No rate hike expected for months

While the housing recovery is a positive sign for the economy, high investor activity may pose a threat in future

 

At the moment, the Reserve Bank of Australia faces a balancing act. On the one hand there are signs the rate cuts over the last couple of years have got traction, particularly in the housing sector. Against that, there is still a lot of uncertainty about how quickly the mining investment slowdown will occur and whether the rest of the economy will be strong enough to withstand that.

Consequently, when the Reserve Bank is balancing out those competing forces, I think it’s no surprise it decided to leave rates on hold in April. I think the

Reserve Bank at this stage feels it has cut enough and it is now time to see how the economy unfolds.

In its most recent Financial Stability Review, the Reserve Bank noted a marked pick-up in investor activity and resolved to closely monitor this trend.

While the Reserve Bank has been trying to promote a recovery in the housing sector, it doesn’t want the situation to get out of hand. The Reserve Bank is wary the housing recovery may turn into a bubble, which in turn could threaten financial stability in the economy.

If investors borrow too much and the property market becomes speculative, that would be a concern to the Reserve Bank. In a speculative market, we see people buying solely in the anticipation that the gains we’ve seen over the last year or so will continue into the future. Some of those borrowers might be shocked if property values fall in future, which can cause financial distress.

Arguably, the housing recovery is still in its early days. We’ve only had one year of strong property price growth, whereas in the 2003 to 2004 period, we had about seven years of strength. So at this stage, it’s a matter of ‘wait and see’ for the Reserve Bank.

According to data released recently, house prices in Sydney grew almost 16 per cent over the past year and nationwide they’re up almost 11 per cent. That’s alright for one year, but if that were to continue it might raise concerns.

One way to try and combat that trend is for the Reserve Bank to exercise what is called ‘jawboning’. This refers to the Bank issuing statements that people need to be aware that prices can go down as well as up and messages to banks not to ease their lending standards.

A housing recovery was essential if we were going to get a rebalancing of the economy. Yet the longer the housing recovery goes on, the more the Reserve Bank might start to issue warnings that interest rates are not going to stay this low forever and, when they rise, that might be a dampener on house prices.

At the moment the Reserve Bank is not contemplating a rate hike to slow it down, but it is something it is keeping an eye on. I think we can expect another four months of inaction by the Reserve Bank. However, I think it will probably also use jawboning to ward off a further acceleration in house prices.

If inflation started to take off or house price growth was to speed up further, the Reserve Bank might raise rates before seeing a stronger economy, but I think both of those situations are unlikely. While price growth will remain strong, it probably won’t accelerate from here. Before raising rates, the Reserve Bank would want to see more evidence the economy is heading back to a trending rate of growth, which is three per cent or above.

 

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