Transcript of Question & Answer Session Interest Rates and the Property Market

Well, thank you, Jonathan. So we can turn to the floor. We’ve got, from the Reserve Bank, one of the key policy mogs of the Reserve Bank who is, I think, trying to reduce everyone’s risk appetite just a little bit. Sounds like he’s trying to drive down property prices a bit, so … here’s your chance to have a question or two for Dr Kearns. While we’re waiting for that, Jonathan, clearly, as you’ve set out, there’s a lot of moving parts when you go and tighten monetary policy, push up the cash rate by 225 basis points from a record low period, … in an area where you’ve got very high housing prices. What is the Reserve Bank trying to achieve when it increases interest rates … looks for a fall in housing prices and perhaps commercial property prices and then trying to achieve a reduction in actual house building and commercial property activity? Is it mainly that channel, or is it an overall wealth effect by making everyone feel just not quite as wealthy and buoyant because their house price or their commercial property portfolio is not quite as lucrative as they thought it was?

Yeah.

What do you … how do you think that actually works at this current moment?

Okay. Thanks. That’s a very topical question and very interesting at the moment. So, as the Governor outlined just over a week ago in his Anika speech and then again on Friday, when he was appearing before the politicians in Canberra at the parliamentary testimony, there are significant reasons why monetary policy has been tightened from exceptionally low levels, the result … because of high inflation. So there are many channels that interest rates operate through, and the wealth effects, the property market is a significant one of those channels. But it’s only one of those channels, so there are lots of other parts that are influenced there. But certainly one of the important channels that you do see is that any increase in interest rates is going to reduce asset prices, and that’s affecting in equity markets, in commercial property and residential property, and so that is an important wealth-effect channel. And that’s going to reduce consumption. It reduces turnover and so the amount that people are spending, they need to go down to Bunnings less because they’ve just moved in and found that things don’t fit or if they need new furniture, all of those things. But then you’re also going to see sort of some of those other effects that you referred to. So we know in Australia that mostly a lot of investment in property, particularly apartments, is financed when a buyer puts down a deposit and then the developer can go and get bank lending because they’ve got enough pre-sales. And so if you have a reduction in those pre-sales, then you’re going to have a reduction in new investment construction as well. And so we see sort of a multiple series of channels where interest rates are responding, impacting property, and so they’re some of the important channels certainly.

So we mentioned before the comparison between now and maybe the 1950s, when unemployment was very low, inflation was high. We’ve got inflation high again, and we had, compared to, say, the late-1980s, when asset prices were booming and the Reserve Bank lifted interest rates up to 17 or 18 per cent—some people can remember that—but back then, of course, the household sector was nowhere near as indebted. How much more sensitive now is the household sector, given they’ve got much more debt than they had before, to interest rates even going up from, even to still quite low levels historically?

That’s a really good point. So household debt is clearly much higher than it was, you know, in the 1980s and a lot of people look at the total level of household debt and notice that it’s that’s higher than even the early-2000s. But, if we take into account the amount that households have in their offset and redraw accounts and so look at that sort of net concept of household debt, it actually hasn’t really changed much relative to income compared to the early-2000s. So, on that basis, the household sector as a whole is not going to be too much more sensitive. But, of course, you don’t help me out when I’ve got high mortgage payments, and so we actually need to look at what’s happening with individual borrowers rather than the aggregate of the household sector. So that distribution really matters a lot, which is why we put a lot of effort into understanding who has those large offset-account and redraw-facility balances and what borrowers have much smaller balances and so, therefore, are potentially going to be more sensitive both in their consumption and also, if they were to lose their job or have a chop to their income, what’s the chance that they’re not going to be able to keep up with their interest payments. So that distribution matters. So even at the aggregate sense, because the net debt hasn’t changed too much, we have to be very careful looking at that distribution, which is where we look for the risks.

But net debt is a lot higher surely than it was in the late-1980s.

Higher than the late 1980s, absolutely, but hasn’t changed so much relative since sort of the early-2000s.

Yes. So, as you mention, there’s a lot of moving parts, and again, I will take questions from the floor if anyone puts up their hand. There’s a lot of moving parts, one is immigration. And we saw, at the Jobs Summit, the government announce that, in the Budget, they’ll announce an increase of immigration from, I think, 160,000 to 195,000.That will put more demand into the system for housing. How much impact will that go in pushing prices sort of up, while, I think you’re trying to push them down pushing them up?

Well, it’s a really interesting point about what effect immigration will have on the property market and property prices, and what really matters there is what immigration is relative to what’s expected by the market. So we all know—and you’d know much better than me—that the lag in constructing a lot of new housing developments is going to be 18 months or longer, particularly when you’re talking about large apartment complexes. And so developers are having to forecast what demand is that far out, and so changes in immigration flow that are unexpected can have a relatively sizeable effect. And we saw some of that effect in the mid-2000s, where an unexpected increase in immigration seemed to have contributed a bit to the run-up in housing prices until the property sector could adjust to that increased flow and increase the construction rate a bit. So it’s very much the forecasting and how that differs to what’s expected.

So would it be your judgement that the people in this room and the housing sector have expected the increase in immigration that’s coming, or not?

I mean, I think there’s been a lot of uncertainty about that. So, we saw a very large, unexpected decline in immigration with the pandemic. And the interesting thing there is that lots of people initially forecast that that reduction in population growth was going to have a big impact on property prices and depress residential property prices, but what we actually saw was that households responded and decided they wanted to live in smaller … have fewer people per household, so what we call the ’household formation rate’, and that offset the reduction in demand that was coming from reduced immigration. So there was that offsetting effect. But certainly it’s the projection, the expectation, of how much demand two years out is going to be which is really important for the people in this room.

But does the Reserve Bank, and this is the point of the exercise, one of the mechanisms, are you seeking to reduce housing construction by lifting interest rates at a time when immigration might be going up?

The Reserve Bank doesn’t get to pick and choose which channels monetary policy operates. As, you know, people frequently comment, monetary policy is a blunt instrument, it’s affecting all parts of the economy. And we know that one of the channels that it’s going to operate through will tend to be reducing construction. That’s one of the effects that’s out there. It’s not necessarily a goal of the Reserve Bank, but it’s a known aspect of how monetary policy will affect, along with all of the other channels, where it will affect the economy.

Right. And we’ve got, you know, more—we’ve also got—obviously, commercial property is a big part of all this, and you mentioned a bit of commercial property and classically, in Australia, when we go through a bit of tighter money, sometimes there can be commercial property busts around the place and we’re seeing a few builders go under. What’s your estimate of how this tightening phase might affect the commercial property sector?

That’s very important. And historically, both in Australia and internationally, we actually have tend to see that the commercial property market has a much bigger impact on the financial system and the banks than does residential property. So, you know, globally, if you look at the GFC, which we all think of as being a residential housing price bust, in most countries the impact was actually greater on banks from their commercial property, so that’s certainly something that we watch a lot. But, in Australia, the banking system has very little exposure to commercial property. So for … I think as a … for the banking system as a whole, the exposure to commercial property is around six per cent of their assets, and for all banks it’s essentially in the single digits. So our banks are pretty well insulated against the commercial property market and if there was a downturn, so we certainly wouldn’t expect to see the effects that we saw in the late-1990s, for example, when the commercial property market had a really big impact on the banking system.

Okay. Well, we want to keep to schedule. We’ve given Jonathan some questions here. Please, everyone, can you put your hands together and thank Dr Jonathan Kearns.

Thanks very much. Thanks, Michael.