Bubble bubble?

AUGUST 2009

Jason Anderson - Senior Manager

Attitudes to the housing sector have skipped along over the past month. Evidence of a recent rebound in prices emerged for June quarter 2009, which was consistent with high auction clearance rates and an improvement in turnover.

Property price metrics vary, but the overall picture is that modest price declines during the second half of 2008 were followed by small increases during the first half of 2009. Certainly, the RBA action to raise interest rates during 2007/08 was effective at rapidly cooling the housing sector with turnover and approvals reaching a trough in December quarter 2008 which was a drop of 25-30% on the previous corresponding period.

The rapid reversal of interest rates during 2008/09 has also been effective, in that turnover and prices have recovered. Not surprisingly, the degree of response to rate cuts has been quite gradual, as sentiment was severely affected by the startling developments in the global economy and uncertainty from the Australian outlook. That uncertainty is dissipating, as the effectiveness of stimulus measures on households has been borne out. It is less clear as to what the path for recovery looks like.

We continue to think that increasing property prices have to be part of the process– this view should be uncontroversial, given that it is so rare for market-wide house price measures to show outright declines. However, it seems likely that further evidence of rising prices, irrespective of magnitude, will be referenced as a ‘bubble’, a term that has achieved currency due to its ongoing power in the minds of the public.

Part of this power is the inherent tension between excessive property price growth and interest rates– if prices shift quickly, then rate rises are likely to happen earlier and be more substantial, making the price gains only a temporary phase. This debate will play out for the rest of this year, and is only likely to be quietened by a series of subdued figures for retail sales and business investment.

More significantly, there will be the initial evidence of declining first home buyer (FHB) demand from September 2009, given that contracts must be signed by the end of that month if FHBs are to qualify for the maximum value of the Boost Scheme grants.

It seems likely that speculation about softening housing demand and maybe even prices will emerge again from October. In this environment, it will be hard to see much merit in the ‘bubble’ label. Surely the RBA will want to observe a housing market without the Boost Scheme before concluding that a sustained recovery is underway.

Bear in mind also, there will be a substantial drop in dwelling apartment construction activity during the second half of 2009 due to the 26% plunge in apartment starts during 2008/09– and this will be joined by the sharp decreases for non-residential building and engineering construction. National construction work done is forecast to show an annualised decline of 15% during the second half of 2009.
   
It would be a bold move to raise interest rates in this environment– particularly on the basis of property price expectations. Dwelling construction will be vital to national economic growth in 2010 – and that will not happen without modest price growth in that year. We will need a rate of price increase that delivers a safe path for the housing sector, enough to sustain the recovery in investor demand, but not so high that rates are raised substantially (by more than 1%) during 2010.

Arguably, it is the medium term outlook (say three years out) for interest rates that is vital for asset price expectations. History suggests that we should be fairly relaxed. The last tightening cycle from 2001 to 2008 was quite extended. From a low of 6.05% in December quarter 2001, the housing rate was only 0.50% higher by September quarter 2003 (almost two years later). Interestingly, that period of low interest rates came with a sharp upturn in residential building, which was used to offset deep negative effects from the trade balance. In 2010, there will again be some major constraints on economic growth. This time, the problem will be business investment– private sector non-residential building, civil works and equipment; plus very weak household spending as the stimulus ‘drugs’ wear off. If the overall environment in 2009/10 is much more challenging than in 2002, then it seems reasonable to expect interest rates to be on hold for most of next year.

© BIS Shrapnel 2009

Kellie Osta

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