Australia, N.Z. in same boat as Canada
Canada is not alone in having its central bank backed into a corner, forced to warn about the dangers of high debt and hot housing markets, while powerless to change interest rates as a commodity bust weighs on the economy.
Economists at Bank of America Merrill Lynch have now grouped together Canada, Australia and New Zealand as part of a trio heading for “an unwinding.” They blame the complicated situation on the crash in oil and metal prices, and a surge of money into real estate.
The end result is expected to be a “painful unwinding” in the medium term.
“Canada, Australia and New Zealand have all faced commodity shocks that have hampered growth and left the economy highly dependent on housing activity,” a team of BofAML economists wrote. “Despite mounting financial stability risks, central banks in these regions are stuck with low rates to stimulate growth.”
While all three central banks have warned about hot housing markets in each country, BofAML notes that growth in real estate has been incredibly important for each economy, making up 15- 30 per cent of the GDP gains seen in the past two years.
“As such, we see no rate hikes on the horizon to stem financial stability risks as a slowdown in housing would impair growth,” the economists write.
All three countries are also struggling with rising trade deficits and growing foreign capital being pumped into housing. BofAML notes that actual data about foreign buying in all three countries is hard to come by, but anecdotal data suggests the money is there and it’s going into real estate.
“Evidence of a large foreign presence is abundant,” the economists write. “For example, resale house prices fell by 19 per cent monthover-month in Vancouver in August, the first month of a new foreign real estate transaction tax.”
The BofAML economists lean toward taxing foreign buyers to solve the problem, as they note that higher interest rates or changes to bank loans mainly affect domestic borrowers. “This puts the onus on measures targeting foreign buyers such as foreign real estate taxes,” the economists write.
Ultimately, Bank of America Merrill Lynch lays out three scenarios for how the current housing boom will play out in each of the three countries. They describe each scenario as “bad, worse and worst,” as all require a somewhat painful unwinding of the record debts accumulated by households.
The baseline scenario involves a successful implementation of mortgage and housing policies, which avoids a housing crash, but household debt balances remain high. In this scenario, all three central banks maintain easy monetary policies. It doesn’t solve the debt problem, however, which BofAML notes is of particular concern in Australia, where household debt levels are highest.
Essentially, the status quo remains in the baseline scenario, with some easing of sales and prices.
The “worse scenario” involves an overly aggressive tightening of policy, which leads to a sharp curtailing of demand, falling prices and sales. While domestic home buyers get cheaper houses, this scenario removes a significant amount of growth from each economy and forces the central banks to ease further.
Australia is particularly at risk in this scenario, because a huge amount of new supply is scheduled to come online next year in cities such as Sydney, and data show that foreign buyers account for more than seven per cent of purchases — and growing.
The final scenario is one where governments are too timid on action, allowing the current real- estate bubble to grow even larger. When governments are eventually forced to act because of financial stability risks and populist pushes against growing unaffordability, the result is a much more serious price correction and potential housing crash.
Ultimately, BofAML says there is “no happy ending” for the situation. The hope is that governments and central banks at least make the right choices to tackle the problem sooner rather than later, and with the right tools.