The Aussie dollar beats house prices in the minds of the RBA

Tue, 01 Apr 2014  |  

As I sit back and contemplate what is, I often wonder which is more damaging to the Australian economy: rapidly inflating house prices which are starting to look and smell a bit bubble-ish, or on the other hand, a strong Australian dollar which sort of, maybe, kind of, perhaps is a bit overvalued?

The lever pullers at the RBA clearly think it's the Aussie dollar rising that is the biggest threat with its decision today to let the house price surge continue unchecked with interest rates being held at record lows.

I don't agree with the RBA. One reason is that I am not sure the Australian dollar is all that over valued, while I am also unsure whether interest rate hikes would see its value rise for any sustained period. After all, if interest rate differentials were the main driver of currencies, the Japanese yen would be worth next to nothing and the Turkish Lira would be a world beater.

Clearly other issues are also at play when it comes to working out fair value for a currency and that includes the Aussie dollar.

Which means that the housing issue is more important, at least in my mind. House prices are heavily influenced by the borrowing capacity of borrowers which in turn is heavily influenced by the interest rate paid of any mortgage taken out by that borrower.

This means, quite simply, that higher interest rates will nip away at borrowing capacity, the risk assessment of new lenders by the mortgage providers, and as a result, house price growth will lose momentum as interest rates rise.

Which goes all the way back to the RBA policy priority at the moment, in thinking it can hold the Aussie dollar down by leaving interest rates rate on hold and that this is more desirable than hiking rates, risking a higher Aussie, but shooting a bit of buckshot at the possible housing bubble.

For the sake of the longer run well-being of the economy, let's hope the RBA changes its priorities and tweaks interest rates higher sooner rather than later.

The next RBA meeting is scheduled for 6 May and that might be a good time to start.

 

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