Ris­ing rates re­tard hous­ing re­cov­ery

All the por­tents point to an econ­omy with an in­fla­tion­ary bias

The Weekend Australian - Review - - Landmarks - FRANK GEL­BER ECON­O­MIST

WHILE in­ter­est rates con­tinue or threaten to rise — and that looks like the case for some time yet — a re­cov­ery in the hous­ing mar­ket will be de­layed.

The re­sult­ing build- up of de­mand means a big­ger boom when the re­cov­ery fi­nally comes.

As we en­ter the last week of this seem­ingly in­ter­minable elec­tion cam­paign, it’s prob­a­bly worth while tak­ing stock of the in­ter­est rate is­sue. De­spite the rhetoric, whoever wins will be faced with a strong econ­omy, ca­pac­ity con­straints and labour short­ages. This econ­omy has an in­fla­tion­ary bias.

While the min­er­als boom con­tin­ues to drive in­vest­ment, the econ­omy will stay strong. And that’s likely to be for a few years yet.

That places the Re­serve Bank in an in­vid­i­ous sit­u­a­tion, with only ris­ing in­ter­est rates to con­tain in­fla­tion­ary pres­sure.

Un­for­tu­nately, rais­ing in­ter­est rates is do­ing lit­tle to con­tain de­mand. Higher rates are likely to do lit­tle to con­tain in­vest­ment and are hav­ing lit­tle im­pact on con­sump­tion ex­pen­di­ture. Last year’s rises were like wa­ter off a duck’s back.

Mean­while, gov­ern­ment ex­pen­di­ture is locked in, not only to elec­tion prom­ises but also to al­le­vi­at­ing in­fra­struc­ture bot­tle­necks re­sult­ing from years of in­ad­e­quate in­vest­ment.

Rather than spend­ing all the pro­jected bud­get sur­pluses on tax cuts, thereby boost­ing de­mand and in­fla­tion­ary pres­sure, it would have been nice to see a lit­tle more con­cern about the con­se­quences for in­ter­est rates rather than con­cern about match­ing the other side in the race to an elec­tion win.

The RBA’s only in­stru­ment is rel­a­tively in­ef­fec­tive in the cur­rent cir­cum­stances. It can­not be used as a fine tun­ing in­stru­ment — only as a cud­gell. For­tu­nately for the RBA, de­spite skilled labour short­ages, wage rises have been re­mark­ably or­derly un­til now.

And its also for­tu­nate for the RBA that the rise in the Aus­tralian dol­lar this decade ( from US50c to US90c) has given us a free ride on in­fla­tion, re­duc­ing in­fla­tion for im­ports and im­port- com­pet­ing goods, such as cars and cloth­ing, and off­set­ting the solid in­fla­tion on non- trade­ables ( such as house build­ing and gov­ern­ment ser­vices), which has been run­ning above the RBA’s com­fort zone at be­tween 3 and 4 per cent for the past five years.

With­out the free ride from cur­rency ap­pre­ci­a­tion, we would have seen hefty rises in in­ter­est rates long ago. The re­cent strength in the dol­lar will pro­vide breath­ing space, mod­er­at­ing the need for in­ter­est rate rises through the first half of next year. But in­ter­est rates will rise nev­er­the­less. While the econ­omy re­mains buoy­ant, skilled- labour short­ages mean an in­fla­tion­ary bias. That means that mone­tary pol­icy has a tight­en­ing bias. And given that the econ­omy looks like stay­ing strong for some time, this is a long game not a short game.

For me, the ques­tion is not whether in­ter­est rates will rise, but how many rises will be re­quired to con­tain in­fla­tion­ary pres­sure over the next few years.

Ris­ing in­ter­est rates and the threat of fur­ther rises will con­tinue to sup­press the much- needed res­i­den­tial re­cov­ery. Be­cause of its sen­si­tiv­ity to in­ter­est rates, the res­i­den­tial sec­tor is the col­lat­eral dam­age in tight­en­ing mone­tary pol­icy.

We’re not build­ing nearly enough hous­ing. We’re build­ing around 150,000 dwellings a year Aus­tralia wide com­pared with our es­ti­mate of un­der­ly­ing de­mand of 182,000.

That means fur­ther tight­en­ing in rental mar­kets and fur­ther rises in rents. It means a greater build up in the cu­mu­la­tive de­fi­ciency of res­i­den­tial stock and hence a stronger rise in both con­struc­tion and prop­erty prices once this de­mand is re­leased.

If we are wor­ried about af­ford­abil­ity, if we are wor­ried about pric­ing peo­ple out of home own­er­ship, this is not a good out­come.

In any case, af­ford­abil­ity will get worse from here as first in­ter­est rates rise and then, as res­i­den­tial prop­erty re­cov­ers, prices rise.

Can we live with lower af­ford­abil­ity? Of course we can. There’s no choice.

It means we’ll have to down­grade our ex­pec­ta­tions, live in smaller houses and units, live fur­ther away from the more ex­pen­sive city cen­tres and, for many, it will un­der­write a move to re­gional cen­tres where hous­ing is cheaper. Mind you, the av­er­age floor area of new houses is over 250sq m, up 30 per cent since the mid- 1990s.

Even so, some house­holds will never get out of the rental mar­ket. That was al­ways the case.

To min­imise the pain, we need to con­tain rental rises by en­cour­ag­ing avail­abil­ity of suf­fi­cient rental prop­erty and, as much as pos­si­ble, con­tain­ing prop­erty price rises.

That means en­sur­ing ready avail­abil­ity and con­tain­ing the cost of pro­vi­sion of land and sites for res­i­den­tial con­struc­tion.

I’d like to see gov­ern­ments re­duce their fo­cus on in­fra­struc­ture cost re­cov­ery and once again sub­sidise site pro­vi­sion, thereby help­ing to con­tain prop­erty price rises. I’d like to see the free­ing up for medium- den­sity res­i­den­tial de­vel­op­ment of a lot of those old, now ob­so­lete, in­dus­trial ar­eas around in­ner ar­eas of our cities which plan­ners quaintly call ‘‘ em­ploy­ment land’’.

The shift to ser­vice in­dus­tries means in­creas­ing num­bers of peo­ple work in of­fice build­ings in ma­jor cities — that’s the real em­ploy­ment land.

We’re forc­ing many to com­mute long hours from dis­tant dor­mi­tory sub­urbs. Let’s ei­ther put hous­ing where peo­ple work or put jobs where peo­ple live.

Mean­while, ris­ing in­ter­est rates have dif­fer­ent ef­fects on dif­fer­ent sec­tors of the com­mu­nity. They are a boon for peo­ple on fixed­in­ter­est in­comes, but cre­ate prob­lems for those with high bor­row­ings, par­tic­u­larly those whose in­ter­est rates are vari­able.

I know I’ve been say­ing this for many years now, but it still makes sense to fix rates in th­ese times of low bond rates as a cheap in­sur­ance pol­icy against fur­ther rises.

So far, the dam­age from ris­ing in­ter­est rates has been rel­a­tively con­tained, largely off­set by ris­ing wages and em­ploy­ment.

There is lit­tle dan­ger of some­thing like the US sub- prime mort­gage fi­asco, where many bor­row­ers now com­ing out of the low- start loans find their mort­gages un­ser­vice­able. Aus­tralian lenders have been more cau­tious. But US ex­pe­ri­ence pro­vides a timely warn­ing against ag­gres­sive lend­ing prac­tices. The prob­lem in Aus­tralia is quite dif­fer­ent. My fear is that the strength of the cur­rent eco­nomic boom will end in tears, that keep­ing in­ter­est rates too high for too long, or a col­lapse in the min­er­als boom and min­er­als in­vest­ment, will re­sult in a down­turn and a sig­nif­i­cant rise in un­em­ploy­ment.

That’s what will hurt the mort­gage belt most. We can ser­vice debt while we still have jobs, but not when we lose them.

Mean­while, Aus­tralian in­ter­est rate rises are hav­ing a mod­er­ate ef­fect on house­hold dis­pos­able in­come but op­er­at­ing more strongly to re­duce de­mand for the pur­chase of res­i­den­tial prop­er­ties, to re­duce the amount that can be bor­rowed and to dis­cour­age de­vel­op­ment of dwellings.

That means that the next cy­cle will be de­layed. But when it does come it will be much stronger.

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