RBA: Housing market “is being watched closely”

Services sector activity hits 2½-year high
Reserve Bank Financial Stability Review; Services gauge; China data

Reserve Bank Financial Stability Review: The Reserve Bank notes: “housing price growth (and to a lesser extent housing borrowing) has picked up notably in recent months and is being watched closely by regulatory authorities.”

Services gauge: The AiGroup Performance of Services index rose by 2.9 points to a 2½-year high of 58.7 in March – the sixth successive monthly expansion in activity (reading above 50).

China inflation: Chinese consumer prices rose by 0.4 per cent over the year to March (survey: +0.3 per cent). And producer prices grew by 4.4 per cent in March on a year ago (survey: +3.6 per cent).

The Financial Stability Review has implications for finance providers, the broader sharemarket and interest rate settings. The services purchasing managers index provides guidance on conditions in retailing, financial services and the services sector more broadly. The Chinese data have implications for the currency markets and therefore exporters and importers.

What does it all mean?

• The Reserve Bank has book-ended an Easter holiday-shortened week with the release of its semi-annual Financial Stability Review (FSR) today, having already handed down its monetary policy decision on Tuesday. While policymaker’s left monetary policy unchanged at the meeting – reaffirming that the Board does not expect the conditions (i.e. lower unemployment and higher wages) that would require lifting the cash rate target to be met until “2024 at the earliest” – attention quickly turned today’s FSR.

• Ahead of the release of the FSR, the latest CoreLogic home prices data was released on April 1. National home prices surged by 2.8 per cent in March – the most in 32 years – to record highs. Soaring home prices have also been accompanied by surging home loan finance commitments and council building approvals, fuelled by record-low mortgage rates and government housing stimulus measures. The Reserve Bank’s own annual housing credit growth data lifted by 3.8 per cent in February – the strongest growth rate in almost two years – with investor home loan approvals increasing sharply in recent months. And high loan-to-value ratio (LVR), high debt-to-income lending and broker-originated lending have been also increasing.

• Given this backdrop, it was unsurprising that Reserve Bank policymakers devoted a fair chunk of their FSR commentary to addressing concerns about the risk posed by rising property prices and lending standards to the financial stability of the economy. The Bank said, “In a number of economies, including Australia, housing price growth (and to a lesser extent housing borrowing) has picked up notably in recent months and is being watched closely by regulatory authorities.” Policymaker’s cautioned, “If housing prices continue to rise as the end of stimulus payments slows household income growth, this will present renewed challenges for housing affordability for lower income households.” But added, “The improvement in lending standards in Australia for property from the mid 2010s helped to ensure borrowers were well placed to weather the economic shock over the past year, demonstrating the benefits to the financial system and the economy of appropriately controlling risks.”

• And it’s not only residential property piquing the concerns of the Reserve Bank. Commercial property was again a focus in the FSR: “Globally, the pandemic has accelerated structural change in the retail sector, including increasing online sales, leading to falling retail commercial property prices, while demand for office property is uncertain given changing work practices.” And, “Vacancy rates continued to rise across most CBD office markets in the December quarter 2020, and in Sydney and Melbourne are currently around their highest levels in about 20 years. But, “Impairment rates on commercial property lending remain low, consistent with relatively low LVRs and strong debt covenants leading into pandemic, but are expected to rise.”

• While financial stability risks presented by high unemployment have eased somewhat, the expiry of the JobKeeper wage subsidy and a potential increase in business insolvencies – as government bankruptcy-related moratoriums are wound back – were also key focuses of the FSR. In fact, policymaker’s said, “As at February 2021, the share of businesses still receiving JobKeeper payments was highest in Melbourne and in areas with a relatively high share of businesses operating in sectors more affected by the pandemic.” And, “If some businesses have trouble making their payments, this would spill over to other businesses through trade credit networks. Overall, the risks of insolvency appear largest for SMEs operating in high risk industries, given they tend to have smaller cash buffers and have been more reliant on temporary support measures than larger firms. Looking ahead, it is likely that insolvencies will rise further for some months, notwithstanding the expected improvement in aggregate economic conditions. Vulnerable businesses may find it difficult to continue to operate and/or to meet their debt repayments if their revenues do not increase sufficiently to cover the withdrawal of government support.”

• Australia’s growth engine – the services sector – is in good shape with activity the strongest in over 2½ years in March following last year’s pandemic shock. Importantly, available capacity being utilised across the services sector is back at pre-pandemic levels at 82.4 per cent, which bodes well for hiring and investment intentions. While conditions and confidence in the services sector have improved with an easing of government restrictions, supply disruptions and rising freight costs continue to increase input costs for business owners. But businesses have reported passing these costs on to consumers – amid stronger demand – with selling prices the highest in 13 years.

What do you need to know?

Reserve Bank Financial Stability Review

• Key issues and quotes identified in the central bank’s review of the Aussie financial system:

• On the economic recovery: “An incomplete, or very uneven, economic recovery would present risks to financial stability.”

• On rising asset prices: “Cyclically low interest rates and rising asset prices create a risk of excessive borrowing.”

• On business risks: “Risks are elevated in industries most affected by the pandemic and for small businesses.”

• On households: “Improving economic conditions and temporary policy measures have supported households’ and businesses’ cash flows, allowing almost all to make debt repayments and most to maintain or even grow their liquidity buffers. This has in turn reduced the risks of large scale defaults on housing and business debt.”

• “Some increase in household and business financial stress is likely as temporary support measures end and borrowers deplete their financial buffers.”

• On the housing market and borrowing: “Around half of all mortgages have prepayment buffers equivalent to more than 3 months’ worth of repayments and, for more than one-quarter of loans, the buffer exceeds 2 years’ worth of repayments.”

• “Housing market strength has reduced near-term risks to household balance sheets.”

• “Demand for inner-city apartments is likely to remain constrained in the near-term given changes in housing preferences and a sharp fall in immigration; however, the short-term risk of over-supply is limited by the relatively low volume of expected apartment completions in 2021.”

• “Lending standards are largely unchanged and remain robust.”

• On banks: “Banks resilience is supported by their profitability and strong capital ratios.”

• “Liquidity in the banking system is also high.”

• “Banks’ non-performing loans have increased, but by less than expected.”

• “The share of housing loans by value on repayment deferrals at end-February was 0.7 per cent from a peak of 11 per cent in May 2020.”

• “The share of high loan-to-value ratios rose in 2H 2020 but remains low by historical standards. Some of the rise reflects a greater share of first-home buyers entering the market.”

• “The evidence for Australia is that lower rates do not have a meaningful impact on overall bank profitability.”

• “The RBA’s reverse stress testing model implies that it would take a recession comparable to the Great Depression for CET1 capital ratios to fall below 6 per cent.”

• On Cyber attacks: “Cyber attacks are a growing risk for financial stability.”

AiGroup Performance of Services index – March

• The AiGroup Performance of Services index rose by 2.9 points to a 2½-year high of 58.7 in March – the sixth successive monthly expansion in activity (reading above 50).

• According to the AiGroup, “Businesses reported improved conditions and sales to household customers in March, as easing restrictions combined with a large degree of pent-up demand. Many participants said their activity levels in March were on par with their typical pre-pandemic levels of demand. Respondents selling services into business sectors (e.g. wholesale trade and logistics) reported that their customers are constructively increasing their inventory levels as a buffer to future supply disruptions and to lock in product pricing and freight costs, due to fears they may be disrupted or delayed again.”

What is the importance of the economic data?

• The Financial Stability Review is published by the Reserve Bank every six months. The report is basically a health check on the financial sector but it also assesses the state of household and business balance sheets.

• The Australian Industry Group compile the Performance of Services index each month. The survey is amongst the timeliest economic indicators released in Australia. The surveys are useful not just in showing how key sectors are performing but also in providing some sense about where they are headed. The key ‘forward looking’ components are orders and employment.

• China’s National Bureau of Statistics releases its monthly economic statistics around mid-month. Quarterly GDP data is released around the 19th of January, April, July and October. China’s Customs Office releases trade data, and the People’s Bank of China releases financial statistics, around the 10th of each month. China is Australia’s largest trading partner and changes in the Chinese economy have major implications for the Aussie economy.

What are the implications for investors?

• Another Reserve Bank Financial Stability Review has come and gone. Global central bankers are largely singing from the same hymn sheet, attempting to allay financial market concerns about building inflationary pressures and worries about the potentially sooner-than-anticipated removal of monetary stimulus.

• It’s a delicate balancing act. Unemployment remains high, wage growth is anaemic and business investment is subdued. But record low interest rates are fuelling a rapid rise in asset prices with sharemarkets and home prices straddling record highs across parts of the developed world, including Australia. Record-low borrowing costs have boosted household cashflows, encouraging spending, but have also boosted mortgage indebtedness and reduced housing affordability. In this environment concerns about a ‘housing bubble’ and the potential risk this poses to the economy and Aussie households will remain a persistent conversation until policymakers eventually act to restrain home prices.

• That said, Commonwealth Bank (CBA) Group economists do not expect the bank regulator – the Australian Prudential Regulation Authority (APRA) – to step in with macroprudential policy measures to cool the housing market yet. Investor housing finance only represented around 25 per cent of total housing finance in February, well below peaks of around 45 per cent six years ago. In our view, APRA is more concerned about the stock of housing debt than new lending flows, while interest-only lending remains subdued. Nevertheless, the Reserve Bank today re-affirmed its message earlier this week that the Council of Financial Regulators “places a high emphasis on lending standards remaining sound” and “will continue to closely monitor developments and has indicated that it will consider possible responses if financial risks increase.”

• But while concerns over Australia’s housing boom and the risk that presents from a financial stability risk standpoint will hog the headlines, arguably a bigger risk still lurks. Overnight US Federal Reserve Chairman Jerome Powell and the director general of the World Trade Organization (WTO) Dr. Ngozi Okonjo-Iweala both voiced concerns about the inequitable vaccine rollout, vaccine nationalism and the potential impact on the global economic recovery. During a webinar on the global economic outlook hosted by the International Monetary Fund (IMF), Chair Powell said, “Viruses are no respecters of borders and until the world really is vaccinated, we’re all going to be at risk of new mutations, and we won’t really be able to resume activity all around the world.” And Dr. Ngozi Okonjo-Iweala – also a panel participant – said inequality of vaccine access between advanced and low-income countries had to be addressed.

• Aussies are of course acutely aware of the risk that another potential Covid-19 outbreak poses to our health – especially with the more virus-transmissible winter months imminent. A continuation of ‘mini-lockdowns’ and border closures – due to the delayed vaccine roll out – poses a significant downside risk to an otherwise positive economic outlook.

Published by Ryan Felsman, Senior Economist, CommSec