The RBA rolls the dice on house prices

Wed, 21 Nov 2018  |  

This article first appeared on The Wire, the web page for FIIG, at this link: 


RBA ignores property at its peril

The RBA rolls the dice on house prices

The usually careful and well considered Reserve Bank of Australia is taking a huge gamble on the Australian economy into 2019 and 2020.

The RBA is betting that the current slump in house prices and dwelling approvals are orderly and will not have any material or lasting consequences for the economy. In fact, RBA Governor Philip Lowe believes the fall in Australian house prices “is good news”, “manageable” and “a welcome development”. Further, in its November Statement on Monetary Policy, the RBA suggested that house prices “have continued to ease gradually”, which is a remarkably bland assessment given that close to $400bn has been wiped off the value of Australian houses since the price peak in September 2017.

Governor Lowe and the RBA’s open indifference to what is a major shift in the $7trn valuation of residential property is bold.

Wealth and household spending – The link

While some cooling in house prices was always inevitable following the price boom in the four years to 2017, the price falls are getting close to a point where the loss of household wealth will impact household spending. The RBA itself and a bevy of global academic research show a link between changes in household wealth and growth in household spending.

The research findings differentiate regarding the extent of the link and the time lag between the change in wealth and its impact on spending growth, but there is unambiguously a strong correlation between the two. These differences are largely driven by the speed and size of the price falls and the level of debt held against house prices. When wealth rises, household spending growth picks up; when wealth falls, household spending growth slows.
Household wealth is falling.

Plain and simple.

Nationwide, house prices have fallen 6% from the late 2017 peak and coincidentally the value of Australian shares has fallen sharply as the ASX dropped around 20% from its August 2018 high. With near record low auction rates, the tightening in credit and increase in dwelling supply feeding into market conditions, there is no doubt house prices will register further sizable falls over the next six months, perhaps longer.

Reputable housing analysts are expecting the peak-to-trough movement in house prices to be in the order of 15 to 20%. At 20%, this would see household wealth in housing assets drop around $1.25trn.

Figure 1 shows a strong correlation between the change in house prices and growth in the volume of real retail sales per capita. While the correlation is not perfect, it is a good fit that shows changes in house prices leading to changes in retail sales by one to two quarters.

Even if the current fall in house prices was to come to an end in the next month, retail sales growth on this measure can be expected to dip to around zero, or a little lower. Based on the scenario where house prices fall around 7 to 10% in annual terms over each of two years (15 to 20% in total), real retail sales per capita will fall by about 1% in each of those two years. Retail figures have not been that weak since the global financial crisis and the early 1990s recession.

Bottom line GDP growth at risk

Such weakness in retail spending and household consumption would leave a significant hole in bottom line GDP. In particular, at a time when new dwelling construction is poised to fall and subtract from GDP, when numerous public sector infrastructure projects are close to competition, and when the world economy is showing signs of material weakness (note falls in GDP in Japan and Germany and slowing in China) – Australian growth is set to dip towards 2.5%, or lower.

A broad slowdown is inevitable, unless there is a surprising upswing in some other segment of the economy or house prices stabilise.

Playing with fire

The RBA ramped up its optimism for the economy with its November Statement on Monetary Policy. In that Statement, it lifted its forecasts for GDP growth and lowered its forecasts for the unemployment rate.
It did this in full knowledge of recent house prices and global trends. It is a scenario that assumes everything that can go right, will go right. It assumes falling house prices and lower wealth has a trivial impact on household spending and assumes that wages growth will register a strong pick up, even with the unemployment rate remaining around 4.75%.

There is little or no margin for error, which means the forecasts have little upside risk.

The downside to the RBA’s rose coloured assumptions are more extreme.

What about inflation and wages?

The RBA has – perhaps had - an objective of having annual inflation tracking around 2.5%. Up until two years ago, this meant occasional periods where inflation was near 2% or less, or just over 3%. The ‘misses’ on inflation outside the broad 2 to 3% target were usually short lived. When the momentum for inflation was tracking higher or lower, the RBA would adjust monetary policy to recast the momentum in the economy to get inflation back around 2.5% over a reasonable time frame. Until two years ago, the RBA forecast for inflation on an 18 to 24 month time frame was always 2.5%.

To forecast a different inflation outcome would indicate that the RBA’s current policy was wrong, either being too tight or too easy.

More recently, the RBA has lowered the importance of inflation as its prime concern and instead has been looking at financial stability in the form of household debt and house prices as its main area of concern. By definition, it has kept monetary policy tighter than necessary. The result has been inflation below target and in the September quarter, underlying inflation actually slowed to 1.7%. It has been below target for the best part of three years and inflation is not forecast to hit the middle of the target at any stage in the RBA’s forecast profile.

The inflation target is dead – long live the inflation target!

The RBA is reactive not proactive – is the next interest rate move up or down?

For the past year, the RBA has been telling the market that the next move in official interest rates is likely to be up, not down. It is still banging the drum about financial stability and as indicated, it is welcoming the falls in house prices and probably has the most upbeat view on the economy of any forecaster. For the RBA to make an about face on this view and move to actually cut interest rates, there needs to be a material weakness in the economy. This is possible and would be likely if the link between house prices and household spending retains its long run historical relationship.

As such, the hurdle for the RBA to clear before it moves to an interest rate easing bias, let alone delivering an interest rate cut is very high. The RBA will need to change its internal analysis of financial stability and see the hard data on the economy deteriorate.

It is safe to say that it will not cut interest rates pre-emptively to head off disinflationary weakness in the economy. It is not in the mindset of the current Board and senior staff. Put simply, the RBA will need to see some mix of a stalling in GDP growth and an uptick in the unemployment rate. The big question is whether the decline in house prices (and other factors including weaker global growth) will be sufficient to deliver this news. The research suggests it is more likely than not

If house prices slide 15 to 20%, it would be a rolled gold certainty that household consumption spending growth will weaken and with that, inflation will remain well away from the target.

Where to look?

While all economic data is important, the highlights to test the RBA theory will come from changes in house prices and household consumption spending. Data on inflation, wages and unemployment are of course important, but it is houses and households that are the key in the current cycle. Corelogic publishes daily house prices for the five main cities – Sydney, Melbourne, Brisbane, Perth and Adelaide – and monthly data for Australia. The beauty of this series is that it shows broad and remarkably timely trends in the housing market.

Without getting caught up in the daily moves, trends in prices on a weekly and fortnightly basis and as the month unfolds can and do provide an early signal as to whether the RBA is likely to be wrong or right when it comes to its current upbeat view on the economy.

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My house price bet with Tony Locantro - an update

Mon, 01 Apr 2019

This article first appeared on the Yahoo Finance web page at this link: 


My house price bet – I’m very happy and getting ready to collect

I recently made a bet with Tony Locantro, Investment Manager with Alto Capital in Perth on the extent to which house prices would fall over the next three years.

Just to reiterate, the bet centred on Locantro’s view that prices would drop 35 per cent or more by the end of 2021 from the peak levels in 2017, a forecast that looked absurdly pessimistic given the raft of factors that influence house prices over the course of years.

For Mr Locantro to win the bet, house prices measured by the Australian Bureau of Statistics on a quarterly basis in either Sydney, Melbourne or for the average of the eight capital cities would need to fall by 35 per cent or more from the peak levels by the time the December quarter 2021 data are released. The ABS released the latest residential property price data last week which presents an opportunity to see how the bet is unfolding, admittedly with three years to go until it is settled.

As everyone knows, house prices are falling in most cities, reversing part of the boom over several decades.

Get ready for a cash rate cut in April

Mon, 25 Mar 2019

This article first appeared on the Yahoo Finance website at this link:


Get ready for a cash rate cut in April

The data is in and it is compelling.

The Australian economy is faltering and the risk is that it will weaken further if nothing is done to address this decline.Not only has there been recent confirmation of a per capita GDP recession – that is, on a per person basis the economy has been shrinking for two straight quarters – but inflation is embedded below 2 per cent, wages growth is floundering just above 2 per cent, house prices are dropping at 1 per cent per month and dwelling construction is in free fall.

Add to this cocktail of economic woe an unambiguous slide in global economic conditions, general pessimism for both consumers and business alike and a worrying slide in the number of job advertisements all of which spells economic trouble.Blind Freddie can see that there is an urgent need for some policy action. And the sooner the better.For the Reserve Bank of Australia, there is no need to wait for yet more information on the economy.

It has been hopelessly wrong in its judgment about the economy over the past year, always expecting a growth pick up “soon”. Instead, GDP has all but stalled meaning that inflation, which is already well below the RBA’s target, is likely to fall further.In short, no. It is not like a 25 basis point interest rate cut on 2 April and another 25 in, say, May or June will reignite inflation and pump air into a house price bubble.

Such a claim would be laughable if there are any commentators left suggesting this.