How Painful House Price Bust can be?


San Francisco Fed president, Dr. Williams said Australia has “hot markets” in certain big cities and cautioned against trying to fix the problem by hiking rates, which will have “very unfavorable trade-offs when trying to control either a debt build-up or a housing price build-up or a stock market build-up – excessive costs in terms of unemployment and inflation”. Further, emphasized that monetary policy should be focused on achieving the macroeconomic goals and must use the regulatory, supervisory, micro- and macro-prudential tools to get at some of these other issues.” Dr. Williams warned the lack of a housing downturn, even a recession since 1991, may be making many Australians too complacent about the risks that have built up. A lot of people’s attitudes towards investment, economic phenomena, like inflation and things like that really are shaped by lifetimes.

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The lack of a housing market shakeout and the boom in unit construction are among key reasons Australia’s economy has continued to outperform countries like the US over the past decade, but there are growing signs that in coming years that relative difference may swing into reverse. The US Fed has already hiked its benchmark rate twice in 2017, with at least one more increase certain before the end of the year. They are likely to be joined fairly soon by the Bank of Canada and the Bank of England, while the European Central Bank has also becoming more hawkish in recent weeks. Financial market betting in Australia implies for the first time in months that there is no chance at all another Reserve Bank rate cut, and there is now a 40 per cent prospect of a hike by April of next year.

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Former board member John Edwards alarmed many indebted households last week by suggesting that if the economy and inflation strengthen as the Reserve Bank predicts there may be as many as eight official rate rises in 2018 and 2019. Notably, members of RBA board, hosted by the Australian National University and made up of specialists including two former board members, said the probability of a rate hike in six months from now stands at 71%. However, Australia’s economic outlook remains mixed as the unemployment rate unexpectedly fell to 5.5% while headline inflation remains well contained. However, household debt continues to break new records, raising concerns about a possible housing crash in the major capital cities. If the central banks raise interest rates to slow the house price build-up or debt build-up, that harms the economy, while making it harder to achieve the central bank goals of whatever inflation target is.

Further, Reserve Bank governor Philip Lowe last month emphasized the need for workers to win higher wage gains before inflation was likely to rise back into the central bank’s 2-3% target range. Any advantages of funding property portfolios with popular interest-only loans are rapidly disappearing as lenders hit the red alert button by raising rates, tighten terms and offer lucrative incentives to pay down debt. Further, big banks are responding to regulatory pressure by hiking rates on the loans, which are used by 70% of investors, by up to 50 basis points and encouraging switches to principal and interest loans by reducing rates by about 50 basis points. Traditionally loan repayments have been cheaper on interest-only loans, both because repayments don’t include principal and rates have been lower than on principal and interest loans. Annual rents are falling in Perth, Brisbane and Darwin by between 1% and 9%, while they are rising by 11% in Hobart, 5% in Melbourne and 3% in Sydney.

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