‘Major adjustment’ in house prices when rates rise: Westpac

Mr Evans is one of the few to forecast that rates are to remain on hold for at least a year. The Westpac chief economist can’t see a rate hike next year, nor in 2019, as the Reserve Bank struggles to achieve its inflation target.

ANZ has tipped two rate hikes next year and NAB believes that the RBA will lift rates by 25 basis points in August and by the same amount again in November. NAB is confident that the cash rate will be lifted by a further 50 basis points in 2019.

This would mean a 2 per cent increase to the current cash rate (1.5 per cent), taking it to what the Reserve Bank has called its “neutral” rate of 3.5 per cent.

According to Mr Evans, if this happens, the real estate market will be in major trouble.

“The RBA believes neutral is 3.5 per cent,” Mr Evans told brokers at a Loan Market lunch in Sydney on Friday (20 October). “That is 200 basis points from where we are today.

“The day they start to raise rates will be very, very damaging. I’m giving you comfort by saying I don’t think it will happen in 2018 or 2019.

“But all the other experts are saying, and the market is saying, that they will. If it does happen, there is going to be a pretty major adjustment in the market. As we saw in Canada.”

House price growth has collapsed in Canada since its central bank raised rates by 50 basis points this year. The monetary policy tightening comes as Canadian banking regulators introduced further macro-prudential measures on lenders.

Mr Evans fears that the Reserve Bank of Australia has no room left to cut rates if the market turns, particularly as rate cuts have historically been used as a lever to stimulate the property market.

The Westpac economist outlined how the central bank “rescued” real estate with rate cuts after prices fell in 2008. This boosted inflation. Rates were then raised, at which point prices in Sydney fell again in 2011. Rates were cut to 2 per cent in 2015, which rejuvenated the market.

“Every time house prices have fallen, the central bank has come to the rescue and cut rates to get prices moving again,” Mr Evans said.

In 2015, the six-month annualised house price growth in Sydney peaked at 25 per cent.

“That’s when the regulator got nervous and said to the banks they can only grow investment book by 10 per cent.

“House price inflation in Sydney collapsed. In May, the RBA cut rates again. They cut again in August and we saw house price inflation take off.”

The chief economist said that this last rate cut made APRA “livid”. Further lending curbs were introduced in March, this time on interest-only mortgages.

Now house price growth in Sydney is trending down.

Mr Evans said: “The worry this time around is rates are at 1.5 per cent. They will not cut rates again. What we don’t know is how the market will evolve when the Reserve Bank is not there to bail you out.

“That presents a big challenge.”

[Related: APRA eager to wind back lending curbs]