As fears for the stability of the global financial system continue to ease, the thoughts of a central bank inevitably turn to more home grown concerns.
So it is that the Reserve Bank of Australia has issued a timely reminder to homebuyers that interest rates will not remain at record lows indefinitely.
In its biannual stocktake on the health of the local and international financial system, the Financial Stability Review, the RBA has devoted some attention to developments in the local property market.
This is hardly surprising – as the US sub-prime crisis so spectacularly demonstrated, what goes on in real estate can have explosive and devastating consequences for the rest of the economy.
Low interest rates are usually seen as a good thing (except by those trying to live off interest-bearing investments), but they come with risks.
The longer that rates stay low, the more desperate the competition among lenders for customers, and the greater the temptation for borrowers to increase their debt.
While rates stay low, many borrowers may be comfortable servicing their loan. But, inevitably, rates will rise, and as the financial squeeze increases, an increasing proportion of borrowers may find themselves in over their heads. And if they can’t unload their assets at a price to cover their debt (as can occur when many people simultaneously find themselves in trouble) things can get ugly very quickly.
This is the scenario the RBA is keen to avoid, and explains why it is watching borrowing behaviour and lending practices like a hawk.
It warned in today Review that there are already “indications that some lenders are using less conservative serviceability assessments when determining the amount they will lend to selected borrowers”.
It goes on: “It is important for both investor and owner-occupiers to understand that a cyclical upswing in housing prices when interest rates are low cannot continue indefinitely, and they should therefore account for this in their purchasing decisions.”
In other words, don’t bank on the idea that the recent surge in house prices will be sustained. If you are borrowing to your limit to buy a house, don’t be surprised when interest rates eventually go up, and the price you paid turns out to be at the top of the market.
None of these dangers are in immediate prospect.
The international economic recovery is still in its early days, and subdued local growth means there is little pressure at this stage to inch official interest rates higher.
But, while financial markets don’t expect the RBA to begin tightening monetary policy until at least early next year, the RBA might be tempted to act sooner if it sees a risky build up in household debt.
Monthly Archives: March 2014
Timely warning for home buyers
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When the bank calls, bells start ringing
If, like me, in the last couple of days you’ve had a call from your bank eager to talk about how to they could save you money on your mortgage, you’ve probably twigged that something is up.
Usually they call to flog insurance policies I don’t want, or offer a lift in my credit card limit that I can’t afford.
So to hear them actually prepared to come to the table to strike a cheaper deal on what is one of their core products is an interesting development.
It tells me that their own economists have told them the prospects of an official interest rate rise sometime this year are looking pretty slim.
This is no news to the market, which sees no chance of a rate hike before March next year, and instead is pricing in the possibility of a rate cut.
As RBA Governor Glenn Stevens put it today when announcing the Reserve Bank Board had decided to hold the central bank’s cash rate steady for a seventh consecutive month, “on present indications, the most prudent course is likely to be a period of stability in interest rates”.
It also shows that the field of competition has well and truly shifted from deposits (remember when the interest rate on 3-month deposits reached above 5 per cent? It is now down to around 3 per cent), and the scramble now is to sign up home buyers.
It is pretty clear that at the moment the economy is like a dog on roller skates, desperately trying to gain some traction.
Mr Stevens said that, while consumer demand was “slightly firmer”, and data foreshadowed a “solid expansion” in housing (building approvals jumped 6.8 per cent in January to be up almost 36 per cent from a year earlier), demand for labour is weak and the unemployment rate is likely to rise higher.
Its cause isn’t helped by a Federal Government that at every opportunity thunders about the dire state of the nation’s public finances and hints darkly at the need for painful spending cuts.
In central bank-speak, “public spending is scheduled to be subdued”.
It can’t be doing anything to improve the willingness of businesses to invest. Official figures confirm private capital expenditure has been sliding for the past couple of years, even as profits have grown – gross operating profits were up 107 per cent in the year to the December quarter, yet over the same period private capex fell 5.7 per cent (and spending on plant and equipment plunged more than 16 per cent).
As Mr Stevens put it, resource sector investment is set to decline significantly, while there are only “tentative” signs of improvement in investment intentions in other sectors.
The economy is partly the victim of an unfortunate clash of timing between the business and political cycles.
The incentive for the Abbott Government is to cut hard in its first Budget, giving itself room for vote-enhancing largesse closer to the next election, while the economy could do with some productivity-enhancing infrastructure investment.
Fat hope of that at the moment.
Even more people are likely to be out of work in the coming months, and being able to negotiate a cheaper mortgage is likely to be of little comfort.
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Outlier 