The spectre of deflation

Well it has been an eventful week.  The RBA cut the cash rate by 25 points on the same day as the Federal Government released its pre-election budget.  As far as I can see the budget pretty much ignored the property market.  There were no changes to negative gearing or capital gains tax exemptions and no measures to deal specifically with the now large problem of housing affordability, particularly in Sydney and Melbourne.  

The RBA Quarterly Statement on Monetary Policy was remarkable in that it made clear that the RBA is not concerned with economic growth.  In fact it has forecast a rise in GDP growth for the current financial year.  It made clear that it has acted to lower the cash rate because of its concerns about ongoing lower inflation:

"Despite above-trend growth in economic activity and improvements in labour market conditions over the past year, it is possible that domestic cost pressures may weaken further, and so inflation may not pick up as expected,"

The RBA remains concerned that lowering interest rates could lead to renewed demand in the property market.  If that recurs then there will be no more rate cuts.  

But while there may be a change in borrower sentiment, under current lending rules, overseen by APRA, the real borrowing capacity of consumers will not be affected by the RBA decision.  This is because all major lenders are assessing loans at a “floor” interest rate of 7.5 to 8% pa.

 The RBA is using terminology such as persistently low inflation.  It has been careful not to use the “d” word  - deflation. This is the spectre haunting the property market, particularly with respect to apartments in the big cities.   A perfect storm is brewing; consider this:

  • We have record house prices and record household debt
  • We are in the middle of a construction boom which will lead to record supply of new housing stock – particularly apartments
  • APRA has (rightly) imposed stronger lending standards on the banks meaning that the effective borrowing capacity of investors has been substantially reduced.

When the storm breaks, and it will, the banks will respond by further restricting lending secured by housing stock already under downward price pressure; i.e  introducing a negative feedback loop into the system.

Respected investment commentator, Jonathan Pain is forecasting a decline of 30% in property prices so it could get very ugly.  According to Variant Perception: 

The number of apartments built in Australia has doubled over the last four years.  The oversupply is starting to hurt. According to the Australian Financial Review, apartments in central Melbourne are being resold at up to 30 per cent less than their off-the-plan purchase price.

Which perhaps explains why the government steered clear of the property market on Tuesday – it looks angry and they do not want to be accused of provoking it.

Bruce Carr