From our Bill:
The Westpac–Melbourne Institute Consumer Sentiment Index rose by 7.8% in August from 92.2 in July to 99.5 in August.
Ongoing positive news around house prices may have partly buoyed confidence. Certainly there was a much larger lift in the confidence levels of those respondents who wholly own a property (up 6.2%) or who hold a mortgage (up 11.0%) than those who are out of the housing market (up 4.3%).
However Confidence is not being boosted by the expectation of more interest rate relief. In our special question around the outlook for mortgage rates 55% of respondents expect mortgage rates to rise over the next 12 months; 35% expect rates to be steady; and 5% expect further rate cuts (5% with no opinion).
This is in direct contrast with current market pricing. (See discussion below.)
In the survey sentiment towards housing improved. ”Whether now is a good time to purchase a dwelling” increased by 8.2%. But that really only represents a recovery from the precipitous fall last month of 15.4%. The level in August is still 8.5% below the level in June and still represents the second lowest print for this Index since November 2010 – the aftermath of the Reserve Bank’s rate hike cycle.
This sentiment is probably being driven by concerns around both affordability and prospects for prices. We also expect that the responses are dominated by owner occupiers and respondents who are outside the housing market.
Confidence amongst property investors is likely to be much more buoyant. For example, growth in new lending to property investors is up by 22% over the year to June compared with 7% for owner occupiers and has actually fallen by 1% for first home buyers.
However, property investors are now facing considerable challenges. The banks have been directed by APRA, the regulator, to cap the growth in their property investment loan portfolios to 10%.The potential extent of this dislocation is best summarised by the growth in these portfolios in previous property booms.
For example in 2004 growth in this sector peaked at 30%, following peaks of 28% (2000) and 26% (1993). Growth has already exceeded the 10% limit. It is also unlikely that the non-bank market, which is not subject to the APRA directives, will be able to fill the “gap” and take some pressure off the banks.
Immediately preceding the GFC the non- banks controlled around 20% of the investor market. With funding conditions deteriorating sharply post GFC and still not really having recovered, particularly in Europe, the non-banks have been restricted to around 8% of the market.
No doubt these entities will now be supporting more than 8% of the new flow but are still too small to relieve any major distortion in the market. And distortions are likely to emerge. For example, consider the risks of an investor committing to purchase “off the plan” with, say, a 2 year settlement. Uncertainty around the availability of funding in two years’ time is likely to unnerve investors and developers.
And what about the housing markets that remain weak. These include Perth; Brisbane; Adelaide; and Hobart. Investors and new developments are likely to be important in supporting those housing markets and economies in general. Competition for funding from the active centres in Sydney and Melbourne is likely to represent damaging headwinds for those cities.
In an effort to slow demand from investors banks have raised rates on all investment loans (including the “back book”) by around 27 basis points. Overall that represents the equivalent of around a 10 basis point tightening across the mortgage market since investor loans represent around 37% of banks’ outstanding housing loans. Banks have taken other action such as lowering LVR’s and, daresay in some cases, imposing quantitative restrictions.
It is in this back drop that we have been surprised that markets have persisted in maintaining a 90% probability of another 25 basis point rate cut by the RBA by mid next year and a 50% probability of a cut by November.
This is despite the likelihood of FED rate hikes (our central view) beginning in September; a reasonable prospect of growth in Australia at around 3% in 2016; the Reserve Bank now assessing that the unemployment rate has peaked (huge hurdle for a November cut) and the RBA forecasting that growth will centre around 3.75% (around 1% above trend) in 2017. (While we are sceptical about the 3.75% the Bank is likely to maintain that call well into 2016 precluding any urgency to cut rates further.)
Perhaps markets are more focussed on further potential rate increases from the banks. Given the historical evidence of just how quickly investor loans can grow during a boom it is likely that banks will struggle to limit growth to 10%.
Even higher rates for investors may well be an attractive policy option for the banks to further slow investor growth.
For example, a further investor rate increase of, say, 0.5% would be equivalent to 0.2% across the mortgage market.
Markets may be expecting that, in the event of the labour market faltering in such an environment the Bank may see the need to restore more stimulus across the economy. We are not convinced about such prospects but we are also surprised about current market pricing.
This kind of dynamic might provide the explanation. Respondents were less confident about the outlook for house prices. The Westpac Melbourne Institute Index of House Price Expectations fell by 5.6% from its level in July and is now down by 10.3% over the year.
The Reserve Bank Board next meets on September 1. There is very little chance that the Board will choose to move rates. Westpac expects that rates will remain on hold over the course of the remainder of this year and in 2016. It is notable that the Reserve Bank’s forecasts in its recent Statement on Monetary Policy include a 3% growth forecast in 2016 lifting to a “heady” 3.75% in 2017. We are much more circumspect about the growth outlook in 2017. If, however, it became clear through the course of 2016 that the 3.75% growth outlook was likely to be achieved, and even exceeded, then rate increases would quickly move onto the radar screen.
