Home Prices Flashing Amber
Australian house prices over the past year have risen at their fastest annual pace since 1989. Q2 2021 ABS data showed national house prices up 6.7% q-o-q and 16.8% y-o-y with home prices in Australia’s biggest city, Sydney, up 8.1% q-o-q and 19.3% y-o-y. The ABS data covers state and territory capital cities. There is ample evidence that house prices in regional towns and cities have risen faster than in the capital cities.
Even with the lockdowns in Sydney and Melbourne through Q3 housing industry price surveys show signs of only modest deceleration in the pace of rising house prices. The costs to the community of high and still rising house prices and the higher rents that follow in their wake are starting to outweigh the main benefit – the lift in household wealth helping to promote greater willingness to spend.
Among the rising costs are greater social division with increasing numbers of mostly young people forced to give up trying to own a home because of high prices. Fast rising home prices and rents add to upward pressure on general inflation. Also, as expectations of fast rising house prices become entrenched the fear of missing out can cause home buyers to over-extend on their borrowings.
The problem of over-extended home borrowers should be a limited problem if lenders follow prudent lending standards including diligently checking borrowers’ capacity to service loans including an adequate interest rate buffer to assess loans and to cover future interest rate increases. The standards of borrowers and lenders, however, come under pressure during once in thirty -year home price rises. More borrowers try to exaggerate their capacity to pay while lending officers come under greater pressure to meet higher lending targets.
Policymakers are starting to recognise the risks around fast rising house prices. The Australian Prudential Regulation Authority (APRA) has increased by a quarter percentage point the interest rate buffer that banks use to assess loans reducing home buyer borrowing capacity by around 5 per cent. This gentle lean into the fast-rising house price problem may be deployed repeatedly by APRA to slow the pace of rising house prices.
The RBA noted in its half-yearly Financial Stability Review on Friday that a risk to otherwise sound financial stability is excessive borrowing due to low interest rates and rising house prices. The RBA notes that “vulnerabilities can increase if housing market strength turns to exuberance with borrowers taking on greater risk given expectations of further price rises and banks potentially easing lending standards”. The RBA sees the APRA action as responding to the risks.
The RBA recognises that low interest rates have been one of many causes for the rapid rise in house prices but is not indicating that rising house prices will cause a hike in official interest rates. Wage growth and the CPI target are still the key determinants of any official rate hike and both need to rise sustainably to 3% y-o-y or more which they are not likely to do before 2024, according to current RBA forecasts.
The RBA’s wage and CPI forecasts, however, will change. They have been changing over the past 12 months drifting upwards with every quarterly Monetary Policy Statement.
There are reasons we see why that upward drift may become more pronounced. Fast rising house prices and rents will boost the CPI late 2021 and in 2022. International supply chain pressure on inflation around the world is proving longer-lasting and greater than expected (final stage producer prices up 8.3% y-o-y in the US; 9.5% in China; and 13.4% in Europe and still under upward pressure with the latest unhelpful lift in energy prices).
While Australian wages growth has been low at 1.7% y-o-y signs of a turn higher are developing. The Sydney and Melbourne lockdowns and the start of reopening has exposed acute labour shortages in the hospitality and health care sectors. Wage disputes are rumbling on the docks, parcel delivery services, transport and teaching. While institutional arrangements around pay bargaining are fractured compared with the high inflation period of the 1970s and 80s the extent and number of pay disputes is starting to grow.
The likelihood is increasing that Australian annual wage growth and inflation will push higher than the RBA is expecting through 2022 causing it to change at some stage its guidance of when the first official rate hike will occur.
Regardless of when the first official rate hike occurs, the funding costs of home lenders are likely to start to rise well before, mostly because of the upward pressure that has already started on international interest rates. Lenders’ variable rate home loan products may hold low rates a little longer, but the upward pressure on fixed rate products has already started. Progressively through 2022 and 2023 the roll dates on fixed rate home loans will be periods where higher servicing payments cut in for many borrowers causing at the very least reflection on the wisdom of being committed to housing at high prices.
Many factors go into determining why house prices rise fast and why buyers commit to purchase at seemingly crazy prices. Many a forecaster has been thrown wide of the mark trying to forecast house prices. Rather than try and forecast where house prices go after the heady boom of the past year it is worth pointing out that two key signals for housing, the regulatory environment and interest rates are resetting from green to flashing amber.