The RBA’s first board meeting of the year was an important one, as it provided an opportunity for the Reserve Bank to discuss the strength in data flows since its previous meeting in early December.
Since then we have seen the unemployment rate trend down to 4.2%, beating the RBA’s most recent forecast of 4.75%, and core inflation has surged to a level slightly above the mid-point of the target range (at 2.7%). Additionally, housing credit growth has reaccelerated and there has been a further lift in high debt-to-income ratio home loans.
We have also seen housing values continue to rise, although the pace of growth has been gradually softening across most of the capital cities. The cost of new housing and higher rents were key drivers of the higher core inflation reading over the December quarter.
With the recent data flows signposting a stronger than forecast economic environment in 2022, we could see the RBA’s inflation and labour market mandates being met earlier than expected. However, the RBA notes it will remain patient, looking through the recent rise in inflation and strengthening job market to ensure wages growth follows and inflation can remain ‘sustainably within the target band’, which is 2-3%.
The RBA acknowledged that key measures of the economy were performing better than expected, and it was no surprise to see the Bank announce a cessation of the $350 billion bond buying program, but keep the cash rate at 0.1% and the interest rate on Exchange Settlement balances at 0.0%.
The possibility of the cash rate rising later this year remains a downside risk for housing. A growing chorus of economic commentators are forecasting a rate rise later this year and financial markets have the first lift fully priced in by mid-year.
Previous analysis from CoreLogic shows a strong inverse correlation between movements in the cash rate and housing values, albeit with the strongest correlation based on a lag, but other factors are also likely to influence the trajectory of housing values.
Credit policy, where the RBA plays a role via the Council of Financial Regulators, could tighten later this year. Arguably the risk of tighter credit policies is heighted considering the rise in high debt-to-income ratio lending through the September quarter, and the recent reacceleration in housing credit growth.
Housing affordability is another downside overlay. Although labour markets have tightened substantially, there is little evidence of a material flowthrough to wages growth. The RBA notes ‘wages growth picked up but, at the aggregate level, has only returned to the relatively low rates prevailing before the pandemic.’
The most recent update on wages is to the September quarter last year which showed a 2.2% lift over the year. The RBA is looking for wages growth over 3% to keep inflation sustainably within their target range. We will see an update on wages to the December quarter on 23 February.
Despite the growing downside risks to the housing sector, other factors should help to offset a significant downturn. As the economy strengthens and labour markets tighten the risks around mortgage stress or default should lessen. Open international borders will help to support demand, initially from a rental perspective, but longer term for home purchasing as well.
Additionally, housing inventory levels remain remarkably low across most jurisdictions which is adding some support for housing values and it will take some time for interest rates to normalise once they start rising, providing a low cost of housing credit for some time yet.
CoreLogic Australia