The latest RBA minutes, published today do not provide much extra insight, other than saying the longer-term impact of Brexit is yet unknown, and local economic signals remain mixed. Looks like August will provide the data point to determine possible next steps.
GDP growth in Australia’s major trading partners looked to have remained slightly below average over recent months, in line with earlier forecasts. GDP growth in China appeared to have eased further, which was continuing to affect economic conditions throughout the Asian region. Monetary policy remained very accommodative across the major economies and was expected to remain so given that inflation was below most central banks’ targets, despite improvements in labour markets leading to full employment in several large advanced economies.
The United Kingdom’s vote to leave the European Union had led to considerable financial market volatility, which had since settled. Financial markets had functioned effectively throughout the episode and borrowing costs for high-quality borrowers remained low. Any effects of the referendum outcome on UK and global economic activity remained to be seen. In any event, the referendum result implied a period of uncertainty about the outlook for the United Kingdom and the European Union. In the absence of significant financial dislocation, the staff’s central case was that this uncertainty was expected to have only a modest adverse effect on global economic activity.
Commodity prices had generally increased since the previous meeting. At the time of the present meeting, the Australian dollar (in trade-weighted terms) was around the levels assumed in the forecasts at the time of the May Statement on Monetary Policy.
In the domestic economy, the transition of economic activity to the non-resources sector was now well advanced and recent data suggested that growth had continued at a moderate pace in the June quarter. Low interest rates were continuing to support household spending and the lower exchange rate since 2013 had continued to assist the traded sector of the economy. Members noted that an appreciating exchange rate could complicate the necessary economic adjustments.
Recent data showed that conditions in the labour market had been more mixed of late. The unemployment rate had remained around 5¾ per cent for most of 2016, having fallen noticeably over 2015. Inflation was still expected to remain quite low for some time given very subdued growth in labour costs and very low cost pressures elsewhere in the world.
Indicators of conditions in housing markets had been somewhat mixed over recent months. Housing prices were recorded as having risen in Sydney and Melbourne in April and May, but were little changed in June. Building approvals remained elevated at levels that would add to the considerable amount of dwelling construction work already in the pipeline. Considerable supply of apartments was scheduled to come on stream over the next few years, particularly in the eastern capital cities. At the same time, however, housing credit growth had eased, in line with a lower turnover of housing and the earlier tightening in banks’ lending standards following the announcement of supervisory measures. Various state government measures and changes to bank lending requirements were likely to temper foreign investor demand for housing.
Taking account of the available information, the Board judged that holding monetary policy steady would be the most prudent course of action at this meeting. The Board noted that further information on inflationary pressures, the labour market and housing market activity would be available over the following month and that the staff would provide an update of their forecasts ahead of the August Statement on Monetary Policy. This information would allow the Board to refine its assessment of the outlook for growth and inflation and to make any adjustment to the stance of policy that may be appropriate.
The latest RBA chart pack, released today includes data on household debt. Debt a a percentage of disposable income is up again, to an all time high. This is driven by flat income growth, and ever more home loan borrowing. Even after the May interest rate cut, interest paid as a proportion of disposable income has risen.
This is of course an average, and segmented data contains considerable variation.
The world still needs the central banks to bail us out of trouble but the impact of monetary policy is complicated in a world of zero or near-zero interest-rate policy (ZIRP) and negative interest-rate policy (NIRP).
Money presents us with three alternatives: we can spend it, save it or invest it. Most households and governments do the first; financial institutions take the third option; and virtually no one saves. Except Asia, obviously.
In 2008, spending and investment froze during the global financial crisis (GFC). This forced central banks and governments to ultimately adopt unorthodox and largely unprecedented strategies. Two tools were available to governments: fiscal stimulus and looser monetary policy. Most governments adopted a mix of both.
However, there are political and financial limits to fiscal policy, particularly as governments grew increasingly overextended during the GFC. Consequently, since 2008, monetary policy has largely displaced fiscal policy as means of generating economic stimulus. Except in Sydney, at the Reserve Bank of Australia (RBA).
ZIRP it. ZIRP it good
The Bank of Japan (BoJ) was the first to adopt ZIRP, as it sought to deal with the aftershocks of the Heisei recession of the early 1990s. This was referred to as Japan’s “lost decade”, as it experienced stagnant growth, a condition still bedevilling the country today, despite the best efforts of Abenomics.
As the global financial crisis emerged throughout 2007–08, the US Federal Reserve, the European Central Bank (ECB) and the Bank of England sank hundreds of billions of their respective currencies into their foundering financial sectors. The People’s Bank of China injected massive liquidity into Chinese markets.
In Australia, the RBA slashed interest rates, with deep successive cuts in 2008–09. Looser monetary policy was matched by the Rudd government’s significant fiscal expansion to prevent the collapse of consumer spending.
The reason behind this fiscal pump priming, combined with the dramatic monetary measures, was clear: in late 2008, credit markets froze. Admittedly, there is much debate about how long and to what extent this occurred. However, the fear of contagion was so palpable that the interbank lending market experienced systemic dysfunction and, at the very least, credit rationing took place.
The problem for central banks is that they have relatively few monetary tools available to them. The traditional lever to prevent overheating is to exert monetary discipline by raising interest rates, thus increasing the cost of credit.
Conversely, under the crisis conditions of the GFC, the central banks slashed interest rates to encourage consumption. However, the US Federal Reserve, the Bank of Japan, the Bank of England and the European Central Bank reached their lower limits faster than the RBA, which never adopted ZIRP.
But that may be about to change. The RBA’s cash rate is at a historic low of 1.75%, and the bank may cut further as the Australian economy plateaus, combined with the uncertainty wrought by Brexit.
The new normal
Make no mistake: ZIRP and even perhaps NIRP are the new normal. Just ask Janet Yellen. When the Federal Reserve chairman increased US interest rates by 0.25% in December 2015, the markets reacted savagely. It was the first Federal Reserve (Fed) rate rise since 2006.
US Federal Reserve chair Janet Yellen.JIM LO SCALZO/AAP
Fourteen months earlier, Yellen had tapered off the US’s third quantitative easing program (QE3), ending it on schedule in October 2014. Between 2008 and 2014, the Fed had purchased over US$4.5 trillion in government bonds and mortgage-backed securities in three rounds of QE, plus a fourth program, Operation Twist (2011–12).
The outcome was an avalanche of “free” money. Why “free”? Because, in the long run, the real cost of the capital for commercial banks was zero, or less than zero.
The Fed was effectively printing money (although it’s more complex than that). The effects were clear: the US central bank was reflating the American economy, and by extension the global economy, by injecting massive amounts of liquidity into the system in an attempt to ameliorate the worst effects of the 2008–09 financial crisis.
US Fed moves this year
No one on the markets was surprised by the central bank’s December 2015 rate rise. The clear objective was to return some semblance of normality to global interest rates.
The problem is it didn’t work. The tapering-off of QE in late 2014 meant that the last sugar hits of stimulus were wearing off in 2015.
The Yellen rate rise, plus the clear intention of the Fed to incrementally drive rates higher, spooked the markets. In May this year, undeterred by gloomy US jobs figures, Yellen indicated that she would seek to raise US interest rates “gradually” and “over time” as US growth continued to improve. Her concern was that adherence to ZIRP would ultimately bite in the form of inflation.
Not anymore. Brexit has seen to that. It was one of the factors behind the Fed committee’s decision to keep interest rates on hold in mid-June.
ZIRP – or something approximating it – is becoming the “new normal” because cheap money has become structural; the global financial system is now structured around the persistence of low-cost credit. NIRP is thus the logical continuum of this downward interest rate spiral.
Negative interest zates
Until recently, most macroeconomic textbooks argued that zero was rock bottom for interest rates. The GFC shifted the goalposts.
This is where NIRP enters the picture: negative interest rates. How do they work? Typically, commercial banks will park their money in their accounts with the central bank, or in private markets, such as the London Interbank Offered Rate (LIBOR). Thus, their money never sleeps and earns interest 24/7, even when bank doors are shut.
But NIRP is different. Negative rates mean depositors pay for the privilege of a bank to hold their money. Which means depositors are better off holding the cash than placing the funds on deposit. Japan has experienced the results of a NIRP first-hand.
Bank of Japan (BOJ) Governor Haruhiko Kuroda decided to adopt negative interest rates.FRANCK ROBICHON/AAP
There is a method in this madness: the G7 central banks want commercial banks to lend, not to accumulate piles of cash. Consequently, the policy effect of both ZIRP and NIRP is to stimulate business and consumer lending in order to drive real economic activity. With piles of cash looking for investment placements, the shadow banking system of financial intermediaries may also drive enterprise investment.
However, ZIRP and NIRP are blunt instruments; the perverse outcomes of the stimulus programs of the US Fed, the Bank of Japan and the European Central Bank were artificially inflated stockmarkets and various sector bubbles (such as real estate, classic cars).
The combination of ZIRP and QE may have also created a “liquidity trap”. This means that central banks’ QE injections caused only a sugar rush and did not inflate prices, as one would normally expect from a significant expansion of the monetary base.
Instead, many developed countries have experienced multiple recessions and a prolonged period of deflation. In April this year, the Australian economy experienced deflation for the first time since the GFC, which compelled the RBA to make its most recent 0.25% cut in May 2016.
Yellen knows the global economy cannot retain ZIRP indefinitely. But, ironically, all of the central banks are caught in their own liquidity trap: unable to relinquish ZIRP for fear of market catastrophe; unwilling to abandon QE entirely as “the new normal” demands fresh injections of virtually cost-free credit.
A lack of interest
The Australian economy has done quite well by having interest rates above the OECD average, particularly since the GFC. This has encouraged significant foreign investment flows into Australia as global investors seek somewhere – anywhere – to park their cash as other safe-haven government bonds, such as the US, Japan and Germany, are in ZIRP or NIRP territory. It also doesn’t hurt that Australia’s major banks and government bonds are blue-chip-rated. And Australian sovereign bonds have excellent yields too.
If ZIRP is the new normal, that matters to the Reserve Bank of Australia. It also matters to all Australian home buyers, businesses, banks, pensioners, investors, students and credit card holders. Everyone, in other words.
ZIRP has created hordes of winners: mortgage interest rates are at historic lows. Property buyers who borrowed when rates were relatively high (at, say, 6-7%) are now paying less than 4%. Credit card rates are still astronomically high (20–21% or more), but balance transfer rates are zero. New credit issues in terms of consumer debt represented by unsecured loans (which is what a credit card is) have a real capital cost of zero. This is virtually unprecedented.
But ZIRP or near-ZIRP produces many losers as well. There is no incentive to save because rates are so low. Hoarding cash makes no sense.
Global surplus capacity reinforces deflation as both goods and commoditised services are cheap. Wages are terminal. Pension funds’ margins are smaller, thus expanding future liabilities and reducing the value of current superannuation yields.
In a world of ZIRP, is it any wonder that all of this cheap or (effectively) free cash has been stuffed into the global stock exchange and real estate markets, creating not only a double bubble, but double trouble?
The best things in life are free
QE is like heroin: the first hit is always free. The commercial banks got their first hit in 2008 and the prospect of going cold turkey sends them into paroxysms of fear.
The problem is that the dealers – the central banks – have started using their own product and are just as hopelessly addicted to both ZIRP and QE. To rudely cut off supply would destroy their own markets.
The RBA is not immune to the elixir of ZIRP. No central bank wants to assume responsibility for a recessionary economy; the RBA took enough heat for its monetary policy mismanagement of 1989-90, which induced the 1990s recession.
Unlike the Fed, the RBA is not about to fire up the printing presses and engage in rounds of QE, if it runs out of tools and is compelled to adopt ZIRP. The RBA is too conservative to engage in such policy in any case.
But this conservatism has a direct impact upon federal government fiscal policy, irrespective of whether the LNP or the ALP is in power. From Rudd to Turnbull, Treasury has been forced to increase its borrowing time and time again, blowing out the forward fiscal projections year after year.
No government has delivered a surplus because it is no longer possible. The RBA is partly responsible for this because, rather than expanding its balance sheet via QE, it has forced Canberra to accumulate government debt of more than $AU400 billion, which the overburdened Australian taxpayer will pay for.
Like most drug deals, this will not end well.
Author: Remy Davison, Jean Monnet Chair in Politics and Economics, Monash University
Today’s RBA note highlights that inflation will remain low for some time. This is a problem lodged firmly in many economies with ever lower cash rates. Assuming the RBA sticks to their 2-3% target, this leaves the door open for another rate cut. However, we should also question whether even lower rates would have a net positive impact on growth, as savers would take another hit, businesses would be no more willing to borrow, whilst home lending would be stimulated further and it could also stoke investor housing as capital growth is still in play. All up, not a nice cocktail, when incomes are static or falling in real terms. Perhaps some latitude on the inflation target would make more sense.
At its meeting today, the Board decided to leave the cash rate unchanged at 1.75 per cent.
The global economy is continuing to grow, at a lower than average pace. Several advanced economies have recorded improved conditions over the past year, but conditions have become more difficult for a number of emerging market economies. China’s growth rate has moderated further, though recent actions by Chinese policymakers are supporting the near-term outlook.
Commodity prices are above recent lows, but this follows very substantial declines over the past couple of years. Australia’s terms of trade remain much lower than they had been in recent years.
Financial markets have been volatile recently as investors have re-priced assets after the UK referendum. But most markets have continued to function effectively. Funding costs for high-quality borrowers remain low and, globally, monetary policy remains remarkably accommodative. Any effects of the referendum outcome on global economic activity remain to be seen and, outside the effects on the UK economy itself, may be hard to discern.
In Australia, recent data suggest overall growth is continuing, despite a very large decline in business investment. Other areas of domestic demand, as well as exports, have been expanding at a pace at or above trend. Labour market indicators have been more mixed of late, but are consistent with a modest pace of expansion in employment in the near term.
Inflation has been quite low. Given very subdued growth in labour costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time.
Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 is helping the traded sector. Financial institutions are in a position to lend and credit growth has been moderate. These factors are all assisting the economy to make the necessary economic adjustments, though an appreciating exchange rate could complicate this.
Indications are that the effects of supervisory measures have strengthened lending standards in the housing market. Separately, a number of lenders are also taking a more cautious attitude to lending in certain segments. Dwelling prices have risen again in many parts of the country over recent months. But considerable supply of apartments is scheduled to come on stream over the next couple of years, particularly in the eastern capital cities.
Taking account of the available information, the Board judged that holding monetary policy steady would be prudent at this meeting. Over the period ahead, further information should allow the Board to refine its assessment of the outlook for growth and inflation and to make any adjustment to the stance of policy that may be appropriate.
The RBA released their Financial Aggregates for May 2016. Total housing grew by 0.5% in May, compared with 0.4% in April. Business lending grew by 0.3%, compared with 0.8% in April. Personal credit fell again by 0.1%. Housing lending overall lifted by $7.5bn, of which $6.5 bn was for owner occupation and $0.9bn for investor loans. Total housing loans are now $1.56 trillion, another record and comprise 61% of all loans outstanding.
Annual growth rates for home lending is 6.5%, compared with 6.2% in May 2015, Business was 7.1%, compared with 5.3% last year, and Personal lending was down 1.1% to May 2016, compared with up 1.1% this time last year.
A further $1.1 bn of loans were switched between owner occupied and investment housing loan categories.
Following the introduction of an interest rate differential between housing loans to investors and owner-occupiers in mid-2015, a number of borrowers have changed the purpose of their existing loan; the net value of switching of loan purpose from investor to owner-occupier is estimated to have been $41 billion over the period of July 2015 to May 2016 of which $1.1 billion occurred in May. These changes are reflected in the level of owner-occupier and investor credit outstanding. However, growth rates for these series have been adjusted to remove the effect of loan purpose changes.
New standards on how much businesses can surcharge their customers for credit or debit card purchases start in September. However, it’s not clear how the rules will be policed and whether this will lead to all businesses enforcing a surcharge, rather than just those who choose to.
The Reserve Bank of Australia (RBA) has revised the regulations, aiming to limit the amount merchants can surcharge customers for paying by credit or debit cards. The new rules will initially apply to large merchants, defined as those employing over 50 staff, as these businesses are seen to be overcharging the most.
Businesses have been able to add on surcharges to these type of purchases in Australia since January 2003. This was part of RBA regulatory interventions in the first place, as it originally allowed merchants to surcharge in order to recover the costs of accepting card payments. The surcharges can be ad valorem (in proportion to the value of the transaction) or a fixed dollar amount.
A current example is that taxi fares using a Cabcharge terminal, whether they be paid by charge, credit or debit card, are surcharged at the same ad valorem level of 5%, as a processing fee. Not all the goods and services suppliers who accept card payments chose to impose surcharges on their customers, but a significant and seemingly ever increasing of them do surcharge.
The Australian airlines are well known for their fixed dollar surcharges. Qantas charges a card payment fee (per passenger, per booking) of $2.50 for debit and $7.00 for credit, on domestic flights and $10 for debit and $30 for credit, on international flights.
JetStar charge a booking and service fee (per passenger, per flight) of $8.50 domestic and up to $12.50 for international, whilst Virgin charges a Fee of $7.70 for payments made by credit or debit card. These examples of surcharging have caused much angst amongst consumers and the recent Financial System Inquiry had over 5,000 submissions to its final report, complaining about surcharging, particularly by airlines.
But how will the new standards be enforced? In February, The Australian Competition and Consumer Commission (ACCC) was given the power to issue infringement notices worth up to just over $100,000 to listed corporations who charge their customers excess payment card surcharges
These are defined as charges that exceed the costs of acceptance of payment cards. It remains to be seen if the size of these penalties deters merchants from excessive surcharging.
In May, the RBA published new standards as to the average cost a merchant is permitted to charge for accepting credit or debit cards. These apply to the following so-called card schemes, EFTPOS; MasterCard credit and debit; Visa credit and debit and American Express companion cards, issued by Australian banks.
Under the new rules the average cost of accepting a debit or credit card is defined in percentage terms of cost of the transaction. This will vary by merchant, but it means that merchants will not be able to levy fixed dollar surcharges.
The permitted surcharge for an individual merchant will be based on an average of their card costs over a 12 month period. In the interests of transparency, the financial institution who processes each merchant’s transactions, will be required to provide regular statements of the average cost of acceptance for each of the card schemes.
This information will of course also be important for the ACCC in any cases where enforcement is required if merchants are surcharging excessively.
Now that surcharges are well defined by the RBA, the risk is that surcharging will become a normal extra charge like GST, an unintended consequence of the new rules. Also why should merchants be allowed to charge their customer a surcharge for such payments, which are surely just another cost of doing business, just as is their utility bills and employee wages?
The ACCC is currently finalising guidance material for consumers and merchants which will provide further information on the ACCC’s enforcement role and how consumers can make complaints if they believe that a surcharge is excessive.
Surcharges on card payments have certainly already provoked rage amongst consumers, the final question is, will the next iteration of surcharge standards make surcharging the norm?
Author: Steve Worthington, Adjunct Professor, Swinburne University of Technology
A snapshot of data from the RBA highlights the root cause of much of the economic issues we face in Australia. Back at the turn of the millennium, banks were lending relatively more to businesses than to households. The ratio was 120%. Roll this forward to today, and the ratio has dropped to below 60%. In other words, for every dollar lent now it is much more likely to go to housing than to business. This is a crazy scenario, as we have often said, because lending to business is productive – this generates real productive growth – whilst lending for housing simply pumps up home prices, bank balance sheets and household balance sheets, but is not economically productive to all.
There are many reasons why things have changed. The finance sector has been deregulated, larger companies can now access capital markets directly and so do not need to borrow from the bank, generous tax breaks (negative gearing and capital gains) have lifted the demand for loans for housing investment, and the Basel capital ratios now make it much cheaper for banks to lend against secured property compared to business. In fact the enhanced Basel ratios were introduced in the early 2000’s and this is when we see lending for housing taking off.
So how much of the mix is explained by tax breaks for investors? If we look at the ratio of home lending for owner occupation, to home lending for investment, there has been an increase. In 2000, it was around 45%, now its 55% (with a peak above 60% last year). This relative movement though is much smaller compared with the switch away from lending to business. Something else is driving it.
We therefore argue that whilst the election focus has been on proposed cuts to negative gearing and capital gains versus a company tax cut, the root cause issue is still ignored. And it is a biggie. The international capital risk structures designed to protect depositors, is actually killing lending to business, because it makes lending for housing so much more capital efficient. Whilst recent changes have sought to lift the capital for mortgages at the margin, it is still out of kilter. As a result, banks seek to out compete for mortgages and offer discounts and other incentives to gain share, whilst lending to business is being strangled. This is exacerbated by companies being more risk adverse, using high project hurdle thresholds (despite low borrowing rates) and smaller businesses being charged relatively more – based on risk assessments which are directly linked to the Basel ratios. Our SME surveys underscore how hard it is for smaller business to get loans at a reasonable price.
The run up in house prices is a direct result of more available mortgage funding, and this in turn leaves first time buyers excluded from the market. But it is too simple to draw a straight line between negative gearing and first time buyer exclusion. The truth is much more complex.
We are not convinced that a corporate tax cut, or a further cut in interest rates will stimulate demand from the business sector. Nor will reductions in negative gearing help that much. We need to re-balance the relative attractiveness of lending to business versus lending for housing. The only way to do this (short of major changes to the Basel ratios) is through targeted macro-prudential measures. In essence lending for housing has to be curtailed relative to lending to business. And that is a whole new box of dice!
In this post we combine the latest data from the RBA and ABS, and our own analysis to look at the relationship, at a state level, between income growth, home price growth and credit growth. These three elements should logically be closely meshed, yet in the current environment, they are not. We think this is an important leading indicator of trouble ahead as these three factors will come back eventually to a more normal relationship, signalling potential falls in home values and credit volumes in a low income growth environment.
The latest data from the ABS shows that home prices fell slightly in the past quarter. The Residential Property Price Index (RPPI) fell 0.2 per cent in the March quarter 2016, the first fall since the September quarter 2012. Attached dwellings, such as apartments, largely drove price falls in the RPPI. The attached dwellings price index fell 0.8 per cent in the March quarter 2016. Falls were recorded in Melbourne (-1.3 per cent), Sydney (-0.6 per cent), Perth (-1.1 per cent), Canberra (-1.1 per cent) and Adelaide (-0.4 per cent). Brisbane (+0.7 per cent), Hobart (+2.3 per cent) and Darwin (+0.1 per cent) recorded rises. Established house prices for the eight capital cities was flat (0.0 per cent). The total value of Australia’s 9.7 million residential dwellings increased $15.4 billion to $5.9 trillion. The mean price of dwellings in Australia is now $613,900.
Dwelling investment had continued to grow strongly over the year, consistent with the substantial amount of work in the pipeline noted in previous meetings. Members observed that private residential building approvals had increased strongly in April, to be close to peaks seen earlier in 2015. Although these data are quite volatile from month to month, the trend for building approvals had been stronger than expected of late and the pipeline of residential work yet to be done had remained at high levels. This implied that growth in new dwelling investment would continue to add to the supply of housing over the next year or so, particularly in the eastern capitals.
In established housing markets, prices increased significantly in Sydney and Melbourne over April and May and, to a lesser extent, in a number of other capital cities. Auction clearance rates and the number of auctions increased in May, but remained lower than a year earlier. At the same time, the monthly data available for April showed that there had been a further easing in housing credit growth and the total value of housing loan approvals, excluding refinancing, had fallen in the month. Members noted that the divergence in the trends in housing price and credit growth was not expected to persist over a long period of time.
So this got us thinking about the relationship between income, home price growth and credit growth. To look at this, we drew data from our surveys, and also the ABS and RBA data-sets, to map the relative cumulative growth of average household income, home price growth and credit growth. The results are interesting. We used 2006 as a baseline and measured the relative cumulative growth since then, by state.
First, here is the average across Australia. The growth of credit since 2006 (the yellow line) is significantly stronger than home prices and income. Income is notably the slowest. This is course confirms what we know, households are more leveraged (highest in the western world), and home prices are higher relative to income, supported by credit availability and more recently low interest rates. Note also the recent slowing in credit growth.
Looking at the state variations is really insightful. In the ACT credit growth is very strong, but home prices and incomes are moving at a similar trajectory. This is partly because of the micro-economic climate supported by well paid public servants.
In NT, home price growth is higher than credit and income growth, but the growth is beginning to slow, in response to the mining slow down. Home prices are significantly extended relative to incomes.
In TAS, home prices are tracking incomes, whilst credit has been growing more slowly, thanks to lower price growth and local demographics.
In WA, we see significant home price momentum through the mining boom years, but it is now adjusting, and credit which has been strong has been easing in the past 12 months. Home price growth is now tracking income growth.
In SA, credit is quite strong now, and we are seeing home prices moving ahead of incomes, as they did in 2010, but only slightly.
In QLD, credit is growing faster now, and home prices are moving faster than incomes, there is an interesting dip in 2011-12, thanks to some “local political difficulties!”
VIC holds the award for the strongest credit growth in recent time, and as a result we see home prices moving ahead of income growth, a trend which can be traced back to before the GFC.
Finally, in NSW, we see a dramatic run up in credit and home prices, especially since 2013. Both are growing faster than incomes. Prior to this, income growth and home prices were more aligned.
So a few observations. Incomes and home prices, and credit are disconnected, significantly. This is a problem because credit has to be repaid from income, in some way, at some time. Next, there are strong correlations in some states between credit growth and home prices, in other states it is less clear. NSW and VIC have the largest gaps between income and prices. So it reconfirms the property markets are not uniform. Finally, and importantly, we think that home price and credit growth will have to come back to income growth – and as incomes will be static for some time, downward pressure on home prices and credit will build, especially if the costs of borrowing were to rise.
Glenn Stevens’ ten year stewardship of the Reserve Bank of Australia has been characterised by remarkable challenges. Yet, if the Australian economy has shown considerable resilience over this troubled decade, particularly during the global financial crisis, part of the credit certainly goes to the RBA.
When Stevens’ deputy, Philip Lowe succeeds him in September, he will need to continue to shepherd Australian prosperity through the challenges of global deflation and faltering global economic growth.
What direction will he take with the country’s monetary policy?
Glenn Stevens’ Legacy
Under Stevens, inflation has remained relatively stable and predictable, which is the main target for a central bank like the RBA. The repercussions of the financial crisis in North America and Europe have been mostly avoided thanks to the solidity of the Australian financial system, which is also a key responsibility of the RBA.
Sure enough, the exchange rate has experienced some wide fluctuations. But in an economy where the central bank targets inflation and there is no external anchor, these fluctuations are inevitable. In fact, the flexibility of the exchange regime has been another important factor driving Australia’s resilience.
Finally, the RBA has maintained its strong reputation and credibility both domestically and internationally; and in the current context where central banks in many industrial countries are blamed for poor macroeconomic management (well beyond their actual faults), this is no little achievement.
A solid background
A graduate from the University of New South Wales, Lowe holds a PhD from the Massachusetts Institute of Technology. He began his career with the RBA in 1980 and, until 1997, occupying a various positions in the International Department and Economic Group, before becoming Head of the Economic Research Department in 1997-98 and then the Financial Stability Department in 1999-2000.
In 2000-02 he was Head of Financial Institutions and Infrastructure Division at the Bank for International Settlements. After returning to the RBA, he headed the Domestic Markets and Economic Analysis Departments.
In 2004 he was appointed Assistant Governor (Financial System), then Assistant Governor (Economic) from 2009 until 2012, when he assumed his current position as Deputy Governor. This already impressive curriculum is enriched by several academic publications.
Lowe’s on monetary policy and financial stability
The RBA operates with an inflation target; that is, its objective is to use monetary policy to stabilise inflation at around 2%-3% on average over the business cycle. The pursuit of the inflation target requires the RBA to respond to demand pressures that can eventually lead to undesirable fluctuations in inflation and consumer prices.
In a low inflation environment such as Australia, these demand pressures can manifest themselves in rapid credit and asset prices growth, which in turn trigger episodes of financial instability.
In some of his academic work, Lowe has documented these links, showing that inflationary pressures are likely to become evident in asset prices before they show up in goods and services prices.
Taken to the operational level, this means that the emergence of an asset-price bubble calls for a deflationary intervention of the RBA before the further enlargement of the bubble threatens financial and monetary stability.
We can therefore expect Lowe’s RBA to be watching credit and asset markets closely and be prepared to respond to fluctuations on such markets as a way to prevent a more general increase in consumer prices. To use an economist’s jargon, credit and asset markets become part of the monetary policy reaction function of the RBA.
But even under an inflation target regime, monetary policy should concern itself with the cycles of the “real” economy (that is, cycles of gross domestic product and employment). Provided that the inflation target is not compromised, monetary policy should be adjusted to stabilise cyclical changes in production and labour market conditions.
In fact, the RBA has never been the type of excessively hard-nosed central bank that exclusively pays attention to monetary stability. Even recently, monetary policy has been significantly accommodating, meaning that interest rates have been kept low as a way to support the cyclical recovery of the Australian economy.
This approach to monetary policy is very likely to continue under Lowe. For instance, in a recent address to Urban Development Institute of Australia (UDIA), he indicated that “[this] low inflation outlook provides scope for easier monetary policy should that be appropriate in supporting demand growth in the economy.”
In this regard, the challenge for him will be twofold. For one thing, as interest rates continue to decline, the effectiveness of further interest rate cuts in stimulating the real economy is likely to weaken. For another, a debt-obsessed government might end up relying too much on monetary policy and too little on fiscal policy to stimulate the economy.
This would then place the RBA in a difficult position, with Lowe having to protect the independence and autonomy of his institution.
Lowe’s on the long term prosperity of Australia
What else can monetary policy do for Australians? Someone might be tempted to argue that monetary policy should deliver long-term growth and prosperity.
In a sense, any public policy should aim at the greater good of the community. Monetary policy does that by delivering stable financial and monetary environment and by helping the economy to recover from short-term cyclical fluctuations.
But beyond that, prosperity becomes a matter of long term productivity growth and innovation, which in turn call for actions that fall largely outside the realm of monetary policy.
Sustaining productivity requires reforms to enhance competition, investment in transport infrastructure and in high quality education. Similarly, innovation stems from interventions that specifically support new entrepreneurial activities while preventing the distortions of old-school import substitution policies.
Active labour market policies are required to support the process of structural transformation of the economy and to guarantee that workers can relocate from declining to emerging sectors.
The RBA, or any central bank for that matter, is not meant to provide all that. In fact, expecting the RBA to do all (or even only some) of the above would tantamount to compromising its fundamental functions, throwing the Australian economy towards an era of financial and monetary instability and low economic growth.
In his October address to the CFA’s Australia Investment Conference, Lowe explicitly acknowledged that, ultimately, the rate at which living standards improve is unlikely to be driven by the actions of the central bank.
The hope is that the government will listen to him and take responsibility for bringing the Australian economy into a new era of prosperity.
Author: Fabrizio Carmignani, Professor, Griffith Business School, Griffith University
The recent RBA Bulletin included a section on apartment construction in Australia. They conclude that apartments have become an increasingly important contributor to new dwelling construction over recent years and in 2015 accounted for more than one-third of all residential building approvals. The majority of recent apartment construction has been located in Sydney, Melbourne and Brisbane. Buyers come from all segments – owner occupiers, investors and foreign investors. Across these cities there have been differences in geographical concentration, the types of buyers purchasing the dwellings and supply-side factors such as planning frameworks. The increase in apartment construction has reflected a range of factors, including the nature of land supply constraints and affordability considerations, together with a desire to reside in close proximity to employment centres and amenities. Given that these factors are likely to persist, apartments are expected to continue to play an important role in providing new housing supply.
Initially, approvals for apartments increased in Melbourne in 2010, followed by Sydney, and then Brisbane more recently. Apartment approvals in Perth also increased in recent years, but from a relatively small base. The effect of this increase on the stock of apartments in each city has varied. Cumulative approvals since 2011 in Melbourne and Brisbane have added around one-third to the stock of apartments in those cities compared with an addition of around one-fifth of the 2011 stock for Sydney and Perth.
The location of activity within each of the cities has varied. This has been determined by a variety of factors, including proximity to employment centres and transport infrastructure, planning frameworks and the availability of suitable sites for apartment projects. In Sydney, approvals have been relatively spread out across the inner and middle suburbs – a large area ranging from Parramatta in the west to Chatswood in the north and Mascot in the south. In contrast, a relatively large share of apartment approvals in Melbourne has been in the city (which includes the CBD, Southbank and Docklands – an area of around 30 square kilometres), although construction activity in the middle-ring suburbs has picked up more recently. In Brisbane, activity has been concentrated in the city and in a few of the surrounding inner suburbs, as has been the case in Perth.
Alongside this strong construction activity, competition among developers for suitable sites for apartment projects has intensified and led to increases in site prices. Australian developers account for the majority of apartment projects, though foreign developers have become more active in acquiring sites and developing projects, mostly in Melbourne and Sydney. In addition to competing over the acquisition of suitable new sites and residential land, developers have also sought to purchase lower-grade office and industrial buildings for conversion into apartment projects, thereby supporting prices for these assets.
Turning to buyers, there are a variety of factors that have contributed to increased demand for new apartments from prospective owners and tenants. Employment opportunities and population growth are fundamental drivers of demand for new housing; sustained population growth in Australia’s largest cities has led to increased demand for all dwellings, including apartments. Population growth was strongest in Perth for much of the past decade, in part owing to migration associated with the mining investment boom. That growth has slowed over the past couple of years. In the eastern cities, land supply constraints have led to increased prices for blocks of land and detached houses. This is likely to have driven demand for apartments relative to other dwellings, as apartments use land more intensively than detached houses and are therefore relatively more affordable. A desire to reside close to CBD employment centres is also likely to have stimulated demand for apartments, as residents in increasingly populated cities value the convenience and reduced travel time associated with the proximity to amenities in these areas.
Three types of buyers can be distinguished – owner-occupiers, domestic investors and foreign buyers (‘non-residents’). Liaison with industry contacts suggests that, in recent years, the relative importance of these three groups has varied across different cities. Foreign buyers have played a relatively significant role in the inner city of Melbourne. In the inner suburbs of Brisbane, domestic investors (particularly from interstate) have underpinned demand, driven in part by the higher yields available relative to Sydney and Melbourne. In contrast, sales in Sydney have been more evenly spread across the three groups of buyers.
Whether buyers are owner-occupiers or investors can influence the composition of the net supply of housing. Purchases of new apartments by domestic investors are most likely to lead to an increase in the supply of rental properties. For owner-occupiers, the net effect will depend on the location and size of the existing property from which the purchaser is moving and whether there is a change in the rate of household formation. For example, if the owner-occupier is a first home buyer moving out of their parents’ home, total demand for housing increases alongside the increased supply of housing, whereas if they are moving from a rented property this will create a rental vacancy elsewhere.
Similarly, owner-occupiers who are downsizing will leave an established property that can possibly accommodate a larger household. The net impact from foreign buyers on housing demand will depend on the relative mix of those buyers who plan to occupy their dwelling (or leave it vacant) and those who plan to rent out their property. All foreign buyers, other than temporary residents, are generally restricted to purchasing newly constructed dwellings. The observations on foreign buyer activity in this article are sourced from liaison with property developers and other industry contacts.
Developers must record the residency of buyers to ensure that they do not exceed Australian banks’ caps on pre-sales to foreign buyers (if funded by an Australian lender). Non-residents and temporary residents must apply to purchase Australian property – the Foreign Investment Review Board records data on approvals for these purchases, though these data are limited and partial. Industry contacts have often reported that many foreign buyers, especially those who reside in East Asia, have additional motivations for buying apartments in Australia. It is commonly reported that foreign buyers purchase Australian property to diversify their wealth and intend to hold the property for a long period. Contacts also suggest that foreign buyers’ motivations can include the prospect of future migration, providing housing for children while they study in Australia, or acquiring holiday apartments. The interest from foreign buyers of property, particularly those from Asia, is not unique to Australia; such buyers are also active in the property markets in other countries, such as the United States, the United Kingdom, Canada and New Zealand. Other features that have been cited as attracting foreign buyers include the lower prices of apartments in Australia in recent years relative to major cities in some other countries (particularly following the depreciation of the Australian dollar), geographic proximity to Asia and a stable political and regulatory environment.
Apartments have driven the increase in new dwelling construction in Australia since 2010 and have provided an important contribution to economic growth and employment. The increase in apartment construction has reflected a range of factors, including land supply constraints, affordability considerations and a desire to reside in close proximity to established amenities and employment centres. This has delivered many new dwellings to the market, which has had an effect on housing prices and rents, with growth in these indicators slowing of late. The majority of recent activity has been located in areas with existing links to transport, infrastructure and services, particularly the inner suburbs of Sydney, Melbourne and Brisbane, and, to a lesser degree, Perth. The increase in apartment construction in these cities has been characterised by differences in the geographical concentration of activity, the proportional increase in the apartment stock, the types of buyers purchasing the new dwellings and the planning frameworks, which can affect the behaviour of developers and the supply response. Apartments are likely to continue to play an important role in providing new housing as land supply constraints motivate prospective home owners to purchase higher-density dwellings (which use land more intensively and are therefore less expensive relative to larger, lower-density houses), and as tenants and residents choose to live closer to employment centres and amenities for convenience.
