Why the Reserve Bank is happy to see Sydney, Melbourne house prices edge lower

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Karen Maley| Australian Financial Review| 17 July 2018


The Sydney and Melbourne property markets are gradually deflating, and the Reserve Bank of Australia couldn’t be happier.

That’s the clear message from the minutes of the RBA’s latest board meeting, held a fortnight ago.

Judging from the minutes, the RBA board spent much more time than usual examining the complex interlinkage between Australian property prices, household debt and economic activity.

In the first place, the RBA will be reassured there’s little sign that the country’s house price bubble is headed for a spectacular collapse.

Construction activity is likely to remain strong in Sydney and Melbourne for some time.
Construction activity is likely to remain strong in Sydney and Melbourne for some time. aarcher@fairfaxmedia.com.au

Instead, it seems that Sydney and Melbourne property prices – the two markets that witnessed the most staggering rises – are gently ebbing lower. And this is exactly what the RBA wants to see.

“Housing prices had declined in Sydney and Melbourne following significant increases in previous years”, the RBA minutes note, without the slightest sign of regret. “Housing prices had fallen by almost 5 per cent in Sydney over the preceding year.”

Prices are cooling in Sydney and Melbourne because investors – who no longer see any prospect of making a quick buck out of buying properties – have largely left the market.

As the minutes note, “housing credit growth had declined, mainly because investor demand had slowed noticeably”.

Lending standards

Another reason is that bankers have bowed to pressure from regulators to adopt more stringent lending standards.

The RBA recognises the possibility that banks could become even more assiduous about lending following the Hayne royal commission, with the minutes noting that “some further tightening of lending standards by banks was possible”.

Of course, there is a good reason why the RBA is keeping such a vigilant watch on the property market. And that’s to do with the close link between Australian house prices and household indebtedness.

As house prices surge, households start to panic that they’ll be priced out of the market. This encourages them to load up with even larger mortgages, helping to push Australian household debt levels even further into nosebleed levels.

The RBA's Philip Lowe. The bank says housing credit growth has declined, mainly because investor demand has slowed ...
The RBA’s Philip Lowe. The bank says housing credit growth has declined, mainly because investor demand has slowed noticeably. Brendon Thorne

Meanwhile, bankers become increasingly emboldened as they watch the security they hold for their home loans continue to rise in value.

According to a special paper prepared for the RBA’s July board meeting, we’re not the only country that’s seen this relentless rise in debt.

“Household debt has increased by more than household income over the preceding three decades in many countries, but particularly so in Australia.”

There are several factors driving this relentless rise in household debt. Falling interest rates have meant that borrowers can afford to service bigger debts, while financial deregulation, which has improved households’ access to finance.

Household debt

Where we are unusual is that we’re more inclined than most to borrow in order to invest in housing, and this has helped push Australia’s household debt to income ratio to a record high of close to 200 per cent.

The combination of surging housing prices and rising high household debt also results in undoubted risks for the overall economy – as both the International Monetary Fund and the Organisation for Economic Co-Operation and Development have pointed out.

The RBA is well aware of the economic risks flowing from high household debt levels. People with heavy debt loads are more likely to cut back on spending if they start to worry about their future incomes, and they’re less likely to respond to interest rate cuts by borrowing even more.

But the central bank appears cautiously optimistic that we’ll manage to escape the worst effects of our debt binge.

Robust economic activity is boosting jobs growth, and this should eventually result in stronger income growth, which will make it easier for households to shoulder their debt burdens.

Also, even though housing prices are edging lower in Sydney and Melbourne, the large amount of work in the pipeline in NSW and Victoria suggests that construction activity is likely to remain strong in these two states for some time.

Inevitably, there are risks. Soaring household debt levels could crimp consumer spending, especially if wages growth remains weak.

Alternatively, consumer confidence could be hit hard if, as seems increasingly likely, the country’s big four banks decide to follow their smaller rivals in nudging mortgage rates higher to reflect the rise in funding costs.

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