Yesterday, RBA Governor Lowe tried to downplay the housing slump in Australia, focusing 80% of his speech on that subject. Both the choice of words, aiming to explain the factors behind the slump, and the extent devoted to the topic alarmed investors and pushed the Aussie Dollar lower.
The important question arising from this is whether exerting so much effort should signal that things are not going well. In fact, it should. The reason lies simply in that any Central Bank is more like Titanic’s captain, refusing to give in at the time of danger. Admitting that things are deteriorating would essentially create something similar to a self-fulfilling prophecy: as people try to act to protect themselves against the consequences of the prophecy, they end up making it happen faster. In the RBA case, acknowledging that there is more to the drop in house prices than cyclical factors would mean that real estate investors would seek to protect themselves from the potential reduction in prices by selling now instead of later. This would, however, push prices lower and accelerate the reaction, thus making the “prophecy” come true.
To be fair, the points Lowe makes in his speech are valid and besides, he also comments that “the current adjustment is unusual”. Still, the purpose of downplaying this starts by suggesting that the increase in supply has outperformed the increase in demand (i.e. population) in recent years, explained as a delayed response of the construction sector to the increase in population. While this would make sense, to an extent, it is highly unlikely that this is the main reason behind the construction boom since 2014.
The real driver can be found in Graph 7, which shows the evolution of foreign real estate investment. As foreign investment rose from 2011 onward, more than doubling in 2014 from its 2013 levels and moving to nearly double again in 2016 from its 2014 levels, it caused an increase in demand for housing pushing prices lower. FDI in real estate plunged in 2017 and further declined in 2018, to a quarter of the 2016 peak. The reason behind this is that this investment stemmed mainly from Chinese investors who, as prospects deteriorated in the last couple of years, kept most of their money in China as a result of the authorities’ management of capital flows.
While Lowe comments that this inflow exacerbated the ongoing trend, it is also highly plausible that it had, in fact, created it; what’s more, as this previously inconspicuous statistic is brought to light, it is easier to see how banks have begun to accept less and less loans (Graph 8), given that buyers are scarce. Once owners realize that prices have been declining then they will likely postpone their purchases in order to secure lower prices in the future, further pushing housing prices down and making things more difficult for banks which have already seen their non-performing loans increase, albeit not to a dangerously high level (yet). This is a point Lowe also makes in his speech.
All of the above simply imply that RBA cannot proceed with rate hikes, as this would hurt existing borrowers by increasing the cost of repayment, as well as push away potential house seekers who will be less willing to purchase as loan installments rise. Rate reductions will also not assist much here: small rate cuts will not likely persuade new loan applicants to borrow and, in addition, it will likely push inflation, which is already standing in the proximity of 2%, higher, further watering down existing borrowers’ purchasing and repaying ability.
Overall, Australia has been benefiting from the overall improvement in the US-China relationship, even though this is not likely to persist for long, especially if China continues to exhibit a growth deceleration.
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Dr Nektarios Michail
Market Analyst
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