RBA warns property investors of macroprudential

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ScreenHunter_4598 Oct. 22 08.18

By Leith van Onselen

RBA deputy governor, Phil Lowe, gave a speech yesterday afternoon to the Commonwealth Bank of Australia’s 7th Annual Australasian Fixed Income Conference, whereby he expressed overwhelming frustration that the prolonged period of record low interest rates had not generated genuine productive investment, and had instead been channeled into existing assets, like property, inflating values:

Interest rates are as low as they have ever been in most advanced economies…

This shadow has created a difficult environment for savers and those managing savings. Perhaps at the risk of over-simplifying things, they have three basic choices:

They can leave the savings in the bank and earn zero (or less).

1. They can use the savings to purchase existing assets from other investors in the hope of earning a positive return.
2. They can use the savings to finance the development and creation of new assets, for example a new piece of capital equipment, a new building or some new intellectual property.
3. It is this third use of savings that is critical to the resumption of strong growth in the global economy.

When the crisis hit in 2008, the first of these three savings choices dominated…

[But] as we gradually climbed out of the crisis, attitudes to investing evolved. Faced with very low interest rates on safe assets and evidence that the global economy has been on a recovery track of sorts, investors have been prepared to move out along the risk spectrum and purchase existing assets as they search for yield. In response, the prices of these assets have risen again.

This rise in the prices of existing assets is understandable…

[However] it is this latter part of the transmission channel that is proving frustratingly slow in many countries. The strong demand for many existing assets has not yet generated a strong appetite for the creation of new assets. Many investors remain very cautious when considering funding business expansion and aggregate investment remains low. In response, central banks have felt that they have had no choice but to continue with very expansionary policies and, in some cases, to add yet further stimulus. The hope is that in so doing they will eventually induce a shift from the world of strong demand for existing assets to one in which there is strong demand for the new assets that will create the growth and jobs that are so badly needed.

Lowe also turned his sights on Australia’s growing band of property investors, warning that the RBA and APRA had come to the conclusion that parts of the housing market had become “somewhat unbalanced” and raised “overall risk”, necessitating policy intervention:

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…it is in the housing market where the strong demand for existing assets is most evident. Many investors, including those in self-managed superannuation funds, have decided that investment in residential property is an attractive option, partly given the low level of interest rates. Prices have risen as a result…

The good news is that this increased demand for existing housing assets is translating into increased demand for new housing construction. This is a very welcome development. Investment in residential construction has increased by 9 per cent over the past year and further increases are expected…

[But] the judgment that we have reached over recent times is that at least some aspects of the housing market have become somewhat unbalanced and that this has generated some increase in overall risk.

The area that has attracted most attention is the very strong demand by investors to buy housing for the purposes of renting. Currently, loan approvals to investors buying properties to rent out account for nearly 45 per cent of total loan approvals, with most of the investment properties being existing properties. Perhaps not surprisingly, the biggest increases in housing prices have occurred in the city where investor demand has been strongest – namely Sydney. Overall, investor credit outstanding is growing at an annual rate of close to 10 per cent, around twice the rate of increase in household income. A fairly high and increasing share of these investor loans do not require the repayment of any principal during the life of the loan. And this is all occurring in an environment in which growth in rents has slowed and the ratio of housing prices to income is at the top end of the range experienced over the past decade or so.

Now as I said, one cannot draw conclusions with absolute confidence, but I contend that a reasonable interpretation of these events is that they are leading to some increase in overall risk… on average, recent loans are probably a bit more risky than those made earlier…

As has been well publicised, the members of the Council of Financial Regulators, including the Bank and APRA, have also held discussions regarding the merits of additional measures within the existing prudential framework. If risk has increased, then it might be appropriate to adjust one or more of the elements within that framework to reflect that change in risk… [That is] consideration of modest and sensible changes within the existing prudential framework.

Finally, Lowe claimed that interest rates in Australia (and globally) are likely to remain low for an extended period to come in order to facilitate the ‘rebalancing’ of the economy away from mining investment:

As I have said, low rates have boosted asset prices globally, including in our own housing market. The judgement that the Reserve Bank Board has reached is that in Australia these low rates are entirely appropriate. They are required to assist in the necessary balancing of the Australian economy following the once-in-a-century boom in resources sector investment. This is especially so when the exchange rate has not been providing the degree of support that might normally have been expected. The low interest rates are helping boost construction activity and spending more broadly in the economy. This is the transmission mechanism at work.

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Of course, the subtext to Lowe’s speech is that with interest rates likely to remain on hold and investor housing demand at record levels, macroprudential curbs on investor mortgages are coming, possibly by the end of the year.

Better late than never.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.