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 

Doomed if he does doomed if he doesn’t

What can I say, sterling is just leaving us with our mouths wide open. After last week’s disappointing production figures, it was easy to assume that today’s employment figures would just meet expectations. However, the light shone brightly on the UK this morning, and not only did claimant count smash expectations, but the unemployment rate dropped to 7.7%. All this does is boost market sentiment and confidence about the UK outlook. Now, as much as the UK has produced outstanding figures, one can only wonder about how this affects the BoE’s stance on interest rates and unemployment.

While it is unlikely that strong August figures will alter the central bank’s view on maintaining loose monetary policy, what should be noted is that the better the UK economy does, the more the market will question Governor Carney’s commitment to keep rates low at least until 2016. Today’s release of employment figures are even more crucial considering forward guidance outlined by the BoE.

Shouldn’t we really be thanking the central bank for its pledge to ensure low rates to promote growth, which considering recent figures seems to be doing the job? Yet you can’t help but ask: what about inflation? Currently inflation is above the central bank’s target at 2.8% and with growing domestic demand you must wonder how much further it can push. One thing we can be certain of is that if the recovery continues to be as robust as we have seen, the central bank may have to re-evaluate policy in order to ensure price stability. Not only will the market be listening attentively to the Inflation Report hearings tomorrow, but they will be also anticipating inflation figures released next week. When the going gets tough will Carney abandon his growth commitment and enforce price stability or vice versa? Either way, it looks like something will have to give.

Sasha Nugent
Currency Analyst
Caxton FX