A long period of record low interest rates has set up a situation where Australia’s economy could be distorted. This is the view of the Organisation for Economic Cooperation and Development (OECD), which has mulled Australia’s housing market and warned that this is a source of vulnerability.
The OECD is not suggesting a swag of mortgage defaults are likely, but elevated prices and related household debt have set up a situation where, as house prices start to retrace significantly in the major cities, there is the possibility of a hard landing.
Importantly, a commensurate drop in consumer confidence as house prices continue falling could reduce expenditure such that it puts pressure on the whole economy. Australia’s Reserve Bank has also become a little more concerned that tighter lending conditions have contributed to weaker demand for property.
Governor Philip Lowe has stated that, while credit standards were way too loose a few years ago there has now been a correction, which is signalling the pendulum may be swinging a little too far the other way and the RBA will monitor this closely.
For some time now UBS has had a non-consensus view that macro prudential tightening would cause house prices to fall further and create a negative wealth affect, and official interest rates would not be hiked for some time.
The broker argued the case for a credit crunch after the Hayne Royal Commission commenced, believing this would cause a material tightening of credit applied to home loans. This thesis has played out, with accelerating weakness in housing, and the worst trend since 2010 in the broker’s calculations.
The household savings ratio has dropped to an 11-year low of 2.4%, which UBS believes is unsustainable. Moreover, further credit tightening is considered inevitable, as the Royal Commission final report is likely to require greater verification of income and expenses, while debt-to-income limits are implemented under comprehensive credit reporting.
Moreover, the federal election, due in May 2019, could reduce credit demand, as borrowers contemplate potential changes to negative gearing and capital gains tax. Hence, the broker believes the risk of a credit crunch is rising, not falling.
In contrast, Morgans does not believe new potential regulation will be as onerous as many suggest. The broker does not expect the magnitude of potential customer redress will affect the ability of the major banks to meet APRA’s unquestionably strong capital requirements by January 2020.
Asset quality conditions remain benign and system home loan growth is likely to be subdued, but the broker does not believe it will get worse. This stems from the belief that increased first home buyer participation will support owner-occupier housing credit growth.
While there has been an uptrend in 90-day arrears in housing in some states, Morgans believes this is driven by transient factors outside of Western Australia and the Northern Territory.
On credit growth more broadly, the broker is encouraged by improved lending in the areas of small-medium enterprises and institutional. The broker believes the regulatory risk premium incorporated into the banking sector will unwind over the next year and support share prices.