Ohhhh, please…Australian interest rates are not going to the moon

The global economy stands on the precipice once again. I have to believe that European politicians will find the resolve to fix the situation by guaranteeing Greece’s debt or finding some other work around but I also believe that the weakness in the global economy is a return to post-crisis trend rather than a soft patch that will be easily washed away and thus unfortunatley the outlook has darkened regardless.

So when I read predictions of house prices soaring and mortgage rates going to the moon I have to wonder – how? Such was the case today as I read reports in the Newcastle Herald and online of the latest round of BIS Shrapnel forecasts. Looking first at the Newcastle Herald story, link here NH Housing. I would like you to read the story on the left and then the story on the right and then ask the critical question, “how then these two stories coexist in the real world?”.

Clearly they can’t – on the one hand we are hearing that house prices are going to rise at Sydney rates of 18% (I’ll look at that later) but on the other affordability is slipping away and smaller more affordable accomodation is the new McMansion. At the same time the authors of this report now reckon that rampant inflation is going to drive mortgage rates to 9.4%.

Ohhh please…give me a break.

The authors of this report are notorious for these big calls and I find them interesting insofar as the underlying rationale of this and previous reports is so narrowly focussed but they get such good airplay, (note to self – make big calls that fit with what people WANT to hear and if we get it wrong then it is just that conventional wisdom is wrong) to me its a very cynical approach. Indeed I have personally heard the principals dismiss the fact that their forecasts were wrong in the past in such a way as to make me cringe.

Now as you know this economic/market forecasting/commentary/trading thing is really hard so I don’t like to play the man so lets play the ball. What are the current settings in the economy that could drive house prices up close to 20% between 2011 and 2014 and that would see rates at 9.4%.

The first thing to note is that the nuanced argument is very clever – if house prices match inflation of say 3% per annum over the next 3 years then they should be 9.3% higher. This makes the 18% figure double inflation but not quite so big a return. If you think that inflation is only going to be a little outside the RBA’s target and average 3.5% per annum for three years then house prices should grow rougnly 11%. JUST TO MATCH INFLATION.

So the non-inflationary (or real return) is much lower than the nominal headline.

But how are we going to get that growth in house prices if inflation is rampant and the RBA has to tighten rates. Seems a fallacious argument – how do we square the circle?

So lets look at a few charts and draw some conclusions.

Australian Households are holding a lot of debt and paying a lot of interest.

As we have discussed before a large portion of this debt is held by Households with a head over 50 and they are focussed on repayment. Thus the demand for credit is falling and with it upward pressure on house prices, ex-inflation.

So its hard to see the pressure on house prices to roar higher. NOW REMEMBER, as we have shown before the correlation between prices and demand for credit, quarterly ABS data, is 97%.

So, while I’d argue prices are stickier to the downside than the upside – on this relationship it is hard for prices to rise at all let alone twice the level of inflation:

  • if debt levels are high,
  • interest payments as a proportion of household disposable income are back toward alltime highs and well above long run averages and
  • the a large cohort of Australians is focussed on repaying debt and saving money.

So could inflation cause the RBA to hike aggressively?

Of course it could if it gets out of control and of course given their tightening bias and belief in the mining boom any signs will be acted on in time. But not to the exclusion of things such as household weakness and global instability and economic weakness. But if rates rise and affordability falls and consumers become more focussed than even now at paying down their debt then can property prices really rise close to 20%.

I doubt it – the argument just doesn’t pull together.

But the good news is that while I don’t think property prices can rise 20% over the next few years, and I don’t buy the argument that the economy can sustain mortgage rates 2% higher I don’t think property prices are going to crash either.

I think the RBA’s view of the economy is evolving and that the short to medium term negatives are getting an even weight with the long run strong mining boom related positives.

Here is what the market thought yesterday afternoon about rates. Probably too pessimisitic and factoring in global weakness if not another financial meltdown. So its probably a good time to lock in borrowing rates for corporates.

 

In the end I think the Australian economy is going to remain a bastion of economic health – only a catastophe would make the RBA move away from its tightening bias, even if I don’t believe they can act on it for many months now. But we just may not see big house price rises because households just dont want to borrow too much these days.

But paying down debt and rebuilding the national balance sheet isn’t such a bad idea though – is it?

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

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  1. Ohhhh, please…Australian interest rates are not going to the moon … | Brisbane Real Estate - June 29, 2011

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