To pop or not to pop? Since the global financial crisis, policymakers in many countries have debated the proper response to soaring asset values.
Australia’s targeted approach to two hot property markets, in Sydney and Melbourne, is kicking in at a time when the overall economy faces headwinds. Already this week, National Australia Bank and AMP Bank have announced rate increases on home loans favored by property investors and, in the latter case, a temporary moratorium on new investor credit. This follows the December 2014 directive by the Australian Prudential Regulation Authority to banks to restrict growth in such investor lending to 10% a year, and changed guidance just last week in relation to risk weights applied to residential mortgages.
Yet the economy’s post-crisis grace period is coming to an end. For several years after the crisis, Australia’s economy defied gravity for a host of reasons, including China’s growth policies post-crisis, the availability of significant fiscal and monetary firepower and a fortuitous window in energy demand that resulted in significant capital investment in liquefied natural gas (LNG). Although these differences mitigated the severe left-tail events that plagued the rest of the developed world, the gravitational pull has finally taken hold of Australia.
We believe the neutral policy rate – the rate that is neither stimulative nor restrictive to an economy – will be lower in many developed economies going forward than the historical average (this is our New Neutral view, a term we coined back in May 2013 in Australia and expanded a year later into a global theme). We estimate that the Reserve Bank of Australia’s so-called emergency rate of 3% in 2009 is now the New Neutral rate in 2015. At 2%, the policy rate today is clearly stimulative for the economy.
This move to a lower neutral rate has clearly been a strong support for the Australian property market, yet low rates have not ignited animal spirits in the corporate sector. As a result, the banking sector is heavily concentrated toward the highly levered Australian consumer, which has necessitated increased bank capital requirements.
Interest rate levels and the fear of missing out are the key drivers of borrower confidence in Australia, we have found. (See the Viewpoint, “A Look at Rising Household Debt in Australia and the Implications for Policy.”) This appears to continue to be the case in the Sydney and Melbourne markets. We shall see if the recent increase in certain mortgage rates dents that borrower confidence.
In any case, The New Normal has arrived in Australia and this has important implications for Australian investors. With overall interest rates low and likely to remain so, the real return available from bank deposits is no longer positive. Investors who lower their return expectations and risk tolerance sooner rather than later should be able to protect their capital and still earn decent income. Read more suggestions for investors in our previous blog post, “The Kitchen Is Closed for Australian Depositors.”