By David Bassanese

The upshot of recent commentary from the Reserve Bank of Australia is pretty clear: our new suite of so-called “macro-prudential” controls to contain risks in the housing sector have failed miserably. 

It’s such a problem that the RBA is now loath to cut interest rates again, even at the risk of entrenching uncomfortably low inflation, lest it lead to a further build-up of household borrowing and frothy house prices in Sydney and Melbourne. 

Reserve Bank Governor, Philip Lowe, could not have been clearer. In a speech last week, he noted the RBA is now more carefully balancing the risks “from having inflation low for a longer period against the risks from attempting to increase inflation more quickly, which would partly occur through encouraging more borrowing.”

As Lowe conceded, “if inflation is low for a long period of time, it is certainly possible that inflation expectations adjust, making it harder to achieve the [inflation] objective.”  

In this regard, the fact that underlying inflation has dropped to below the RBA’s 2 to 3% target band, and does not look like lifting back into the band within a year or so, should be a cause for concern, as should be the fact that annual wage growth has dropped to historic lows of less than 2%.

Yet, Lowe downplayed such a risk, claiming “at the moment though, I don't see a particularly high risk of [low inflation expectations] in Australia. The recent lift in headline inflation is helpful here and most measures of inflation expectations are within the range seen over recent decades.”

This marks a big departure from the RBA’s inflation concerns last year – when it cut rates twice in the face of the first initial decline in inflation to below its target band. Now, however, the bank is more concerned with “continuing rises in indebtedness, partly as a result of low interest rates, [which] increase the fragility of household balance sheets.”

Why the change in sentiment? The obvious rebound in the Sydney and Melbourne property markets following last year’s rate cuts clearly didn’t please the Bank – particularly after it partly justified the case for rate cuts on the view that prices were moderating in these cities earlier last year, as well as growth in investor lending, thanks to some extent the APRA imposed “macro-prudential” tightening in lending standards.  

With hindsight, the Bank now fears it helped throw petrol on a wild bonfire that had thankfully already started to simmer down. As seen in the chart below, annual growth in investor lending bottomed in August last year, and has been accelerating ever since. 

 

Another more recent ground for caution is the mid-2016 slowdown in consumer spending, which seems to suggest households have reached the limit on the degree to which they want to run down their savings further to keep spending in the face of still quite muted income gains. The Bank is loath to risk pumping up household leverage even further, given the risk of a severe reckoning later.

Fair enough: but it does beg the question – why didn’t our “macro-prudential” tightening in lending conditions do more to contain our hot property markets even in the face of lower interest rates? The balancing act clearly failed. 

One problem appears to be that investor buying – which is the main driver of higher house prices – is not as credit driven as seemed apparent. After all, the latest credit figures from the RBA show that annual growth in investor housing credit, while accelerating again, has so far only lifted to back to 6.7% by January, which is still comfortably below APRA’s 10% desired cap.  

Maybe the cap needs to be lowered? 

The other, less well documented problem, is the extent of foreign (largely Chinese) buying in our major cities. The law states that buying of established properties needs to be by residents, or at least temporary residents, with the latter required to sell their properties when they leave. But how well these laws are enforced is hotly debated!

Given the tentatively encouraging signs of growth in the economy, the fact the RBA is less inclined to react to stubbornly low inflation by cutting rates anytime soon is, as yet, no great tragedy. But the inability of macro-prudential controls to contain recent property excess is clearly constraining the Bank’s options. 

With unemployment high and inflation low, the economy can, and should, be able to growth faster than it is at present. Lower interest rates would help, if only we did not need to worry about the bubbly Sydney and Melbourne markets. It means other still weak property markets across the country can’t benefit from a further lowering in rates, and it has left the $A higher than it would otherwise be. It’s also likely to mean share market performance, while reasonable thanks to recent gains in commodity prices, will lag that of our international peers.