists call “wealth effects”.
This is the idea that when people feel richer because of gains in their paper wealth, they are more likely to spend a bigger share of their income.
The RBA has previously said new car purchases, which are particularly sensitive to changes in housing wealth, can increase by 0.5 per cent for every 1 per cent rise in house prices.
However, there are convincing reasons to think the recent flattening in house prices probably won’t drive a rebound in consumer spending this time around.
For one, Jarden analyst Carlos Cacho says housing turnover is a more important influence on household spending than house prices – and turnover remains low. “There’s a very strong relationship between housing turnover and household good sales,” Cacho says. The lack of housing turnover is different from turnover during past cycles when the volumes of sales and listings have typically increased before prices.
Second, those mortgage holders who see their paper wealth increase when house prices rise are still feeling the squeeze from sharply higher mortgage repayments.
And third, the tight supply of houses is also bad news for large groups of the community, such as renters, who face sharp rises in rents, and hopeful first home buyers, who face worsening affordability.
Moreover, it is safe to assume that the RBA won’t want to see wealth effects driving a recovery in household spending, which would only worsen Australia’s inflation problem. Indeed, one of the ways in which rising interest rates slow the economy is by lowering asset prices, including houses.
When it raised rates this week, the Reserve Bank warned it may raise rates again if needed, depending on how inflation and the economy evolved.
But the clear risk is that with every time the Reserve Bank makes a further rate rise, it increases the chances of a “hard landing” caused by stepping on the brakes too hard. Oliver, for example, estimates Australia’s economy has a 45 per cent chance of recession and a 55 per cent chance of a soft landing. Deloitte Access Economics went further, this week, warning the Reserve Bank was playing “recession roulette”.
But NAB’s McEwan, who runs the country’s largest business bank, struck more of a cautiously optimistic tone.
He said economic growth would be slow for the two years and the cost of living was biting, but it looked increasingly likely Australia would avoid a “pronounced economic correction”. McEwan said that despite the slowdown, business clients were telling the bank they were still growing, and importantly, they were still finding it hard to find staff.
“So the message here is that it’s likely to feel harder over the next six to nine months, but the Australian economy is proving resilient,” McEwan said.
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