Economics and Banking – Page 465 – Digital Finance Analytics (DFA) Blog

The UK’s “Twin Peaks”

Speaking at the Kenilworth Chamber of Trade business breakfast event Andrew Haldane, the Chief Economist of the Bank of England, discussed developments in the labour market, and the implications for monetary policy in the United Kingdom. His perspective is important and relevant in the Australian context.

The main messages of Andrew’s speech are:

In June, as he made clear in a speech, he put even weight on moving interest rates sooner (which he termed being ‘on the front foot’) and moving interest rates later (being on the back foot). Three months on, the statistics now appear to favour the back foot.
Recent evidence, in the UK and globally, has shifted Andrew’s views about the likelihood of weaker outcomes. That reflects markdowns in global growth prospects and weak pipeline inflationary pressures, both from wages and prices internally, and energy and commodity prices externally. He is gloomier about demand and sees inflationary forces weakening in the near term. This implies that interest rates could remain lower for longer than he had expected three months ago, without endangering the inflation target.
Turning to the performance of the UK economy, Andrew notes various reasons to be cheerful: ‘growth at the top of the G7 league table’ and ‘well balanced between consumption and investment’; ‘borrowing costs at exceptionally low levels’; ‘employment up 1.8 million since its trough’ and unemployment falling from 8.4% to 6%, and expected to fall further. The combination of GDP growth, inflation and unemployment suggests that the economy is in ‘fine fettle’ and has only been bettered in 5 of the last 44 years.
But looking at a different set of indicators suggests ‘reasons to be fearful’. ‘Growth in real wages has been negative for all bar three of the last 74 months’. ‘The level of productivity is no higher than it was six years ago’. And real interest rates are around zero. This combination of poor economic outcomes is ‘virtually unprecedented going back to the late 1800s, with the exception of the aftermath of the world wars and the early 1970s.’
Andrew concludes that the economy appears to be ‘writhing in both agony and ecstasy. It is twin peaked’.
Looking forward he suggests that the key issue is which of these twin forces will win out. The Monetary Policy Committee’s forecast suggests that by 2017, ‘productivity growth and real wage growth are back to around 2% and real household deposit rates are in positive territory’ or in other words ‘the sun will come out tomorrow’. But Andrew notes that such forecast have been confounded in the past, and he also notes that the low level of expected real interest rates implied in the UK’s yield curve may reflect pessimistic assumptions about future growth prospects.
Turning to the labour market he finds more evidence of polarising patterns: ‘the upper peak of the labour market is clearly thriving in both employment and wage terms. The mid-tier is languishing in both employment and real wage terms. And for the lower skilled, employment is up at the cost of lower real wages for the group as a whole’.
Turning to the implications for interest rates, he suggests that financial market participants must weigh up the likelihood of the UK taking a strong path or a weak path – the twin peaks he has been discussing. ‘Over the past few months, the implied path for interest rates has shifted down’. ‘One interpretation of that move is the market now assigning a somewhat higher probability to the lower peak’. That is also his own assessment of how the balance of risks has shifted.

The Unhappy State Of Investment Property

In the ABS data yesterday there was useful information on the state by state situation with regard to investment property lending. So today we look at the latest data, and it is quite shocking. The chart below shows the 6 month rolling average value of lending for property investment flows across the major states. It is the sum of lending for dwelling construction, and borrowing for established homes by individuals, and others. This is not seasonally adjusted, so it is original data. The most striking observation is the breakout in NSW, and to a lesser extend VIC. There is much more modest growth in the other states. No wonder then the RBA has been starting to warn.

But if we look by percentage splits, its is even more stark. In 2008, 32% of investment lending was in NSW, the most recent data puts it at 45%. In VIC, in 2008, it was 26%, today its still 26%. Compare this with QLD, where in 2008, it accounted for 23% of investment lending, whereas today it has dropped to 14.5%; WA also dropped a little. Combined, VIC and NSW comprise 71% of all investment lending – talk about concentration risks!

There is a strong correlation with buoyant investment activity and house prices of course, and this raises a significant question for the regulators, if macroprudential is brought in, can it be done in a way to target the investment sector without causing unintended consequences, and if investment is slowed in NSW, what does that say about the prospects for house prices in coming months. It is indeed an unhappy state of play.

August Lending Data Released

The ABS released their data series for August covering the entire lending spectrum (the housing details were released previously).

The total value of owner occupied housing commitments excluding alterations and additions fell 0.1% in trend terms, and the seasonally adjusted series fell 2.0%.

The trend series for the value of total personal finance commitments rose 1.0%. Fixed lending commitments rose 1.0% and revolving credit commitments rose 0.9%. The seasonally adjusted series for the value of total personal finance commitments rose 5.2%. Revolving credit commitments rose 5.9% and fixed lending commitments rose 4.7% .

The trend series for the value of total commercial finance commitments rose 0.2%. Revolving credit commitments rose 0.4% and fixed lending commitments rose 0.1%. The seasonally adjusted series for the value of total commercial finance commitments fell 16.3% in August 2014, after a rise of 3.4% in July 2014. Fixed lending commitments fell 18.6%, after a rise of 21.0% in the previous month. Revolving credit commitments fell 9.6%, following a fall of 26.8% in the previous month.

The trend series for the value of total lease finance commitments rose 1.1% in August 2014 and the seasonally adjusted series rose 8.7%, after a fall of 7.3% in July 2014.

This chart shows the seasonally adjusted flows for all finance categories.

Looking at property, we again see the investment lending sector strong, at close to 50% of all property lending, excluding refinancing.

Finally, we look at the share of investment lending as a proportion of all commercial lending. We see it sits above 20%, with a surge recently. The dynamics here are interesting, does if represent a fall in other business lending categories, or a replacement by rising investment property lending?

The other gap in the data is the number of new properties purchased as investment properties (this is different from investing in building new property). This is an important data point because one of the arguments proffered by some is that negative gearing supports new builds. Our own survey data suggests this is not the case, and most investment lending which is negative geared is going to established property.

The Rise And Rise Of The Bank Of Mum and Dad

As part of the DFA household surveys, we segment the housing market, to identify those who want to buy and first time buyers, as well as those down trading, the affluent, suburban and seniors. We described the full segmentation recently. Today we look at those who are trying to buy. This group has been under pressure as prices rise, incomes stall, and property supply is limited.

One striking fact is the number of households in this group who are now banking with the “Bank of Mum and Dad”. The proportion of households who are borrowing from parents, or who are planning to, has been increasing steadily. The chart below shows the proportion who are relying on Mum and Dad Bank, and we also plot relative house price growth over the same period. This is an Australian average, there are state variations.

We then looked at the average amount being supplied by parents. In 2010 is was around $22,000. Today it is over $60,000. We also tracked the percentage increase year on year for transactions assisted by parent loans. Since May 2013, there has been significant growth.

We then looked at which household segments the funds were coming from. Down traders are the largest group, (there are over one million down traders in Australia at the moment) and growing as a percentage of all households, whereas suburban households (who themselves have larger loans now) figure less.

We also discovered that about half of these loans were made interest free, the other half, charged at a rate of interest at or below the market.

So, it is clear the Bank of Mum and Dad is a significant factor in the housing market, and the second order impact of down traders, is significant. It also means that if property prices were to slip, some down traders may find their generous family loans get eaten up in negative equity.

The low first time buyer rates would be even more adverse, without this extra assistance!

Macroprudential Bites in the UK – Bank of England

The Bank of England (BoE) recently published their Q3 Credit Conditions Survey. This is the first edition since the recent Mortgage Market reforms were introduced, and the macroprudential controls were tabled. Looking specifically at secured lending to households they report that demand for credit has eased, and the proportion of higher loan to value loans has reduced. In other words macroprudential is biting!

After eight consecutive quarters of expansion, lenders reported that the availability of secured credit to households fell significantly in the three months to early-September.

The contraction in overall availability was reported to be driven by a changing appetite for risk and lenders’ expectations about house prices. Many lenders noted that operational issues associated with the implementation of the Mortgage Market Review had pushed down on credit availability over the summer. And some lenders commented that they had tightened availability a little in response to the recommendations made by the Financial Policy Committee to mitigate risks stemming from the housing market.

Credit availability was reported to have fallen in Q3 both for borrowers with loan to value (LTV) ratios below 75% and for borrowers with LTV ratios above 75%. Lenders also reported that they had become less willing to lend at LTV ratios above 90% for the first time since the question was introduced in 2013, and some noted that they had introduced policies which restrict lending at high loan to income (LTI) ratios.

Consistent with a tightening in credit availability, credit scoring criteria for granting household loan applications were reported to have tightened in Q3 and the proportion of household loan applications being approved fell.

Ireland Joins The Macroprudential Bandwagon

In the paper released by the Central Bank of Ireland, it is clear they have gone macroprudential! According to the Irish Times new rules will be applied to mortgage lenders in Ireland from 1 January 2015. A 2 month consultation period now starts, so they may get tweaked before implementation. The UK had announced parallel measures earlier.

New mortgage rules published today mean that most house buyers will have to have a 20 per cent deposit when applying for a home loan. The regulations come into force on January 1st.

The Central Bank is proposing that no more than 15 per cent of all new mortgages for private dwelling homes should have a loan to value (LTV) ratio above 20 per cent. This means that most first-time buyers are now going to be expected to have at least a 20 per cent deposit when buying a home.

In addition, it has also decided that just one-fifth of new mortgages should be issued above a level of three and a half times income (LTI).

In the case of buy-to-let properties, no more than 10 per cent of the value of all new loans should have an LTV above 80 per cent.

The Central Bank’s deputy governor said these measures should help to avoid another property crash in Ireland and dampen the rate of price rise currently being experienced in the market.

“Our research has shown there is strong evidence that mortgage losses are much higher where borrowers have a high LTV or LTI rate,” he said. “We believe that measures such as these are a standard part of a well regulated financial system and introducing these precautionary measures should contribute to a stable and well-functioning mortgage lending market.”

The regulator said the income caps would be “more binding” than the LTV ratios in a period of boom as pay levels could never keep pace with soaring property prices.

The LTV caps are not “completely counter-cyclical” as loan values will rise in line with property prices.

Certain exemptions are proposed to the new rules. These cover residual debt from home loans in negative equity, switcher mortgages, and home loans in arrears. Buy-to-let borrowers will also be exempt from the income restrictions.

Here is the Economist’s comparison chart, showing UK, Ireland and Australia – and we thought we had a problem!

IMF On Macroprudential – It Works!

In the just release IMF World Economic Outlook, as well as revising down growth estimates, they discuss macroprudential, highly relevant in the light of RBA comments. The main observations are:

there is evidence that macroprudential can assist in manage house price growth, and credit growth. Different settings should be applied to different types of purchases, e.g. differentiate first time buyers from multiple investors, but
it is less effective if the cause of extended price rises stems from overseas investors, who bypass local controls and credit policy, so specific separate measures may need to be used to target foreign investors
need to make sure business is not simply redirected to the non-bank sector, and
supply side issues also need to be addressed.

RBA please note! The comments in full from the IMF are below, and worth a read. In particular they cite a number of success stories, so macroprudential is perhaps more proven than many would like to admit.

Many countries—particularly those in the rebound group—have been actively using macroprudential tools to manage house price booms. The main macroprudential tools employed for this purpose are limits on loan-to-value ratios and debt-service to-income ratios and sectoral capital requirements. Such limits have long been in use in some economies, particularly in Asia.

For example, Hong Kong SAR has had a loan-to-value cap in place since the early 1990s and introduced a debt-service-to-income cap in 1994. In Korea, loan to-value limits were introduced in 2002, followed by debt-service-to-income limits in 2005. Recently, many other advanced and emerging market economies have followed the example of Hong Kong SAR and Korea. In some countries, such as Bulgaria, Malaysia, and Switzerland, higher risk weights or additional capital requirements have been imposed on mortgage loans with high loan-to-value ratios. Empirical studies thus far suggest that limits on loan-to-value and debt-service-to-income ratios have effectively cooled off both house price and credit growth in the short term.

Implementation of these tools has costs as well as benefits, so each needs to be designed carefully to target risky segments of mortgage loans and minimize unintended side effects. For instance, stricter loan-to value limits can be applied to differentiate speculators with multiple mortgage loans from first-time home buyers (as in, for example, Israel and Singapore) or to target regions or cities with exuberant house price appreciation (as in, for example, Korea). Regulators also should monitor whether credit operations move toward unregulated or loosely regulated entities and should expand the regulatory perimeter to address the leakages if necessary. For example, when sectoral macroprudential instruments are used to limit mortgage loans from domestic banks, they can be circumvented through a move to nonbanks (as in, for example, Korea) or foreign banks or branches (as in, for example, Bulgaria and Serbia). Macroprudential tools may also not be effective for targeting house price booms that are driven by increased demand from foreign cash inflows that bypass domestic credit intermediation. In such cases, other tools are needed. For instance, stamp duties have been imposed to cool down rising house prices in Hong Kong SAR and Singapore. Evidence shows that this measure has reduced house demand from foreigners, who were outside the loan-to-value and debt-service-to-income regulatory perimeters. In other instances, high house prices could reflect supply bottlenecks, which would need to be addressed through structural policies such as urban planning measures.

RBA Leaves Rates On Hold, Again

At its meeting today, the Board decided to leave the cash rate unchanged at 2.5 per cent.

Growth in the global economy is continuing at a moderate pace. China’s growth has generally been in line with policymakers’ objectives, though some data suggest a slowing in recent months. Weakening property markets there present a challenge in the near term. Commodity prices in historical terms remain high, but some of those important to Australia have declined further in recent months.

Volatility in some financial markets has picked up in recent weeks. Overall, however, financial conditions remain very accommodative. Long-term interest rates and risk spreads remain very low. Markets still appear to be attaching a low probability to any rise in global interest rates or other adverse event over the period ahead.

In Australia, most data are consistent with moderate growth in the economy. Resources sector investment spending is starting to decline significantly, while some other areas of private demand are seeing expansion, at varying rates. Public spending is scheduled to be subdued. Overall, the Bank still expects growth to be a little below trend for the next several quarters.

Labour market data have been unusually volatile of late. The Bank’s assessment remains that although some forward indicators of employment have been firming this year, the labour market has a degree of spare capacity and it will probably be some time yet before unemployment declines consistently. Growth in wages has declined noticeably and is expected to remain relatively modest over the period ahead, which should keep inflation consistent with the target even with lower levels of the exchange rate.

Monetary policy remains accommodative. Interest rates are very low and have continued to edge lower over recent months as competition to lend has increased. Investors continue to look for higher returns in response to low rates on safe instruments. Credit growth is moderate overall, but with a further pick-up in recent months in lending to investors in housing assets. Dwelling prices have continued to rise over recent months.

The exchange rate has declined recently, in large part reflecting the strengthening US dollar, but remains high by historical standards, particularly given the further declines in key commodity prices in recent months. It is offering less assistance than would normally be expected in achieving balanced growth in the economy.

Looking ahead, continued accommodative monetary policy should provide support to demand and help growth to strengthen over time. Inflation is expected to be consistent with the 2–3 per cent target over the next two years.

In the Board’s judgement, monetary policy is appropriately configured to foster sustainable growth in demand and inflation outcomes consistent with the target. On present indications, the most prudent course is likely to be a period of stability in interest rates.

This was in line with expectation, despite some calling for a rise to signal the markets in relation to speculative housing. However, these ultra-low rates cannot last for ever, and the average mortgage rate is closer to 7% rather than the current 4.75%.