Saturday, May 28, 2011
Will RBA save the housing?
There is a lot discussion around about RBA's ability to stop house price fall using rate cuts). The argument for this is 2008-2009 period when allegedly RBA stoped price fall and government even inflated prices using FHBG. Second argument people use is that USA had fixed rate mortgages that stoped similar policy work there. Other people use UK example to show that lower rates cannot stop but rather slowdown the price fall. Surprisingly to many, I think our situation is more similar to Irish.
In 2006-07 when bubble bursted in USA situation was in many ways different than in Australia year after when GFC broke out. I would agree that RBA rate cuts in 2008 saved house prices but the timing of cuts was different from what we may expect today. Reason for RBA cuts in 2008 was not falling house prices, but outbreak of GFC. Rate cuts were just on time to save house prices that just started falling few months before rate cuts. In addition, Australian sentiment about house prices in 2008 was completely different. People believed that house price fall was caused by external disturbance – GFC, and that after disturbance is removed housing will continue growth.
Today, there are not so many similarities with our situation in 2008, but there are many similarities with conditions in other countries at that time. Surprisingly Ireland is in my focus. House prices started to fall in Ireland but interest rates were on rise some time after (five rises after the peak price). Reasons for this are EURO and Ireland’s lack of Interest rate control. This situation looks completely different than ours but the core reason looks very similar to RBA inability to respond to falling house prices. ECB had to deal with two speed economy in Eurozone. In 2007 debt driven economies of PIIGS were heading into recession (or were already there as Ireland) while some other parts of Eurozone was doing very well. ECB was not able to respond to rising inflation in some countries and falling prices in Ireland at the same time.
Our situation today is quite similar. We also have two speed economy that prevents RBA to use rates as a response on house prices only. Under current conditions and falling house prices at current rates it is unlikely that will see rate cuts soon - before economy starts feeling the pain on larger scale. Global inflation, instead deflation is this time around making RBA job even harder. This environment will force RBA make decisions in ECB rather than the FED style.
Even if RBA decides to respond on housing only while risking inflation, as FED did, rate cuts will not happen any time soon. FED started cutting rates over a year after bubble bursted (prices started to fall). By that time tipping point was already reached. Rate cuts combined with FHBG somewhat helped house prices in USA to stop falling but almost a year after first cuts.
Sentiment is one of the main drivers of bubbles whether up or down. This time, housing crush is just our own; nobody can blame external forces for crush or hope that everything will be fine if external problem gets solved. People are aware that house price fall is result of a bubble that we inflated. They know that if rates get cut again that will be just temporarily relief.
Even an unlikely scenario (RBA cuts rates now to help house prices) would just prolong what must happened – significant price correction. RBA is well aware of this and they are trying to make correction slow to minimize effect on the economy. Their ultimate goal is stagnation over long period (slow fall in real terms). I don’t believe they will be able to achieve that because of two speed economy we have. Our housing is more like PIIGS’s debt while our mining is German export. Our rates will stay the same (or even go up a little bit) for some time, and when finally RBA cuts them it will be too little too late.