With house prices in Australia’s largest cities — Sydney and Melbourne — continuing to increase at a rapid clip, fuelling fears over financial stability risks as a result of increased household indebtedness, Australian regulators have once again turned to macroprudential measures to curb increased investor activity in these markets.
In late March, Australia’as banking regulator, APRA, announced it will limit interest-only lending from authorised deposit-taking institutions (ADIs) to 30% of total new mortgage debt, widely seen as yet another measure to further reduce investor demand following its decision in late 2014 to introduce a 10% annual cap in investor housing credit growth.
To Bill Evans, chief economist at Westpac, while this approach of targeting investors is similar, it’s unlikely to have the same impact on new lending to investors that we saw in 2015, potentially raising the prospect of even tighter macroprudential measures arriving in the period ahead should rapid house price growth persist.
“This new approach of imposing caps on new interest only loans is not directly comparable with the ‘investor loan speed limit’ approach but does appear to be more benign,” he says.
“Overall it is reasonable to conclude that the sharp slowdown in house price inflation in 2015 is unlikely to be repeated under the current set of policy and rate adjustments although some moderation in price pressures can be expected.
“Consequently, it is not unreasonable to assume that further action by the Bank and APRA can be expected,” Evans adds, acknowledging that APRA has already alluded to possible increases in capital requirements for ADIs for investor mortgages.
Given the push to use macroprudnetial tightening to cool housing market demand, done in part because the RBA is reluctant to lift interest rates given other parts of the economy are not strong enough to absorb higher borrowing costs, many are now asking just how effective these measures will be in slowing house price growth, and with it perceived heightened financial stability risks.
They are, after all, new to Australia, and no one knows just what impact they’ll have, particularly if they are tightened further.
And the 10% annual cap on investor credit growth introduced in late 2014 did have an impact, seeing house price growth in Sydney and Melbourne slow sharply over the course of 2015.
Evans says that policymakers will need to tread carefully, warning that a too heavy-handed approach could actually create even greater risks than those posed at present, particularly at a time when out-of-cycle mortgage rate increases have been passed on to borrowers.
“This process of macroprudential tightening care will need to be taken if the authorities want to avoid an unnecessarily sharp downside response in the market,” he says.
“While recent developments in housing markets are being assessed as ‘unhelpful’ by the authorities due to the lift in household leverage, the risk of a damaging fall in prices in response to a heavy handed approach must be a consideration for the regulators.
“Such a reaction could prove to be much more damaging for the overall economy than the current lift in household leverage,” he adds, noting that the RBA is not in a position to stimulate housing market demand given the cash rate currently sits at a record-low level of just 1.5%.
Put simply, it does not have the same ability to boost demand like it did in the past when house prices were weakening.
It’s a delicate balancing act for policymakers, ensuring that current risks are contained without creating even larger problems that could have a significantly larger impact on the broader Australian economy given weak labour market conditions and inflationary pressures.
Higher house prices have been one of the positives for household consumption levels over the past few years, helping to offset persistently weak household incomes growth.
Should house prices also weaken, it will leave the largest component within the Australian economy in a precarious position.
“The best and most likely outcome is a prudent application of the current policies and probably others that may or may not be publicly announced,” says Evans. “That will help engineer a manageable slowdown in house price inflation without precipitating a dangerous over reaction in the housing markets.”