Why the Reserve Bank of Australia are in denial

Over the past two RBA monetary policy meetings, the minutes released have revealed a somewhat positive outlook on the housing market. The minutes for the September 3rd meeting reiterated the view that the housing sector has continued to show signs of development. It also outlined that low interest rates have contributed to the improvement in the housing sector.

What is worrying here is the fact that the central bank has failed to identify how this could contribute to another boom-bust housing cycle. Australian homes are already regarded as overvalued, and as the mining boom cools, it is easy for the central bank to become more reliant on the housing sector as a source of growth. The recent uptrend in housing figures from Australia has confirmed this, and with household debt currently at 150% of GDP the Australian housing market is definitely something to monitor.

Even the Aussie’s neighbours have taken steps. The central bank of New Zealand have already acknowledged the potential risk to their economy and have put in place macro prudential policies, such as loan to value ratio restrictions, in order to curb housing related credit growth and price pressure. RBNZ Governor Wheeler outlined that this would help better position banks in the event of shocks, limiting damage to the housing sector and the economy.

The chart below shows the world’s most overvalued economies, with Australia not too far behind New Zealand.

Source: OECD

Chart 2 allows us to analyse the effects of the base rate against house prices more closely. From this we can see that when interest rates were higher, house prices rose more steadily, such as the period from 2005 through to March 2008. As the global crisis took hold in 2008 house prices plummeted and rates were lowered in order to support the economy. The lower rate then fuelled a sharp acceleration in house prices which tumbled shortly after, highlighting the significance of lower interest rates to house prices. The problem is the RBA fails to recognise that the effects of record low interest rates are already being seen. If the central bank needs to cut rates further to support economic growth, we could potentially see the housing market spiral out of control. In addition, the RBA has stated that a weaker Aussie will help the recovery, but a weak Aussie, coupled with high household debt that is likely to increase if rates are cut further, can easily create turmoil in the housing market and vulnerability to shocks.

RBA Asst Gov Malcolm Edey has said we should not rush into a bubble analogy, but surely recognition and consideration of the potential longer-term effects, of an already overvalued housing market is not too much to ask? Especially considering we have witnessed the repercussions when such signals are ignored.

Sasha Nugent

Currency Analyst

Caxton FX