Low rates could see 30% house price rise: RBA

The Reserve Bank of Australia (RBA) has released new data from is economic analysis and financial stability departments regarding its analysis of the impact of low interest rates on asset prices, and the impact of monetary policy on savers, depositors and self-funded retirees.

According to the document, released by the RBA this week following a Freedom of Information request, it believes that monetary policy will support the economy and asset prices.

The FOI sought documents since 1 July 2020 regarding changes in asset prices caused by monetary policy settings.

The RBA cut the official cash rate from 0.25 per cent to a new record low of 0.10 per cent in November 2020. In March 2020, the RBA board held an emergency board meeting and made an out-of-cycle rate cut amid the coronavirus pandemic, cutting the official cash rate to 0.25 per cent.

This was the second rate cut in March, and followed a 25-bps cut to interest rates earlier in the month to 0.50 per cent, and marked the fourth cut since June 2019 when the easing cycle commenced.

Among the information released is an estimation that a permanent, 100-basis-point reduction in the cash rate would push real house prices up by 30 per cent after about three years, while a temporary reduction would increase house prices by 10 per cent.

The estimates are based on a 2019 research discussion paper conducted by Trent Saunders and Peter Tulip, which found that RBA interest rate cuts drove up house prices.

Furthermore, the RBA said that “monetary policy appears to have larger effects in local areas in which housing supply constraints are binding, mortgage debt is higher, and there are more housing investors”.

The RBA stated that its term funding facility, quantitative easing measures and lower interest rates across the yield curve would assist with the economic recovery from the coronavirus pandemic by lowering financing costs for borrowers and supporting the supply of credit, and contribute to a lower exchange rate.

It would also increase asset prices and the value of collateral, which would increase borrowing capacity for households and businesses, the RBA said.

The risks of low interest rates

However, the RBA also noted the risks associated with low interest rates, including the fact that higher asset prices could induce borrowers to assume too much credit if accompanied by looser lending standards and/or “optimistic assessments of risk”.

In addition, if price rises lead to significant amounts of new property construction, this could create an “overhang” of excess supply, which could cause prices to decline further, the RBA said.

“More of the loan book will be borrowers who bought near the price peak as new property purchases tend to increase during booms,” the RBA document reads.

“[It] means more of the loan book is likely to be in negative equity.”

The central bank said that new loan-to-value ratio (LVR) lending above 85 per cent for housing was increasing, but has remained “well below” levels seen before 2015.

Regulators to keep an eye

The RBA said that Australia’s financial regulators will monitor and control risks, and in the event that the scenario outlined above occurs, the Council of Financial Regulators (CFR) “will act if needed”.

The CFR is comprised of the RBA, the Australian Prudential Regulation Authority (APRA), the federal Treasury, and the Australian Securities and Investments Commission (ASIC).

The RBA noted that lending standards have been tightened significantly for both residential and commercial property since 2015, with ASIC and APRA taking steps to reinforce sound lending for residential mortgages in particular.

However, last year, the federal government announced consumer credit reforms, including the proposal to scrap responsible lending laws and extend the best interests duty to more credit assistance providers. The Senate is currently accepting submissions to its inquiry into the changes following concerns about the proposals.

FHBs, owner-occupiers driving growth

The RBA document goes on to summarise that much of the current credit growth has stemmed from owner-occupiers, while first home buyer (FHB) activity has grown strongly in recent months.

It said that there has partly been an increase in the share of loans to FHBs, who have smaller deposits than repeat buyers.

According to the RBA, the strong FHB activity is a positive indication of access to housing for younger households.

Examining the New Zealand LVR market, the RBA noted that the New Zealand central bank is planning on reinstating high LVR lending restrictions in March 2021, after restrictions were removed in May 2020 for what was meant to be 12 months, with the aim of supporting credit supply and avoiding affecting debt repayment holidays in response to the COVID-19 pandemic.

High LVR lending has increased substantially in New Zealand and house price growth has been strong, the RBA noted.

Last year, RBA governor Philip Lowe told the standing committee on economics that he was “not particularly concerned” about housing prices in Australia at present.

He said that it was “unlikely” that Australia would face similar issues as New Zealand, given that population growth in New Zealand was fairly strong (given the number of returning New Zealanders) and the fact “there is also in New Zealand a fairly strong tradition of high LVR loans”.

[Related: Fixed rates slashed over 2,000 times in 2020]

Malavika Santhebennur is the features editor on the mortgages titles at Momentum Media.

Before joining the team in 2019, Malavika held roles with Money Management and Benchmark Media. She has been writing about financial services for the past six years.