Why The Rate Hike Calls Are Wrong
The latest official measure of Australian house prices has again created the predictable angst over housing affordability. According to the Australian Bureau of Statistics, property prices rose 4.1% in the December quarter, and 7.7% over the year.
Prices in Sydney and Melbourne rose by more than 5% in the quarter, and more than 10% over the year.
While there are range of policies being suggested to tackle allegedly high house prices – some which might help and some which would only make matters worse – there’s at least a few excitable commentators also suggesting the Reserve Bank should also be contemplating a possible “one-off” rate rise to break an alleged “bubble” in investor psychology.
But to my mind, the evidence suggests there’s no such bubble, but rather much more fundamental – and hard to dislodge - supply-demand factors at work.
Given this, raising rates might well work in at least momentarily halting the escalation in Sydney and Melbourne house prices – but as this won’t tackle the real underlying drivers of their house price boom, the impact will be fleeting unless the RBA does a lot more than simply “tap on the brakes”.
And were the RBA to tighten more aggressively, the wider-ranging effects on the economy would be disastrous. We’d be throwing the baby out with the bath water.
Indeed, raising rates to simply kill house prices makes about as much sense as the suggestion to slow or even stop immigration. Clearly, given that immigration adds to demand for housing, it can’t be denied that, at the margin, it also naturally adds to upward pressure on house prices – all else constant. But immigration also does a lot in terms of adding to general demand and skills across the economy. To curtail immigration would several damage economic growth and the incentive for currently growing businesses to invest and hire – denying ourselves that is a high price to pay for taking some marginal pressure of house prices in a few regions of the country.
In fact, rising household incomes and employment also adds to upward pressure on house prices – should we kill this also? Indeed, if all we really cared about were house prices, there’s an easy answer to unaffordability – simply drive the economy into recession.
There are other reasons why the RBA should not – and most likely will not – respond to high Sydney/Melbourne house prices by raising rates.
For starters, interest rates (along with negative gearing and capital gain tax changes) are a blunt instrument, where the Sydney/Melbourne house prices challenges are regionally specific. House prices are a lot weaker in most other parts of the country, and fell sharply in Perth and Darwin over the past year.
Sydney and Melbourne are most benefiting from the mining sector downturn, with their prices gains in recent years largely reversing previous years of under performance. Foreign investors demand – legitimate or otherwise – is also particularly strong in these cities. And limited supply options - as much as demand - seems to be a problem. Indeed, it’s noteworthy that vacancy rates in both Sydney and Melbourne are not particularly high, suggesting there’s a much more fundamental demand-supply imbalance underpinning the strength in house prices rather than suggestions of a “bubble” in investors mentality.
That said, even if were true that excess investor and/or foreign demand are causing problems in these cities – there are specific targeted policies that can be pursued.
More broadly, higher interest rates at this delicate stage of our economic transition would be disaster. Only recently, we learnt that the unemployment rate shot up to 5.9% in February, and the National Australia Bank index of business conditions slumped back after an unusually large spike higher in January. Home building approvals are already trending down and business investment intentions remain weak. Even households are expressing new found nervousness over their spending.
A rate rise into this mix could knock the economy for a six, which would only be compounded by a likely surge in the $A to US80c or more. In turn that would crush the tentative signs of improvement in tourism and foreign tourist numbers.
David is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR). His has held former roles as senior commentator with The Australian Financial Review, Macquarie Bank interest rate strategist and Federal Treasury economist. He is also author of the online e-book, TheAustralian ETF Guide.