RBA on hold, housing excesses to ease: Westpac's Bill Evans

RBA on hold, housing excesses to ease: Westpac's Bill Evans
RBA on hold, housing excesses to ease: Westpac's Bill Evans


The Reserve Bank Board meets next week. It is certain to keep rates on hold. The minutes of the March board meeting were less upbeat on the economy than we had seen in previous assessments.

While I was meeting with customers and officials in Asia, my colleagues assessed the minutes as "The overall theme is still of upside risks from global growth and commodity prices near term but a likely muted pass through to local conditions and question marks beyond 2017".

Readers will be aware that our central theme for the Australian economy has been for slightly above trend growth in 2017, partly reflecting the boost to the terms of trade and the ongoing construction boom, to be followed by an abrupt slowdown in 2018 as construction contracts and the terms of trade reverse.

With the Reserve Bank sharing our caution around 2018, along with ample capacity in the labour market (unemployment rate is 5.9% compared to full employment rate of 5.0%) and stubbornly low wages growth, there is only scope to cut rates. But as we have argued consistently, a resurgent housing market disallows such a policy option. Indeed, the minutes refer to “a build- up of risks associated with the housing market”. A tighter macro prudential stance seems appropriate.

Indeed, as we go to press, APRA has announced new controls, restricting the "flow of new interest-only lending to 30 per cent of total new residential mortgage lending" with a particular focus on limiting interest only loans with a loan-to-value ratio above 80%.

Currently, "interest-only terms represent nearly 40 per cent of the stock of residential mortgage lending by ADIs", so this policy will restrict the terms at which a marginal borrower can access credit (investors and owner-occupiers). APRA also noted that they want banks to manage growth in investor credit to "comfortably remain below the previously advised benchmark of 10 per cent growth".

This is not a hard change to the target as had been mooted recently in the press (some suggesting the 10% limit could be as much as halved), but it does suggest lending to investors will continue to grow at a pace meaningfully below 10%.

Looking ahead, the next RBA Stability Review (April 13) may provide more clarity on the macro prudential policy outlook and potential triggers for further action. For the time being though, the 2015 experience offers an understanding of the potential impact of this further tightening.

Figure1 shows the slowdown in house price appreciation that came as a result of curtailing investor loan growth to 10% in 2015. Those direct controls on lending volumes were complemented by interest rate adjustments by the banks themselves.

Figure 2 shows our estimate of the changes in the weighted average of the variable mortgage rate (including investors and owner occupiers) in 2015. We estimate that during that period, the weighted average rate lifted from 5.44% to 5.71%. Of course, that lift was more than fully offset by subsequent rate cuts by the RBA in 2016, pushing the weighted average rate down to 5.34%.

As we see in Figure1, that cut re-ignited house price growth as well as auction clearance rates and new lending.

The RBA has already been given a “start” in this current cycle, with the weighted average rate lifting from 5.34% to 5.51%, largely reflecting increases in investor rates by the four majors. 

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RBA on hold, housing excesses to ease: Westpac's Bill Evans

Complementing these rate adjustments with a more constraining restriction on new lending to investors (as well as to owner occupiers for interest only loans) is likely to yield a comparable response in house prices as 2015.

By year’s end, the RBA’s concerns with “a build- up of risks associated with the housing market” are likely to have eased.

As we move into 2018, despite ongoing rate hikes by the Federal Reserve, the Reserve Bank, troubled by low inflation; on-going spare capacity in the labour market; and weak wages growth might be tempted to ease policy further.

However, the “lessons” of 2016 will have been learnt – do not risk re-igniting house prices – and a more prudent approach will be to rely on the currency to provide the boost to activity.

From our perspective, a reversal of the commodity price boom of 2017, coupled with Australia’s cash rate falling below the US, is likely to yield a sharp lift in Australia’s competitiveness. 

BILL EVANS is chief economist of Westpac.

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