Rising rates retard housing recovery
All the portents point to an economy with an inflationary bias
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.