Finance Market Update – 24 May 19
The boom might be back, if we see certain policy change. In this fortnights update we discuss changes in finance policy, how that could impact property prices and borrowers and when we will see rate cuts.
The boom is dead, long live the boom
The greatest fall in home prices in 40 years that followed the 2013-18 housing boom is coming to an end if two very specific policy changes happen.
The two policies are APRA convincing banks to change the servicing rate and RBA rate cuts.
The combination of these could reverse the price decline and actually lift them back up, potentially to close to the current peak to trough fall of 14% in Sydney, meaning these new measures could bring prices back within a few precent of where they were at the top of the market in 2017. That is to say, within a year of these policies being implemented prices could rise 5 – 10%.
The first key policy change is APRA is reducing the hurdle banks use when assessing applicant’s ability to service and borrow. Scrapping the 7% hurdle and replacing it with a 2.5% buffer.
For example, if you are applying for a mortgage with a rate of 3.8%, they currently assess if you could afford repayments at a 7% interest rate. This is to make sure you can afford the loan when rates rise, but it looks like given we are in a global low rate environment, that won’t be anytime soon.
APRA is now saying to get rid of that hurdle and add a 2.5% buffer on top of the real rate. So, on a 3.8% rate the new buffer rate would be 6.3%. That is a 10% difference, which would almost directly result in borrowing capacity increasing by the same amount.
Banks have not yet agreed to change the assessment rate, and I suspect they will slowly and cautiously implement this with ‘responsible lending’ and unpleasant memories from the ‘Royal Commission’ still hanging over their heads, but implement it they will, given their profits are falling and they don’t want to lose market share.
Since 2014 every bank in Australia has been assessing mortgage applications based on the interest rate being at least 7%. APRA put in this rule in 2014 to curb a potentially destabilising property boom and appears to have now conceded that with the low interest rate environment here to stay, weakening property prices and activity and scared banks from the Royal Commission, it is time to relax, just a little bit.
The second factor is the RBA cutting interest rates. Governor Phillip Lowe basically straight out said in a speech this week that they will cut in June, mainly pointing to the continued weakness in employment as the deciding factor. Most economists are pricing in 2 rate cuts this year, with the second widely tipped to be in August, but I don’t agree with that timing.
The RBA is about to get the knife out
I’ve been asked by many clients, real estate agents, accountants, investors and would be borrowers about the potential rate cuts from the RBA to the cash rate, which has been sitting at 1.5% since August 2016, and when and by how much it will be cut.
Here is my prediction – 0.25% cut in June 2019 and 0.25% cut in September 2019.
There was a lot of expectation recently that the RBA would cut in their May meeting, just weeks before the Federal Election. The general economist survey had it about 50/50, which is quite a close call. But this did not eventuate, as cooler heads prevailed at the RBA.
A more pertinent question about rate cuts is not about timing but rather, how much will it help borrowers and the economy?
If the RBA cuts as per my prediction, we would have the lowest cash rate on record ever for Australia by the end of this year. But for context, much of the developed world is at or below 0% cash rates, so this would leave the RBA with a bit more monetary ammunition to fight deflation or a recession.
The big banks funding pressures have eased over the year, which was the reason they used to increase their standard variable rates last year, so it is likely they will be generous in passing on all, or most of, the rate cuts. My expectation is that the big banks will pass between 0.18 – the full 0.25 bps per cut. This means a cash rate cut will not flow completely through to borrowers.
In an earlier update I used an example of a reduction is a mortgage rate giving someone an extra $1,080 per year, based on a 30 bps bank mortgage rate reduction, and argued that amount of money would not spur significant large purchase decisions or make people feel richer, and the funds would likely be used to pay down existing debts.
Regardless, the wider sentiment shift from a rate cut is a good thing, even if it does signal concern about the economy from the governor.
Pollies and policies
In a “miracle” victory the Liberty party / coalition has been re-elected for a third term, with ScoMo (the accidental Prime Minister) as surprised as anyone, even though he campaigned harder than anyone.
There were a number of factors that led to this win, a positioning of a small government with little to no policy to be attacked, the frightening prospect for some of losing franking credits, the Adani coal mine swinging most of Queensland to the right and pretty much that Australians just want things to stay as they are.
With the Liberals firmly in charge, minus the cross benchers, we have a better understanding of where policy is going, and so where pricing of financial products is heading.
This brings new momentum for property prices.
With the Coalition remaining in power gives certainty to investors and buyers alike, as well as self-funded or cashed up retirees who now might put money back into property.
This means that we could see a steady increase in activity over the remainder of the year, but that might not be enough to completely reverse the property price declines.
The reverse will happen when the RBA cuts the cash rate and banks implement the new buffer rate.
The combination these two policy changes give certainty for property investors and lower rates will effectively mean the housing crash and credit crunch stops dead.
Plus, if we hit a recession more innovative measures on top of that like deploying ‘helicopter money’ (i.e. what Labor did in the GFC by giving citizens cash directly) could also be used again to boost inflation and spending, if things get really dire.
There are a policies that could help boost activity as well.
First home buyers – the government has announced they will develop a scheme which allows people to borrow up to a 95% LVR. This will only be available to individuals and couples with income above and between $125k - $200k respectively and has been criticised that it puts people into expensive loans they otherwise would not have taken. It is important to remember here that there are other options for first home buyers, such as leveraging equity in a parent’s property, or starting off with a smaller property rather than borrowing more.
Business - we could potentially see a tax cut down to 25% within the next few weeks, and the instant asset write off scheme continued (indefinitely).
Negative gearing and franking credits – the targets of Labor during the election, are set to not change at all. It is likely that these key policies, or more accurately how these policies benefit people, were huge deciding factors when voting, which helped win more seats for the Coalition.
All this means we can expect the economy to keep “having a go” as ScoMo would say.