Tag: RBA

The Property Imperative Weekly to 14 April 2018

Welcome to the Property Imperative Weekly to 14 April 2018. We review the latest property and finance news.

There is a massive amount to cover in this week’s review of property and finance news, so we will dive straight in.

CoreLogic says that final auction results for last week showed that 1,839 residential homes were taken to auction with a 62.8 per cent final auction clearance rate, down from 64.8 per cent over the previous week. Auction volumes rose across Melbourne with 723 auctions held and 68.2 per cent selling. There were a total of 795 Sydney auctions last week, but the higher volumes saw the final clearance rate weaken with 62.9 per cent of auctions successful, down on the 67.9 per cent the week prior. All of the remaining auction markets saw a rise in activity last week; clearance rates however returned varied results week-on-week, with Adelaide Brisbane and Perth showing an improvement across the higher volumes while Canberra and Tasmania both recorded lower clearance rates. Across the non-capital city regions, the highest clearance rate was recorded across the Hunter region, with 72.5 per cent of the 45 auctions successful.

This week, CoreLogic is currently tracking 1,690 capital city auctions and as usual, Melbourne and Sydney are the two busiest capital city auction markets, with 795 and 678 homes scheduled to go to auction. Auction activity is expected to be lower week-on week across each of the smaller auction markets

Two points to make. First is a slowing market, more homes will be sold privately, rather than via auctions, and this is clearly happening now, and second, we discussed in detail the vagaries of the auction clearance reporting in our separate blog, so check that out if you want to understand more about how reliable these figures are.

Home prices slipped a little this past week according to the CoreLogic index, but their analysis also confirmed what we are seeing, namely that more expensive properties are falling the most. In fact, values in the most expensive 25% of the property market are falling the fastest, whereas values for the most affordable 25% have actually risen in value.

Their analysis shows that over the March 2018 quarter, national data shows that dwelling values were down by 0.5%, however digging below the surface reveals the modest fall in values was confined to the most expensive quarter of the market. The most affordable properties increased in value by +0.7% compared to a +0.3% increase across the middle market and a -1.1% decline across the most expensive properties.

But looking at the details by location, in Sydney, over the past 12 months, the most expensive properties have recorded the largest value falls (-5.7%) followed by the middle market (-0.9%) and the most affordable market managed some moderate growth (+0.6%).

 

Compare that with Melbourne where values have increased over the past year across each segment of the market, with the most moderate increases recorded across the most expensive segment (+1.6%), then the middle 50% (+6.2%) while the most affordable suburbs have recorded double-digit growth (+11.3%)

Finally, in Perth values have fallen over the past year across each market sector with the largest declines across the most affordable properties (-4.4%) followed by the middle market (-3.2%) with the most expensive properties recording the most moderate value falls (-2.4%).

This shows the importance of granular information, and how misleading overall averages can be.

The RBA has released their Financial Stability Review today. It is worth reading the 70 odd pages as it gives a comprehensive picture of the current state of play, though through the Central Bank’s rose-tinted spectacles! They do talk about the risks of high household debt, and warn of the impact of rising interest rates ahead. They home in on the say $480 billion interest only mortgage loans due for reset over the over the next four years, which is around 30 per cent of outstanding loans. Resets to principal and interest will lift repayments by at least 30%. Some borrowers will be forced to sell.

This scenario mirrors the roll over of adjustable rate home loans in the United States which triggered the 2008 sub-prime mortgage crisis. Perhaps this is our own version! We have previously estimated more than $100 billion in these loans would now fail current tighter underwriting standards.

I published a more comprehensive review of the Financial Stability Review, and you can watch the video on this report.  Importantly the RBA suggests that banks broke the rules in their lending on interest only loans before changes were made to regulation in 2014.  The RBA says that there is the potential that these will result in banks having to set aside provisions and/or face penalties for past misconduct or perhaps (more notably) being constrained in the operation of parts of their businesses.

We also did a video on the RBA Chart pack which was released recently.  Household consumption is still higher than disposable income, and the gap is being filled by the falling savings ratio. So, we are still spending, but raiding our savings to do so. Which of course is not sustainable.  Now the other route to fund consumption is debt, so there should be no surprise to see that total household debt rose again (note this is adjusted thanks to changes in the ABS data relating to superannuation, we have previously breached the 200% mark). But on the same chart we see home prices are now falling – already the biggest fall since the GFC in 2007.

We see all the signs of issues ahead, with household debt still rising, household consumption relying on debt and savings, and overall growth still over reliant on the poor old household sector. We need a proper plan B, where investment is channelled into productive growth investments, not just more housing loans.  Yet regulators and government appear to rely on this sector to make the numbers work – but it is, in my view, lipstick on a pig!

Another important report came out from The Bank for International Settlements, the “Central Bankers Banker” has just released an interesting, and concerning report with the catchy title of “Financial spillovers, spillbacks, and the scope for international macroprudential policy coordination“. But in its 53 pages of “dry banker speak” there are some important facts which shows just how much of the global financial system is now interconnected. They start by making the point that over the past three decades, and despite a slowdown coinciding with the global financial crisis (GFC) of 2007–09, the degree of international financial integration has increased relentlessly. In fact the rapid pace of financial globalisation over the past decades has also been reflected in an over sixfold increase in the external assets and liabilities of nations as a share of GDP – despite a marked slowdown in the growth of cross-border positions in the immediate aftermath of the GFC. My own take is that we have been sleepwalking into a scenario where large capital flows and international financial players operating cross borders, negating the effectiveness of local macroeconomic measures, to their own ends.  This new world is one where large global players end up with more power to influence outcomes than governments. No wonder that they often march in step, in terms of seeking outcomes which benefit the financial system machine. You can watch our separate video discussion on this report. Somewhere along the road, we have lost the plot, but unless radical changes are made, the Genie cannot be put back into the bottle. This should concern us all.

And there was further evidence of the global connections in a piece from From The St. Louis Fed On The Economy Blog  which discussed the decoupling of home ownership from home price rises. They say recent evidence indicates that the cost of buying a home has increased relative to renting in several of the world’s largest economies, but the share of people owning homes has decreased. This pattern is occurring even in countries with diverging interest rate policies. And the causes need to be identified. We think the answer is simple: the financialisation of property and the availability of credit at low rates explains the phenomenon.

And finally on the global economy, Vice-President of the Deutsche Bundesbank Prof. Claudia Buch spoke on “Have the main advanced economies become more resilient to real and financial shocks? and makes three telling points. First, favourable economic prospects may lead to an underestimation of risks to financial stability. Second resilience should be assessed against the ability of the financial system to deal with unexpected events. Third there is the risk of a roll back of reforms. The warning is clear, we are not prepared for the unexpected, and as we have been showing, the risks are rising.

Locally more bad bank behaviour surfaced this week. ASIC says it accepted an enforceable undertaking from Commonwealth Financial Planning Limited  and BW Financial Advice Limited, both wholly owned subsidiaries of the Commonwealth Bank of Australia (CBA). ASIC found that CFPL and BWFA failed to provide, or failed to locate evidence regarding the provision of, annual reviews to approximately 31,500 ‘Ongoing Service’ customers in the period from July 2007 to June 2015 (for CFPL) and from November 2010 to June 2015 (for BWFA). They will pay a community benefit payment of $3 million in total. Cheap at half the price!

In similar vein,   ASIC says it has accepted an enforceable undertaking from Australia and New Zealand Banking Group Limited (ANZ) after an investigation found that ANZ had failed to provide documented annual reviews to more than 10,000 ‘Prime Access’ customers in the period from 2006 to 2013. Again, they will pay a community benefit payment of $3 million in total.

Both these cases were where the banks took fees for services they did not deliver – and this once again highlight the cultural issues within the banks, were profit overrides good customer outcomes. We suspect we will hear more about poor cultural norms this coming week as the Royal Commission hearing recommence with a focus on financial planning and wealth management.

Finally to home lending. The ABS released their February 2018 housing finance data. Where possible we track the trend data series, as it irons out some of the bumps along the way. The bottom line is investor as still active but at a slower rate. Some are suggesting there is evidence of stabilisation, but we do not see that in our surveys. Owner occupied loans, especially refinancing is growing quite fast – as lenders seek out lower risk refinance customers with attractive rates. First time buyers remain active, but comprise a small proportion of new loans as the effect of first owner grants pass, and lending standards tighten. You can watch our video on this.

But the final nail in the coffin was the announcement from Westpac of significantly tighten lending standards, with a forensic focus on household expenditure.  They have updated their credit policies so borrower expenses will need to be captured at an “itemised and granular level” across 13 different categories and include expenses that will continue after settlement as well as debts with other institutions. They will also be insisting on documentary proof. Moreover, households will be required to certify their income and expenses is true. This cuts to the heart of the liar loans issue, as laid bare in the Royal Commission. That said, Despite the commission raising questions over whether the use of benchmarks is appropriate when assessing the suitability of a loan for a customer, the Westpac Group changes will still apply either the higher of the customer-declared expenses or the Household Expenditure Measure (HEM) for serviceability purposes. You can watch our separate video on this. Almost certainly other banks will follow and tighten their verification processes. This will put more downward pressure on lending multiples, and will lead to a drop in credit, with a follow on to put downward pressure on home prices.

We discussed this in an article which was published under my by-line in the Australian this week, where we argued that excess credit has caused the home price bubble, and as credit is reversed, home prices will fall.

Our central case is for a fall on average of 15-20% by the end of 2019, assuming no major international incidents. The outlook remains firmly on the downside in our view.

 

 

ABC The Business Does Mortgage Stress

Good segment from the ABC, in which UBS chief economist George Tharenou says house prices are going to fall because the royal commission will make banks lift their lending standards, making it much harder for people to get credit and be able to bid up prices. As we have already said, its all about credit!

Our Own Version Of Sub-Prime?

The RBA has released their Financial Stability Review today. It is worth reading the 70 odd pages as it give a comprehensive picture of the current state of play, though through the Central Bank’s rose-tinted spectacles!

They home in on the say $480 billion interest only mortgage loans due for reset over the over the next four years, which is around 30 per cent of outstanding loans. Resets to principal and interest will lift repayments by at least 30%. Some borrowers will be forced to sell.

This scenario mirrors the roll over of adjustable rate home loans in the United States which triggered the 2008 sub-prime mortgage crisis. Perhaps this is our own version!

We have previously estimated more than $100 billion in these loans would now fail current tighter underwriting standards.

One area of potential concern is for borrowers at the end of their current IO period. Much of the large stock of IO loans are due to convert to P&I loans between 2018 and 2021, with loans with expiring IO periods estimated to average around $120 billion per year or, in total, around 30 per cent of the current stock of outstanding mortgage credit. The step-up in mortgage
payments when the IO period ends can be in the range of 30 to 40 per cent, even after factoring in the typically lower interest rates charged on P&I loans.

However, a number of factors suggest that any resulting increase in financial stress should not be widespread. Most borrowers should be able to afford the step-up in mortgage repayments because many have  accumulated substantial prepayments, and the serviceability assessments used to write IO loans incorporate a range of buffers, including those that factor in potential future interest rate increases and those that directly account for the step-up in payments at the end of the IO period.

Moreover, these buffers have increased in recent years. In addition to raising the interest rate buffer, APRA tightened its loan serviceability standards for IO loans in late 2014, requiring banks to conduct serviceability assessments for new loans based on the required repayments over the residual P&I period of the loan that follows the IO period.

Prior to this, some banks were conducting these assessments assuming P&I repayments were made over the entire life of the loan (including the IO period), which in the Australian Securities and Investments Commission’s (ASIC’s) view was not consistent with responsible lending requirements. As a result, eight lenders have agreed to provide remediation to borrowers that face financial stress as a direct result of past poor IO lending practices.

However, to date, only a small number of borrowers have been identified as being eligible for such remediation action. Some borrowers have voluntarily switched to P&I repayments early to avoid the new higher interest rates on IO loans, and these borrowers appear well placed to handle the higher repayments.

Some IO borrowers may be able to delay or reduce the step-up in repayments. Depending on personal circumstances some may be eligible to extend the IO period on their existing loan or refinance into a new IO loan or a new P&I loan with a longer residual loan term. The share of borrowers who cannot afford higher P&I repayments and are not eligible to alleviate their situation by refinancing is thought to be small.

In addition, borrowers who are in this situation as a result of past poor lending practices may be eligible for remediation from lenders. Most would be expected to have positive equity given substantial housing price growth in many parts of the country over recent years and hence would at least have the option to sell the property if they experienced financial stress from the increase in repayments. The most vulnerable borrowers would likely be owner-occupiers that still have a high LVR and who might find it more difficult to refinance or resolve their situation by selling the property.

Looking more broadly  at household finances, they say that the ratio of total household debt to income has increased by almost 30 percentage points over the past five years to almost 190 per cent, after having been broadly unchanged for close to a decade.

Australia’s household debt-to-income ratio is high relative to many other advanced economies, including some that have also continued to see strong growth in household lending in the post-crisis period, such as Canada, New Zealand and Sweden.

Household debt in these economies is notably higher than in those that were more affected by the financial crisis and experienced deleveraging, including Spain, the United Kingdom and the United States. While Australia’s high level of household indebtedness increases the risk that some households might experience financial stress in the event of a negative shock, most indicators of aggregate household financial stress currently remain fairly low (notwithstanding some areas of concern, particularly in mining regions). In addition, total household mortgage debt repayments as a share of income have been broadly steady for several years.

Note of course this is because interest rates have been cut to ultra-low levels, and should rates rise, payments would rise significantly.

The RBA says that default rates on mortgages (More than $1.7 trillion) is low, but concedes higher in the mining heavy states.

Then they defend the situation by saying that household wealth is rising (though thanks mainly to inflated property values, currently beginning to correct), and continue to cite out of date HILDA survey data from 3 years ago to demonstrate that the share of households experiencing financial stress has been the lowest since at least the early 2000s. But this is so old as to be laughable, remembering the interest rates and living costs have risen, and incomes are flat in real terms.

And they argue again that households are prepaying on their mortgages. We agree some are, but not those in the stressed category. Averaging data is a wonderful thing!

Finally, a word on the profitability outlook of the banks.

Despite the recent lift, analysts are cautious about the outlook for profit growth. The recent benefits to profit growth from a widening of the NIM and falling bad debt charges are expected to fade, especially if short-term wholesale spreads remain elevated. The financial impact of the multiple inquiries into the financial services sector remains a key uncertainty, including the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, the Productivity Commission’s Inquiry into Competition in Australia‘s Financial System, and the Australian Competition and Consumer Commission’s Residential Mortgage Products Price Inquiry. There is the potential that these will result in banks having to set aside provisions and/or face penalties for past misconduct or perhaps (more notably) being constrained in the operation of parts of their businesses.

This uncertainty around banks’ future earnings has weighed on their share prices, which have underperformed global peers (although Australian banks still have higher price-to-book ratios). The decline in share prices has also seen banks’ forward earnings yields (a proxy for their cost of equity capital) further diverge from that of the rest of the Australian market since mid 2017 (Graph 3.8). Banks’ current forward earnings yields remain a little above their pre-crisis average, despite a large decline in risk-free rates since then.

Tales From The RBA Chart Pack – April 2018

Today we run through some of the latest charts contained in the RBA’s Monthly Chart Pack, released in early April 2018.

Our first chart is of the headline inflation in advanced economies, where we see that inflation is still sitting below the typical target band of 2-3% in the USA, Euro Area and Japan.

However, in two of the most populous countries China and India, inflation is higher with India close to 5% from a high of 17% in 2010.

Inflation in Australia is still sitting below the 2% lower bounds of the RBA 2-3% target range, on both the trimmed mean, their preferred measure and weighted mean basis.

Now to GDP. World GDP Growth is sitting at around 4%, based on purchasing power weighted figures, of around 85% of world GDP.  We could have a separate discussion about whether GDP is a good or adequate measure of growth, but in short, it might work for a manufacturing based economy, but really does not do the job in more advanced and globalised economies, in my view.

Anyway, in comparison, Australian GDP looks pretty poor, and fell towards 2% in the last quarter.

But looking at the contributions to GDP growth, household consumption made the strongest contribution, with non-mining investment and public demand also helping, but dwelling investment, and mining investment fell below zero. Imports also had a negative impact, as you would expect. So the RBA is still over-reliant on the household sector performing, which is a problem.

This next chart is very relevant. Household consumption is still higher than disposable income, and the gap is being filled by the falling savings ratio. So, we are still spending, but raiding our savings to do so. Which of course is not sustainable.

Now the other route to fund consumption is debt, so there should be no surprise to see that total household debt rose again (note this is adjusted thanks to changes in the ABS data relating to superannuation, we have previously breached the 200% mark). But on the same chart we see home prices are now falling – already the biggest fall since the GFC in 2007.

It is worth noting that the ratio of total debt to GDP is also very high, and back up to the pre-GFC levels.

Debt is a critical factor in the equation, and we have too much of it in the system, as our banking system expanded to fill the never ending demand. As a result, although the debts household hold – liabilities – is sky high, total net wealth has stopped growing, and the value of dwellings has slipped a little. This will be an important chart to watch in the months ahead. Note that financial assets – including shares, and other types of savings, remains at a high. But of course those with high debts tend to be the ones with little or no savings, so this chart does not parse out the segmental differences. I think I may make a separate video on this issue down the track.

This chart shows the trajectory of average home price growth across the country. Clearly rates of growth are tumbling, and so we expect the indicator to turn negative soon. Some smaller markets like Adelaide and Hobart are helping to support the figures. Of course the bigger markets like Sydney are already negative.The next chart shows the slight rise in unemployment and the fact that underemployment is still sitting above 8%. So while the Government talks up the creation of more than 400,000 jobs recently, the truth is there are many who want more work – and of course many of these jobs created are part-time and or low paid, or even gig-economy jobs.  The underemployment number belies the apparent low unemployment figures, which other less official sources suggest is nearer to 9%.  It’s a matter of definition, and certainly the ABS data flatters the true state of play, in my book.To round out our quick tour we look at housing lending rates.

Whilst there has been no recent change in the cash rate – for the past 20 months or so, and bank headline indicator rates for new owner occupied loans have come down, reflecting strong competition for low risk new business, the real rates paid by borrowers continue to rise.  And as we know even small rises will put more into mortgage stress – 965,000 households are in this condition, based on our latest research, which equates to 30% of the market. You can watch our separate video on this important topic.

And expect more rate rises, irrespective of what the RBA may do. Here is the US Corporate Bond Yields, which are rising now, in response to the FEDs reversal of QE, and lift in their benchmark rates. And more to come. The latest from the FED today suggested at least three more rate hikes in the next year, which is faster than many were expecting. And inflation is expected to run hot in the US. Ahead.

Spreads between the Australian 10-year Bond Yield and the Cash Rate are rising, all of which is putting more funding pressure on the Banks.

And we can see that Financial companies have been the largest issuer of bonds, with significant rises in recent times. About half of all the bonds from the finance sector are issued abroad, so changes in global interest rates will translate to higher funding costs here, so expect more mortgage repricing upwards. These bond issues of course enabled the banks to lend ever more and so create more deposits, to inflate the economy and their books. You can watch our recent video on this, as well as read the article published in the Australian, under my by-line.  You can see the current finance system in action.

So standing back, we see all the signs of issues ahead, with household debt still rising, household consumption relying on debt and savings, and overall growth still over reliant on the poor old household sector. We need a proper plan B, where investment is channelled into productive growth investments, not just more housing loans.  Yet regulators and government appear to rely on this sector to make the numbers work – but it is, in my view, lipstick on a pig!

The Next Move In Interest Rates Will Be Most Likely Up Not Down – RBA

RBA Governor Philip Lowe discussed “Regional Variation in a National Economy” today in an address to the Australia-Israel Chamber of Commerce (WA). It is worth reading, not least because of the regional variations he highlights. However, the section on monetary policy piqued my interest.

In particular, that the next cash rate move is likely to be up. Recently a number of pundits have started to say there will be a cut. Perhaps not!

The Reserve Bank’s responsibility is to set monetary policy for Australia as a whole. We seek to do that in a way that keeps the national economy on an even keel, and inflation low and stable. No matter where one lives in Australia, we all benefit from this stability and from being part of a national economy. This is so, even if, at times, in some areas, people might wish for a different level of interest rates from that appropriate for the national economy. In setting that national rate, I can assure you we pay close attention to what is happening right across the country.

As you are aware, the Reserve Bank Board has held the cash rate steady at 1½ per cent since August 2016. This has helped support the underlying improvement in the economy that I spoke about earlier.

In thinking about the future, there are four broad points that I would like to make.

The first is that we expect a further pick-up in the Australian economy. Increased investment and hiring, as well as a lift in exports, should see stronger GDP growth this year and next. The better labour market should lead to a pick-up in wages growth. Inflation is also expected to gradually pick up. So, we are making progress.

There are, though, some uncertainties around this outlook, with the main ones lying in the international arena. A serious escalation of trade tensions would put the health of the global economy at risk and damage the Australian economy. We also have a lot riding on the Chinese authorities successfully managing the build-up of risk in their financial system. Domestically, the high level of household debt remains a source of vulnerability, although the risks in this area are no longer building, following the strengthening of lending standards.

The second point is that it is more likely that the next move in the cash rate will be up, not down, reflecting the improvement in the economy. The last increase in the cash rate was more than seven years ago, so an increase will come as a shock to some people. But it is worth remembering that the most likely scenario in which interest rates are increasing is one in which the economy is strengthening and income growth is also picking up.

The third point is that the further progress in lowering unemployment and having inflation return to the midpoint of the target zone is expected to be only gradual. It is still some time before we are likely to be at conventional estimates of full employment. And, given the structural forces also at work, we expect the pick-up in wages growth and inflation to be only gradual.

The fourth and final point is that, because the progress is expected to be only gradual, the Reserve Bank Board does not see a strong case for a near-term adjustment in monetary policy. While some other central banks are raising their policy rates, we need to keep in mind that their economic circumstances are different and that they have had lower policy rates than us over the past decade, in some cases at zero or even below. A continuation of the current stance of monetary policy in Australia will help our economy adjust and should see further progress in reducing unemployment and having inflation return to target.

RBA supports best interests duty for brokers

From The Adviser.

The Reserve Bank of Australia has revealed that it believes all brokers should be required to act in a consumer’s “best interests”.

In its response to the Productivity Commission’s draft report into competition in the Australian financial system, the RBA came out in support of several of the commission’s draft recommendations.

Notably, the central bank revealed that it was in support of the draft recommendation that the Australian Securities and Investments Commission impose on lender-owned mortgage aggregators (and the brokers that operate under them) a “clear legal duty” to act in the consumer’s best interests.

Further, the RBA called for such a duty to be extended to all brokers, not just those operating under lender-owned aggregators.

The bank’s submission reads: “The bank supports the draft recommendation to require lender-owned aggregators and the brokers who operate through them to act in consumers’ best interests… We would support extending this to all brokers.

“While there may be some benefit in enhancing mortgage broker disclosure requirements to consumers to improve transparency, it is important to recognise that some consumers may nonetheless still not fully understand the information provided (given its complexity and the backdrop of consumers not taking out a mortgage frequently).

“Steps to address the underlying conflicts of interest and misaligned incentives are therefore crucial to improving consumer outcomes.”

Further to this, the RBA pulled on several findings from ASIC’s remuneration review, highlighting a number of other factors that it believes “inhibit the effectiveness of competition through mortgage brokers”.

These included:

  • Smaller lenders find it harder to get onto aggregator panels due to fixed costs
  • Brokers need to be accredited with a particular lender to sell their loans and they have incentives — “partly due to variations in commissions and the burden of seeking accreditation” — to concentrate their recommendations on a small number of lenders rather than the whole panel of potential lenders
  • Lenders “may compete on their incentives to brokers, rather than on the quality of their loan products, creating competitive barriers for smaller lenders who find it too costly to offer such incentives”
  • Higher commissions for brokers “may also drive up costs for consumers”

The RBA said that it is therefore in support of “enhancing” the transparency of mortgage interest rates paid by borrowers.

It suggested that possible ways of doing this could include “asking the banks to publish these rates directly” or “conducting a survey of the largest mortgage brokers to obtain representative rates”.

The RBA made several other statements in its submission, including:

  • The bank agrees that, when formulating prudential regulatory measures, it is important that any potential effects on competition be considered
  • It did not believe that the setting of the cash rate either constrains competition or substantially facilitates price co-ordination (as had been suggested by the PC)
  • The bank supports the commission’s draft recommendation to make risk weights “more sensitive to risk”
  • It did not recommend excluding warehouse loans to non-ADIs from the scope of Prudential Standard APS 120 as it “opens the possibility of regulatory arbitrage by treating loans of identical risk differently depending on who the ultimate lender is”
  • The RBA agrees that a review of the regulation of Purchased Payment Facilities “would be desirable” and that a tiered prudential regime is “likely to be appropriate”
  • It agrees with the commission’s draft recommendation that merchants should be provided with the ability to determine the default network for contactless transactions using dual-network cards

Latest Household Debt Figures A Worry

The RBA updated their E2 – Selected Household Ratios today to the end of December 2017.

This series used data from the Australian Bureau of Statistics (which were recently adjusted to remove the impact of  superannuation on the data), plus some RBA supplied data. The series is updated each quarter.

We will walk though these charts, as they highlight some of main and concerning dynamics around household finances.

First, here is the plot of Ratio of household debt to household assets, and the Ratio of housing debt to housing assets. Both are moving up a little, reflecting stronger loan growth, relative to asset prices and home prices.

Corelogics home price index to end March also out today showed prices in most of the main centes are slipping. They said:

Trends across the March quarter showed that capital city home values were 0.9% lower over the March quarter, while values across the regional markets have tracked 1.1% higher. Focusing on the capital cities, six of the eight capital cities have recorded a fall in values over the first quarter of 2018, ranging from a 1.8% drop in Sydney values to a 0.1% fall in Darwin.

Sydney unit values are up 1.9% over the past twelve months, while house values are down 3.8%. Similarly in Melbourne, unit values are 6.6% higher over the past twelve months while house values  are up just 4.9%.

So this means that ahead, we expect prices to slide relative to the debt outstanding, thus, these ratios will go higher.  Household with property have had their balance sheets flattered by the appreciating capital growth, but these same balance sheets will now fall under greater pressure.

The second chart shows the household debt to income ratios, including Ratio of housing debt to housing assets, Ratio of housing debt to annualised household disposable income and Ratio of owner-occupier housing debt to annualised household disposable income. All these are rising, and have been since 2012. During that time, lending to households has been very strong, whilst incomes have been stalling, and in real terms falling into reverse. To me this is a very concerning metric because it shows that greater leverage households have and so the exposure to rising rates.

The RBA, in their statement today when  they left the cash rate unchanged – said:

The housing markets in Sydney and Melbourne have slowed. Nationwide measures of housing prices are little changed over the past six months, with prices having recorded falls in some areas. In the eastern capital cities, a considerable additional supply of apartments is scheduled to come on stream over the next couple of years. APRA’s supervisory measures and tighter credit standards have been helpful in containing the build-up of risk in household balance sheets, although the level of household debt remains high.

So, they are aware of the high debt, but APRA’s moves will only help new loans, now being written, they will not assist the many households with loans written on the earlier looser standards. This is the real pinch point, and we estimate that now 950,000 households are in mortgage stress to end March, a new record – watch out for our detailed analysis of mortgage stress in a few days.

Finally, here are two ratios from the RBA, Ratio of interest payments on housing and other personal debt to quarterly household disposable income AND Ratio of interest payments on housing debt to quarterly household disposable income. So far I have not been able to find out how these are calculated by the way.

The standard RBA argument is that the low interest rates mean the proportion of income, on average required to service a loan is lower than in 2011, thanks to the very low interest rates.

Compare the chart above with the next one. Here are the indicative interest rates from the RBA, (F5) from 2011 onward.

The fall in rates is significant – for example the variable discounted rate in 2011 was 7.05%, now it is 4.45%, so down 2.6%, according to the RBA data.

But the housing interest payment ratio in contrast is 7.2 compared with 9.2 in 2011, so  down just 2%. But translate these to percentage changes and whilst interest rates have dropped by 58.4%, repayments dropped by only 27% over the same period because the average loan is now larger so payments are relatively larger relative to income. So again, we see the impact of large loans on household balance sheets. This is a massive difference.

And of course the final piece of the puzzle is the impact of rates rising from here. Our sensitivity analysis suggests that 1% rate rise would tip well more than one million households into difficulty, and the impact on the interest payment to income ratio would therefore be significant.

Households are leveraged to the hilt. We may have tighter controls on lending now (some would say this is debatable given the active non-bank sector). But the die is cast for people with large existing mortgages, flat incomes, rising rates and household expenses growing.

Combined these charts tell a sorry tale.

RBA Hold Once Again (No Surprise)

At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent. They mentioned that the level of household debt remains high, and inflation may rise ahead, from its current low base. They are projecting stronger growth ahead (but we will see!)

The global economy has strengthened over the past year. A number of advanced economies are growing at an above-trend rate and unemployment rates are low. The Chinese economy continues to grow solidly, with the authorities paying increased attention to the risks in the financial sector and the sustainability of growth. Globally, inflation remains low, although it has increased in some economies and further increases are expected given the tight labour markets. As conditions have improved in the global economy, a number of central banks have withdrawn some monetary stimulus and further steps in this direction are expected.

Long-term bond yields have risen over the past six months, but are still low. Equity market volatility has increased from the very low levels of last year, partly because of concerns about the direction of international trade policy in the United States. Credit spreads have also widened a little, but remain low. Financial conditions generally remain expansionary. There has, however, been some tightening of conditions in US dollar short-term money markets, with US dollar short-term interest rates increasing for reasons other than the increase in the federal funds rate. This has flowed through to higher short-term interest rates in a few other countries, including Australia.

The prices of a number of Australia’s commodity exports have fallen recently, but remain within the ranges seen over the past year or so. Australia’s terms of trade are expected to decline over the next few years, but remain at a relatively high level.

The Australian economy grew by 2.4 per cent over 2017. The Bank’s central forecast remains for faster growth in 2018. Business conditions are positive and non-mining business investment is increasing. Higher levels of public infrastructure investment are also supporting the economy. Stronger growth in exports is expected after temporary weakness at the end of 2017. One continuing source of uncertainty is the outlook for household consumption, although consumption growth picked up in late 2017. Household income has been growing slowly and debt levels are high.

Employment has grown strongly over the past year, with employment rising in all states. The strong growth in employment has been accompanied by a significant rise in labour force participation, particularly by women and older Australians. The unemployment rate has declined over the past year, but has been steady at around 5½ per cent over the past six months. The various forward-looking indicators continue to point to solid growth in employment in the period ahead, with a further gradual reduction in the unemployment rate expected. Notwithstanding the improving labour market, wages growth remains low. This is likely to continue for a while yet, although the stronger economy should see some lift in wages growth over time. Consistent with this, the rate of wages growth appears to have troughed and there are reports that some employers are finding it more difficult to hire workers with the necessary skills.

Inflation remains low, with both CPI and underlying inflation running a little below 2 per cent. Inflation is likely to remain low for some time, reflecting low growth in labour costs and strong competition in retailing. A gradual pick-up in inflation is, however, expected as the economy strengthens. The central forecast is for CPI inflation to be a bit above 2 per cent in 2018.

On a trade-weighted basis, the Australian dollar remains within the range that it has been in over the past two years. An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast.

The housing markets in Sydney and Melbourne have slowed. Nationwide measures of housing prices are little changed over the past six months, with prices having recorded falls in some areas. In the eastern capital cities, a considerable additional supply of apartments is scheduled to come on stream over the next couple of years. APRA’s supervisory measures and tighter credit standards have been helpful in containing the build-up of risk in household balance sheets, although the level of household debt remains high.

The low level of interest rates is continuing to support the Australian economy. Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual. Taking account of the available information, the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.

Business Credit Growth Stalls

The latest Credit Aggregates from the RBA for February 2018  shows continued growth in mortgage lending, and only small rises in business credit and other consume credit. The monthly growth stats are noisy, but  owner occupied lending growth is higher, and this continues to drive overall credit growth higher than business lending.

The smoothed 12 month view shows the trends more clearly, with annualised owner occupied growth registering 8.1%, up from last month, investor lending falling again down to 2.8% annualised, and business credit at 3.6%

Looking at the relative value of lending, in seasonally adjusted terms, owner occupied credit rose 0.71% to $1.15 trillion, up $8.08 billion, while investment lending rose 0.12% to $588.3 billion, up just 0.69 billion. Business lending rose 0.17% to $905 billion, up 1.55 billion and personal credit fell 0.15%, down 0.22 billion to $152.2 billion.

Note that the proportion of investment loans fell again down to 33.9%, and the proportion of business lending to all lending remained at 32.4%, and continues to fall from last year. In other words, it is owner occupied housing which is driving credit growth higher – if this reverses, there is a real risk total credit grow will run into reverse. Again, we see the regulators wishing to continue to drive credit higher, to support growth and GDP, yet also piling on more risks, when households are already terribly exposed. They keep hoping business investment and growth will kick in, but their forward projections look “courageous”. Remember it was housing consumption and Government spending on infrastructure which supported the last GDP numbers, not business investment.

One final note, the loan switching between investor and owner occupied loans are around $1 billion each month. This of course has now been backed out of the RBA numbers.

Now, lets compare the total housing lending from the RBA of  $1.740 trillion, which includes the non-banks (though delayed, and partial data), with the APRA $1.61 trillion. The gap, ¬$130 billion shows the non bank sector is growing, as historically, the gap has been closer to $110 billion. This confirms the non-bank sector is active, filling the gap left by banks tightening. Non-banks have weaker controls on their lending, despite the new APRA supervision responsibilities. This is an emerging area of additional risk, as some non-banks are ready and willing to write interest only and non-conforming loans, supported by both new patterns of securitisation (up 13% in recent times) and substantial investment funds from a range of local and international investors and hedge funds.

Once again, we see the regulators late to the party.  This continues the US 2005-6 playbook where non-conforming loans also rose prior to the crash. We are no different.

Why the RBA needs to talk about future interest-rate policy

From The Conversation.

The Reserve Bank of Australia should follow the example of other central banks and be clearer about when and how rates will change, called “forward guidance”, to make its policy more effective.

At the moment the RBA follows an approach to implement monetary policy known as inflation targeting. This means it has a numerical target for inflation (an average 2-3% inflation over the medium term) and a framework to achieve that target (how it thinks monetary policy affects the economy, and how it communicates policy decisions).

Australia’s cash rate is at a historical low of 1.5%. So if there’s any adverse shock to our economy (for example, a large correction in house prices), the RBA would have little room to reduce the cash rate before getting to 0% – the zero lower bound on nominal interest rates.

At that point, you can’t cut rates anymore. Research shows economic shocks can have a more severe impact on economic activity when the policy rate is at, or near, zero.

Instead the RBA should be more explicit about the conditions that would lead to a rate change. Research shows this has stimulated economic recovery before.

How rates work at the moment

To understand forward guidance it helps to understand conventional thinking about monetary policy. The RBA controls inflation by adjusting the cash rate, which is the interest rate on overnight loans in the interbank market.

Changes in the cash rate change longer-term interest rates in the economy. These then influence households’ and businesses’ spending and investment plans. These decisions also determine demand and inflation.

For example, suppose inflation is below target. A cut in the cash rate reduces longer-term interest rates, which encourages people to buy goods and services (falls in long-term deposit rates and government bonds reduce the incentive to save) and invest (commercial and mortgage loans are cheaper). Rising demand sends prices up, which brings inflation back to target.

As with other central banks around the world, the RBA also explains the rationale for its policy decisions. For example, in the Statement of Monetary Policy, released four times a year, the bank sets out its assessment of current domestic and international economic conditions, along with an outlook for Australian inflation and output growth.

The purpose of these announcements is to enhance the credibility of the inflation target. If people trust the RBA will implement policy to achieve the inflation target, they will make plans around what they spend and how they price goods and services based on this. This makes inflation easier to control.

How being clearer about rates helps

While the RBA might not be able to influence the current cash rate, it can still influence longer-term rates by making announcements about its future policy decisions. Long-term interest rates usually change depending on what people expect of future cash rate changes.

So if monetary policy can influence these expectations, it can move long-term rates.

Of course, words are cheap. To make these declarations credible the RBA would need to communicate its plans for the future cash-rate, with modelling and forecasts justifying those plans.

Economists could then judge whether the RBA is meeting its objective through good luck or good policy. If it’s through good policy, it enhances the RBA’s credibility and, in a virtuous circle, this gives the bank policy more influence over expectations.

A prominent example of forward guidance comes from the United States’ central bank, the Federal Reserve. In December 2008, when the federal funds rate (the US equivalent of the Australian cash rate) was first at the zero lower bound, the Federal Reserve announced:

The committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

Translated, the Fed anticipated keeping the federal funds rate at zero for a considerable time. This communication was meant to influence the public’s expectations about the future course of US monetary policy, and to have consumers and businesses expect an expansionary monetary policy for some time.

During the recovery, the Fed refined its communication strategy to become more explicit about the economic circumstances that would lead to a change in policy. For example, in June 2013, the committee that sets rates anticipated that:

…this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-½%.

This type of announcement gives people more information about the strategy the Fed will take with rates, rather than simply providing forecasts about what it expects future economic conditions to be like (which doesn’t need to have any information about policy strategy).

Recent evidence confirms this had an impact on businesses’ expectations. Right after the June 2013 announcement by the Federal Reserve, there was an increase in the number of quarters until businesses expected the US policy rate to increase above 25 basis points.

FOMC= Federal Open Market Committee (which sets rates) Swanson and Williams: the zero bound and interest rates, Author provided

Other research also suggests forward guidance influenced private sector expectations and stimulated the economic recovery after the global financial crisis.

At the moment, the RBA doesn’t produce statements about future monetary policy and how this would change if the economic environment changed. But the bank could do this.

The RBA has the luxury to develop its communications policy during a time of economic calm, unlike the Federal Reserve, which was forced to experiment with new policies during the worst recession since the Great Depression.

If the RBA waits until a future crisis, it would limit the power forward guidance could have in our economy.

Efrem Castelnuovo, Principal Research Fellow, Melbourne Institute of Applied Economic and Social Research, and Professor of Economics, Department of Economics, University of Melbourne;
Bruce Preston, Professor of Economics, University of Melbourne; Giovanni Pellegrino, Postdoctoral Research Fellow, University of Melbourne