rising house prices

Property Market Exuberance: The Bubble That Needs to be Burst

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The housing bubble, fuelled by low-interest rates, buyers’ exuberance, and investors’ speculation, among others, is something this government might have to deal with soon.       

Because the Reserve Bank of Australia (RBA) missed its inflation target, it is going to be in a lot of pressure to cut interest rates further to encourage consumption and boost inflation back to within the target band.

Cutting the rates too low, though, has the risk of putting the country in financial instability and a housing bubble.  

At present, Treasurer Josh Frydenberg is urging RBA governor Philip Lowe to publicly explain why the 2-3 per cent inflation goal was not met. 

Economist Richard Holden from the University of NSW is of the opinion that the RBA had been ‘‘too slow’’ to cut interest rates in June and July.

“If you had nudged the RBA to explain undershooting the inflation target over the last three years, then the RBA may have cut interest rates sooner,” he said.

“But when the RBA cuts rates to low levels, that has financial stability and asset bubble ramifications.”

Australian Cash Rate Target

Following the September meeting, the RBA has previously said that though it is keeping the interest rate at 1 per cent at this time, it is still open to more rate cuts.  

“It is reasonable to expect that an extended period of low-interest rates will be required in Australia to make progress in reducing unemployment and achieve more assured progress towards the inflation target,” Lowe said.

Since the introduction of the 2 – 3 per cent target band in the monetary policy, inflation has been inside the band 37 per cent of the time, above it 26 per cent and below it for 3 per cent.

But some economists believe a target band of 2 to 3 per cent is antiquated in a persistently low-inflation economy and should be modified.

Mr. Frydenberg, however, made it clear that they are keeping the 2-3 per cent target band but that negotiations on modifying the agreement are underway between the RBA and the government.

“Yes, I am looking to have such an agreement and Treasury are currently engaged in a discussion with the Reserve Bank about that inflation target, which is 2 to 3 per cent,” Mr Frydenberg said.

“It is not going to be a radical change, but there is a discussion about maybe ways we can strengthen that agreement, strengthen that target to ensure that we continue to see inflation where the Reserve Bank and the government want it to be,” he said.

Whatever the changes may be, the new inflation deal would only force the RBA to cut rates down. And the possibility of a housing bubble becomes more real. 

Mr. Holden believes that if we’re going to survive housing bubble in the face of rising house prices and descending cash rates, “APRA would need to do more of a job on macroprudential measures like on interest-only loans to give the RBA more wriggle room to cut rates without being as concerned on asset bubbles.”

The Australian Prudential Regulation Authority (APRA) in 2014 through 2018 has imposed limits on investment loans and interest-only loans to minimise risks of housing bubble following the RBA cutting interest rates to record low levels.

Since these safety limits have been lifted and the two cash rate cuts this year, the country has been seeing rising house prices in Sydney and Melbourne. 

 

Related:  Rich Dad' author Robert Kiyosaki warns investors to avoid real estate. Is he right?

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