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In 2 simple paragraphs, the RBA just outlined the economic nightmare a housing crash would unleash

Photo: Dan Kitwood/Getty Images

When it announced it was cutting the official cash rate to 1.5% this week, the Reserve Bank of Australia noted that the national housing market had eased up a little recently.

With a rate cut having the potential to stoke house price growth, the RBA noted that some of the more concerning features of the property market have been fading, with banks “taking a more cautious attitude to lending”.

“The most recent information suggests that dwelling prices have been rising only moderately over the course of this year, with considerable supply of apartments scheduled to come on stream over the next couple of years, particularly in the eastern capital cities. Growth in lending for housing purposes has slowed a little this year. All this suggests that the likelihood of lower interest rates exacerbating risks in the housing market has diminished.”

Property prices in the eastern states are still growing strongly, though. As we reported earlier this week, CoreLogic’s Home Value Index showed capital city house prices up 6.1% from a year earlier. Prices are at their highest levels on record and have risen 6.3% over the first seven months of 2016.

This brings a range of benefits, not least the so-called “wealth effect”, or the tendency for people to spend up a little more because they realise their house has become more valuable. The demand for construction has also played a key role in delivering some much-needed inflation, too.

In its Statement on Monetary Policy today, the RBA noted just how important sustained demand in the housing market really is.

These are the very last two paragraphs of the Statement (emphasis added):

There is concern about the risk of oversupply in specific geographical areas, such as some parts of inner-city Melbourne and Brisbane. So far, outside Western Australia, the increased supply of housing has largely been absorbed by population growth. However, if growth in housing demand does not continue to keep pace with the further large increases in supply already in the pipeline, it could place downward pressure on prices and rents and increase the risk that off-the-plan purchases fail to settle.

If the housing market were to weaken substantially, consumption could be lower than currently expected due to lower growth in household wealth. Consumer price inflation could also be affected, as housing costs comprise a significant share of the CPI basket.

So you don’t get just the problems for the banking sector and property developers, but it would also be a drag on the already-meagre levels of inflation and would hurt consumption, which makes up almost 60% of the economy, as you can see on the right of this chart (from JP Morgan):

A good reason to keep an eye on clearance rates.

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