Via Westpac’s Bill Evans who is getting more and more blunt:
The Reserve Bank Board next meets on October 2. The Board is certain to keep the cash rate on hold.
The last move in the cash rate was a 25 basis point cut in August 2016; that followed a 25 basis point cut in May of that year.
As usual during this long period of inactivity our primary interest has not been in the outcome of the meeting but the commentary both in the Governor’s Statement and the minutes of each of the meetings.
In the minutes of the September meeting there was the following commentary on the housing market: “Conditions in the Sydney and Melbourne housing markets have continued to ease and nationwide measures of rent inflation remain low. Housing credit growth has declined to an annual rate of 5½ per cent. This is largely due to reduced demand by investors as the dynamics of the housing market have changed. Lending standards are also tighter than they were a few years ago, partly reflecting APRA’s earlier supervisory measures to help contain the build-up of risk in household balance sheets.”
This describes what is happening and in this note we look forward as to how this theme might play out.
Those rate cuts in 2016 were on the watch of Governor Stevens.
Bear in mind that the current Governor (who was Deputy Governor when his predecessor Glenn Stevens cut rates in May and August 2016) seems to have a somewhat different set of priorities to Stevens.
At an ECB Forum on Central Banking in Portugal in June Governor Lowe noted: “I remain confident we’re going to get (inflation) back to 2.5 per cent, it’s just going to take us a bit of time …. To try to get it back to 2.5 very quickly, it would be mainly through people borrowing more money, and having higher asset prices – I think that’s a much bigger risk to our economy than people having surprisingly low inflation expectations.”
He went on to note that “very high“ debt levels and asset prices are the No. 1 domestic risk in Australia.
To put that issue in perspective, the chart below shows that headline inflation in Australia, on a calendar year basis, has printed below the 2% lower bound of the inflation target zone for the last four years (2014-17) with the Reserve Bank itself forecasting 1.75% for 2018.
When Glenn Stevens cut rates in May and August 2016 he predicted inflation at 1.5% in 2016 rising to 2% in 2017 and 2018. Despite efforts to slow the growth of house lending in the 2015/16 period, Stevens was prepared to focus on his inflation target at the risk of renewed momentum in housing credit growth. The low point in new lending to housing investors in that cycle was March 2016. Between March 2016 and August, new lending to investors had recovered by a formidable 20%. That ‘recovery’ was due to a combination of a strong lift in demand in response to the rate cuts, and some easing in credit supply as banks became compliant with limits on investor credit growth.
Governor Lowe does not plan to repeat that exercise. Even though inflation is expected to be below the 2% lower bound for at least two more years than Stevens had expected, Lowe is focussed on containing household debt at the risk of inflationary expectations entrenching below the Bank’s target.
Official policies to target a slowdown in household debt are no longer linked to higher interest rates but coming via specific guidelines for banks’ lending practices. The media is carrying extensive coverage of anecdotal evidence of borrowers having to wait much longer for loan approvals; borrowers’ expenses and incomes attracting detailed attention; final approval amounts being lower than expected; and pressures associated with the move from interest only loans to principal and interest loans. Standard and Poor’s estimate that the transition increases repayments by an average of 30%.
In this latest down cycle, new lending to investors is now down 34% from its peak in December 2016 and 8% from the low point in the previous cycle in March 2016.
With no prospect of rate cuts; tightening in lending policies (as noted by the RBA); and uncertainty about the ALP’s policy on negative gearing and capital gains tax there is no reason to believe that new lending to investors has found its bottom.
Housing credit growth is reflecting this development, slowing from 6.2% in 2017 to our forecasts of 5.2% in 2018 and 4% in 2019.
House prices are falling in Sydney and Melbourne under the weight of stretched affordability and tight credit.
In previous periods when house prices were falling (2008 and 2012), the RBA cut rates (from 7.25% to 3% in 2008/09; and from 4.75% to 3% in 2011-12) and restored affordability and, supplemented by accommodative lending from the banks, boosted house prices, particularly in Sydney and Melbourne.
In this cycle there are unlikely to be rate cuts for the reasons discussed and lending policies appear to have changed structurally. Consequently it seems reasonable that we should prepare for an extended period of falling house prices in Sydney and Melbourne. The degree of the falls is uncertain although our measures of affordability point to the current pace of price falls of around 5% through at least 2018 and 2019.
These dynamics around credit; prices; and confidence will impact residential investment which we expect to be falling in NSW through the remainder of this year, and to turn down in Victoria some time in 2019.
Other issues for the Reserve Bank Board to consider include whether we will see a marked negative wealth effect emerge, particularly given that the household savings rate has fallen to 1%.
The decision to focus policy on household debt is understandable but the risks involved extend well beyond just low inflation.
The next move in rates is down and, to be honest, won’t change much in the long run.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
