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Outlook for property prices: lower for longer?

By Adrian Rollins (this story was first posted by intheblack.com on 7 August 2018, at: https://www.intheblack.com/articles/2018/08/07/outlook-property-prices)

What is the outlook for Australian property prices now that the property market has passed its peak? Will house prices continue to deflate in key markets?

For a country used to ever-rising property prices – they have soared more than 370 per cent in the past 30 years – a new reality of shrinking property values and is taking shape.

Since the market peaked in September 2017, the home value index compiled by property market analyst CoreLogic has slid 1.3 per cent, including a 0.2 per cent decline in June 2018.

The searingly hot Sydney market has been hardest hit. House prices there have tumbled 4.6 per cent since the peak.

Nevertheless, so far the damage to balance sheets has been limited. Nationally, longer-term homeowners have held on to virtually all of their capital gains – prices are still 32.4 per cent higher than they were five years ago.

The property market is deflating, but with a gentle hiss rather than a cacophonous bang.

Nervous mortgage holders and aspiring homebuyers nonetheless wonder how long this decline will last, and how ugly it might get.

Applying the brakes to property prices

Part of the answer lies in understanding what pushed prices so high in the first place, and why they have since turned down.

CoreLogic research director Tim Lawless says easy credit and eager investors underpinned much of the increase in recent years. Buoyed by low interest rates and strong capital gains, investors piled into the property market.

By early 2015, the value of mortgages taken out by investors outstripped those to owner-occupiers, many of them riskier interest-only loans.

At one point, almost half of all loans being written were interest-only.

However, the downturn in house prices has not been driven by higher interest rates or borrowers getting into financial distress. Instead, it has been engineered by regulators, says property analyst Pete Wargent of WargentAdvisory.

Worried by the surge in investor borrowing, financial regulator the Australian Prudential Regulation Authority (APRA) in 2014 placed a 10 per cent speed limit on the growth of loans to investors. Three years later the regulator clamped down on interest-only lending, which had been growing rapidly, imposing a 30 per cent cap on the proportion of new mortgages that could be interest-only.

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Taken together these measures, says Wargent, were “pretty unique” – and effective.

Within a few months of the investor loan cap, borrowing slumped, dropping by almost a third through 2015, and it has continued to decline.

By April this year investors accounted for just 42 per cent of home loans, the lowest proportion since 2012, and growth in investor lending had dropped below 5 per cent, down from a high above 10 per cent.

Interest-only borrowing, too, has wilted. It accounted for more than 40 per cent of loans approved in 2015; by early this year the ratio was less than 20 per cent.

The regulation-driven credit squeeze has dampened housing markets. Auction clearance rates have slumped to less than 57 per cent nationwide, and are the lowest they have been since 2012, according to CoreLogic figures.

APRA released the brakes on investor lending in April but has no intention of relaxing the pressure on lenders, demanding they limit new lending at very high debt-to-income levels, and set debt-to-income levels for borrowers.

Australia: headed for a property crash?

However, the risks already built up in the system are not going away in a hurry.

The Organisation for Economic Cooperation and Development (OECD) has flagged household indebtedness as the economy’s biggest risk. The ratio of total household debt to income has jumped almost 30 percentage points in the past five years to reach 189 per cent in December 2018, and mortgage debt alone was 139 per cent of income.

Although wealth has grown even faster, some who have borrowed heavily may be vulnerable.

University of New South Wales Business School Professor of Economics Richard Holden puts the chances of a house price crash at 30 per cent, most probably triggered by widespread defaults on interest-only loans.

Although Holden says it is most likely that the property market will avoid a collapse, the risks created by more than A$100 billion of interest-only loans are “non-trivial” and cannot be ignored.

The Reserve Bank of Australia (RBA) estimates that each year until 2021, about A$120 billion of such mortgages will convert to traditional principal and interest loans, forcing up repayments by between 30 and 40 per cent.

The RBA thinks most households have enough of a financial buffer to absorb the increase. However, Holden warns that if even just 10 per cent struggle to make their repayments and are forced to sell, that could be sufficient to trigger a crash.

“I’m not really worried about what happens in Point Piper, Double Bay or Toorak,” he says. “I’m worried about what could happen in the western suburbs of Sydney and Melbourne. If there are big forced sales there, then great damage is going to happen to people who can afford it least.”

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Interest rates: the price of money

A sudden jump in interest rates is another risk.

Few expect the official cash rate to budge from its current record low of 1.5 per cent before late 2019 at the earliest.

However, this doesn’t mean borrowers won’t feel some financial pinch.

Wholesale funding costs on international markets are increasing, and already some smaller lenders are responding by pushing up interest rates on selected mortgages.

Lenders including Macquarie, the Bank of Queensland and Auswide Bank have increased rates on variable interest mortgages by an average of between 0.08 per cent and 0.27 per cent, and Lawless expects larger banks will eventually have to follow suit.

Still some life left in the market

Even if the country avoids a default-induced property crash, economists expect that tighter credit standards and the chilling effect of the banking Royal Commission on lenders will force house prices down for some time yet.

Fifteen economists polled by comparison website Finder.com.au tipped that prices in Sydney and Brisbane could drop by as much as 6 per cent by the end of the year, 4 per cent in Melbourne and Hobart, and 2 per cent in Perth, Adelaide and Darwin.

ANZ Banking Group is even more bearish. It predicts prices nationally could fall by 6 per cent from September 2017’s peak to a trough in 2019, including a plunge of up to 10 per cent in Sydney – a view shared by Macquarie Securities. AMP Capital warns they could drop by as much as 15 per cent by 2020.

However, Australia’s status as a destination of choice for migrants may limit the extent of any decline.

The country, particularly its biggest cities Sydney and Melbourne, has been a magnet for immigrants and Australia’s population is growing close to the fastest among developed countries.

Professor Holden says it is on track to expand by 1.6 per cent this year, and all these people have to live somewhere.

With the supply of dwellings set to tighten – building and home loan approvals nationally have both dipped recently – pressure on home prices could again build.

Australia’s seemingly tireless property market might have more life in it yet.

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Australian politics is not broken, but the Liberal Party might be

The Liberal Party’s extraordinary leadership turmoil, and the likelihood that yet another  Prime Minister is cut down before serving out their full term, has many wondering if the political system is broken.

It isn’t.

There is no doubt that the slavish attention now paid to opinion polls, which have assumed oracular status, has made party politics highly volatile, and the position of leaders more precarious.
But what is playing out in gory detail before the eyes of the country at the moment isn’t the breakdown of political machinery, but a fight for the soul of the Liberal Party.
Abbott, Dutton and co. hold the delusion that they are representative of a mythical ‘silent majority’ that ascribes to their vision of a white-bred country. In their world, Turnbull has too much in common with the Left and is leading the country to Gomorrah and the Coalition to oblivion.
There is no doubt that many people, probably the majority, are not particularly thrilled about the current state of affairs. No period is without its challenges, but the sense of uncertainty and apprehension about the future appears heightened at the moment.
Yet relatively few, I suspect, think that the solution is just to shut the eyes and pretend none of it is happening, which is essentially the policy prescription of Abbott and Dutton.
Which brings us to today’s tussle over where the Liberal Party sits, and where it is going.
For years the Coalition has been slowly abandoning the political centre, something the wiser heads in Labor have spied and are trying to exploit.
The politics of migration to one side (bipartisanship on the treatment of refugees has largely neutralised the issue), the Coalition has sought to wind back action on carbon emissions, undermine Medicare, derail public education reforms, narrow Australia’s engagement with the world, drag the feet on child care and pander to the interests of older voters over those of the young.
Turnbull, who was chosen by his colleagues to replace Abbott and stem this rightward drift, has proved himself an inept politician. By pandering to the maddies like Abbott and Christensen rather than staring them down, he undercut his own authority and emboldened them. The dynamic this set in train was always going to end up in tears.
A Liberal split?
The compulsory voting system means that the weight of the national vote is in the centre – only on rare occasions, and in particular electorates, do the extremes gain much traction. Howard understood this. So did Keating, hence his success in beating Hewson by painting him as an economic ideologue and a risk.
If Abbott, Dutton and co. seize the leadership today and try to drag the Coalition even more to the right, they will increase the strain on a party whose unity is already under severe pressure from trying to span such a wide political spectrum.
An outcome of this episode is that the Liberal Party could splinter. In the early 70s, the success of Whitlam-led Labor revealed a shift in the nation’s political centre over the previous decade or so that had been disguised by the dominance of Menzies and the Liberal Party. As the Coalition recalibrated its position, Don Chipp spied a gap in the political centre and formed the Democrats.
If Abbott and co prevail today, some current Coalition MPs may take a leaf out of the same playbook and quit. The Liberal Party could become a rump based in regional Queensland and parts of WA and NSW.
If Bishop ends up succeeding Turnbull, as I suspect is more likely, it would signal that the bulk of Liberal MPs understand that their political future lies in a contest for the centre.
Abbott, Dutton, Christensen and their fellow travellers would then face the stark choice of sucking it up, or finally having the gumption to leave the supportive cocoon of the Coalition and putting the extent of the their electoral appeal to a real test by forming their own party.
My guess is some might follow Bernardi and do the crazy-brave thing, but most are too timid (and smart) and will stay put, because in their heart of hearts they know that their political relevance is likely to be much reduced once they step outside the shelter of the Liberal Party.
If anything, this episode will show the strength of our political system and, in particular, the virtue of compulsory voting.

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Why we should be worried about what happens to Turnbull

By Adrian Rollins

Now that the Band-aid has been ripped off the Coalition’s torn leadership, what does this portend for the nation’s economy?

Among the many self-inflicted wounds of Malcolm Turnbull’s trouble-plagued prime ministership, his dogged pursuit of business tax cuts stands out.

Turnbull expended substantial political capital and effort on the measure, lambasting opponents like the Labor Party and badgering waverers like Pauline Hanson’s One Nation. Despite setback after setback, the Liberal leader did not waver from his support for the policy, which he said was essential to sustain the country’s economic competitiveness.

In the end, it was all for nought. Though tax cuts for businesses with a turnover of less than $50 million have been passed into law, a Bill to provide similar relief for larger firms has today been rejected by the Senate.

Turnbull’s signature economic reform of the past year is dead.

It caps a terrible record of under-achievement for a Prime Minister whose CV sparkled with private sector success as a lawyer, a banker and an investor.

After a string of career politicians leading the country, (Keating, Howard, Rudd, Gillard, Rudd (again), and Abbott), Turnbull was seen as a welcome break – holding out the promise of a practical and results-driven politician just keen to ‘get things done’.

Instead, it is Turnbull who got ‘done’. The rot set in in the earliest stages of his leadership when he caved to the demands of haters and extremists on the Right, rather than staring them down. Having just won the endorsement of his Liberal colleagues by a convincing majority, his political power was at its zenith and the likes of George Christensen, Corey Bernardi, Jim Molan and Craig Kelly could have been marginalised.

Instead, by pandering to their ever-more-strident demands, Turnbull fed the beast of dissent, and is now set to pay the ultimate price.

Having failed miserably to deliver the tax cuts he argues the country needs, and having failed to erase the fog of uncertainty shrouding the nation’s energy and climate change polices, Turnbull’s economic legacy is exceptional only in its mediocrity.

But if you think that’s bad, his potential replacement could well be even worse.

Peter Dutton, a man who rose without trace after being plucked from backbench obscurity by an increasingly embattled John Howard as a sort of electoral talisman, is not a deep thinker.

That by itself is not necessarily a deal-breaker when it comes to being PM, but its opposite should be.

Throughout his career, Dutton has shown himself to be a narrow and unimaginative politician. He has adhered like araldite to a constellation of received attitudes and prejudices that hark back to an Australia that has long since departed from most corners of the country.

Think this is harsh? Consider his response when asked on Sky TV, in the aftermath of his failed leadership bid, what he thinks of the Coalition’s prospects: “I believe strongly that we can win the election if we get the policies and the message right about lowering electricity prices, about … We need to invest record amounts into health and education, aged care and …”.

It’s a shopping list of platitudes, not a manifesto for leadership. Dutton might say he is merely reciting the priorities of the Government of which he remains a member.

But for someone who has long harboured ambitions to reach the top job, it seems like a very thin resume of ideas.

Aside from a determination to ignore the policy challenges of a rapidly changing climate, Dutton’s grab bag of priorities betrays sloppy economic and fiscal thinking.

First the fiscal. Just by virtue of holding its spending steady as a proportion of GDP, governments each year invest “record amounts” in areas like health, education and aged care.

Economic naivety could be much more serious and potentially damaging.

If, by “lowering electricity prices”, Dutton is simply using shorthand to refer to policies that might help contain the extent of price rises, that might not be so egregious. Governments already interfere in market pricing, such as by limiting annual residential rent increases. While this distorts the property market, the potential discouragement of investors is balanced against the financial certainty it provides to renters.

But if he is delving into the agrarian socialist playbook of his fellow-travellers in the National Party like Christensen and Barnaby Joyce to introduce price controls, that is much more concerning.

Because of the modest size of its economy, Australia relies heavily on foreign investment for development.

But every measure taken to prop up farmers and rural industries, to block offshore investors, and to control prices, comes with a cost.

In the aftermath of the GFC, Australia has been a popular destination for foreign investors. But as the US and other economies strengthen, that advantage is waning.

Markets hate uncertainty, so the latest bout of instability surrounding Australia’s highest political office is unhelpful.

Add to that the prospect of a change to a leader even more deeply beholden to vested interests and a Trumpian understanding of the economy and trade (ie. not much), and even the modest growth of recent times might seem like a golden time of prosperity and stability.

As Coalition MPs consider how they will vote in the next leadership ballot, let’s hope they consider what’s best for the country, rather than just what’s best for them.

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The Europeans get a jump on the Poms

WHILE the Brits turn themselves inside-out trying to work out if they should go for a hard, soft or slightly runny Brexit, the EU is keeping its trade negotiation machine running at high gear.

In recent years the Europeans have been busy stitching together a web of regional and bilateral trade deals that span the globe. Of the 164 countries that are members of the World Trade Organisation, just six do not have preferential access to the EU.

Currently, Australia is one of them. But that could soon change after the European Parliament on 26 October authorised the EU to begin talks on a Europe-Australia Free Trade Agreement (FTA).

This authorisation comes at the end of a long process of sounding each other out and assessing whether such a deal is desirable and worth the effort, so it is a big deal.

It means that a Europe-Australia FTA of some kind is virtually inevitable.

Politically, this is soc in the eye for Theresa May’s Government.

One of the conceits of Brexiteers is that, freed from the shackles of the EU, Britain may once again rise to global eminence as a champion of free trade. Some even hope that the Commonwealth can be transformed into a sort of ‘Empire 2.0’. In their imaginings they hope/believe that former colonies like Australia, New Zealand, Canada and India will fall over themselves at the opportunity to resume the trade links that were severed or downgraded when Britain joined the Common Market in the early 1970s.

Put aside the fact that the days of Empire are remembered far from fondly in much of the Commonwealth, the idea has little grounding in the economic reality of today.

In the days of Empire, Britain was a major manufacturer with a huge appetite for raw materials it was an obvious market for commodities produced by its colonies.

But after 40 years of integration with the EU, the British economy is vastly different. Most of its manufactures are intermediate goods that are part of supply chains that crisscross Europe like a web, and services like finance, education and tourism support much of its wealth.

Meanwhile, the former colonies have well and truly moved on.

Canada is closely dies in economically with its giant US neighbour, Australia and New Zealand look much more to China and Asia for their markets, India is developing into a major economic power in its own right and the former African colonies have more extensive trade arrangements with Europe than Britain.

Europe, the land of opportunity?

It is fair to ask whether Australia needs a trade deal with Europe, given that the EU is already our third largest trading partner (bilateral trade was worth A$68.7 billion in 2015), and a major source of foreign investment (worth A$220.3 billion in 2015).

But there are frictions in the trade relationship.

European agricultural markets such as beef, sugar, dairy and cereals remain heavily protected from Australian exports, contributing to a lopsided trade flow.

In 2015, the EU sold almost A$30 billion more of goods and services to us than we did to them.

The question is whether the Europeans will be able to offer better access to their markets for Australian farmers.

In its statement on the negotiating mandate, the EU has stressed that “the European agricultural sector and certain agricultural products, such as beef, lamb, dairy products, cereals and sugar…are particularly sensitive issues in these negotiations”.

Given that Australia is the world’s third largest beef and sugar producer, and is a major player on global cereal and dairy product markets, Europe’s notoriously bolshie farmers are unlikely to meekly accept increased market access for their Australian competitors without a fight.

The EU trading mandate also calls for meaningful commitments from both parties to protect fisheries against illegal and unregulated fishing, which is significant given concerns about the rapacious fishing practices of fishing fleets operating out of Spain, France and other EU countries.

It appears this might be a fight the EU does not have the stomach for in the current fractious political climate prevailing in Europe, where populist and nationalist movements command significant electoral support.

In careful language, the EU negotiating mandate stipulates that a “balanced and ambitious outcome” on agriculture and fisheries is only feasible if it “gives due consideration to the interests of all European producers and consumers”.

Tellingly, this “consideration” includes the possibility of tariff-rate quotas or unspecified “transition periods”, and even holds out the possibility of so-called safeguard clauses to allow preferences to be suspended temporarily, or even excluding the most sensitive sectors (beef, sugar, cereals, dairy) from negotiations altogether.

Australian negotiators might talk tough if the EU tried to block improved access for farm products altogether, but the Europeans would remember how Australia caved to the US when it refused to include sugar as part of the Australia-US Free Trade Agreement.

Whatever happens on agriculture, the EU wants the FTA with Australia to include “significant concessions on public procurement at all levels of government, including state-owned enterprises”, and is also looking for commitments on anti-dumping and countervailing measures that go beyond WTO rules.

Other provisions the EU is seeking include:

  • a “robust and ambitious” chapter on sustainable development;
  • a requirement to promote corporate social responsibility;
  • comprehensive provision to liberalise investment; and
  • strong and enforceable intellectual property protections.

Brexit dangles like an unanswered question over the Australia-EU trade talks.

The final terms of Britain’s exit from the EU will resound globally. But by pushing ahead with its trade negotiation agenda, the EU is staying faithful to its ambition as the world’s foremost transnational economic community.

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