Housing bubble risk if rates are cut?

Home Value Index; TD Inflation Gauge; Performance of Manufacturing

• Home prices lift: The CoreLogic RP Data Home Value Index of capital city home prices rose by 1.3 per cent in January – the biggest rise in six months. Australian home prices rose by 8.0 per cent over the year.
• Inflation contained: The TD Securities-Melbourne Institute monthly inflation gauge rose by 0.1 per cent in January. But excluding volatile items, prices rose by 0.7 per cent – the biggest lift in nine months.
• Manufacturing lifts: The Performance of Manufacturing index rose 2.1 points to 49.0 in January.

What does it all mean?

• The latest batch of economic data has shifted the debate in favour of interest rate settings being left on hold. Underlying inflation lifted sharply in January, the manufacturing sector strengthened and home prices accelerated – posting the strongest gain in six months.
• No doubt the latest economic data has made an interesting Reserve Bank Board meeting even more interesting. While global deflationary forces support the case for an easing of domestic monetary conditions, the risk is that another rate cut will lead to unsustainable strength in domestic home prices and contribute to inflationary risks.
• The lift in key underlying measures of inflation shows that you can never take your eye off price pressures. Excluding volatile items, prices jumped 0.7 per cent in January – the highest reading in nine months. A lift in price of this magnitude is rare – there have only been four increases of similar size in the past five years.
• Could another rate cut add to risks of a bubble developing in the housing market? Home prices are at record highs across Australia and annual price growth of 8 per cent remains well above the long-term average growth rate of 4.8 per cent. The strength of the housing market will clearly feature at the Reserve Bank Board meeting.

What do the figures show?

Inflation gauge

• The monthly inflation gauge rose by 0.1 per cent in January after a flat reading in December. The annual rate of inflation remained at 1.5 per cent. Lower petrol prices are a key influence affecting headline inflation.
• The annual growth of tradable good prices remained at 0.2 per cent, and the annual growth rate of non-tradable inflation remained at 2.5 per cent.
• The underlying rate (trimmed mean) rose by 0.3 per cent in January after gains of 0.1 per cent in the previous four months. The annual rate rose from 1.7 per cent to 2.3 per cent.
• Excluding volatile items like petrol and fruit & vegetables, the inflation gauge was up 0.7 per cent in January after rising by 0.2 per cent in both November and December. The annual rate of inflation lifted from 1.8 per cent to 2.4 per cent.
• TD Securities noted that: “Contributing to the overall change in January were price rises for medical products, appliances and equipment (seasonal, +8.9 per cent), audio, visual and computing equipment (+8.7 per cent) and education (seasonal, +2.4 per cent). These were offset by falls in fuel (-13.4 per cent), fruit and vegetables (-2.3 per cent) and furniture and furnishings (-1.6 per cent).”

Home prices

• The CoreLogic RP Data Hedonic Australian Home Value index of capital city home prices rose by 1.3 per cent in January after lifting by 0.9 per cent in December. Home prices are up by 8.0 per cent on a year ago, after recording 7.9 per cent annual growth to December
• House prices rose by 1.3 per cent in January while apartments rose by 1.3 per cent. House prices were up 8.2 per cent on a year ago and apartments were up by 6.2 per cent.
• The average Australian capital city house price (median price based on settled sales over quarter) was $590,000 and the average unit price was $487,500.
• Dwelling prices rose in five of eight capital cities in January: Melbourne (up 2.7 per cent); Hobart (up 1.6 per cent); Sydney (up 1.4 per cent); Canberra (up 0.9 per cent); and Brisbane (up 0.6 per cent). Prices fell in Darwin (down 1.3 per cent); Adelaide (down 1.2 per cent); and Perth (down 0.6 per cent).
• Home prices were higher than a year ago across all capital cities except Canberra (down 0.3 per cent). Prices rose most in Sydney (up 13.0 per cent), followed by Melbourne (up 7.0 per cent), Brisbane (up 4.6 per cent), Adelaide (up 3.1 per cent), Hobart (up 3.0 per cent), Perth (up 2.6 per cent) and Darwin (up 1.4 per cent).
• Total returns on capital city dwellings in the year to January rose by 12.2 per cent with houses up 12.4 per cent on a year earlier and units up 11.2 per cent.
• The most affordable 25 per cent of capital city suburbs have recorded a gain of 7.3 per cent in January compared to 8.8 per cent across the middle 50 per cent of suburbs and 7.9 per cent across the most expensive 25 per cent.
• RP Data report: “As capital gains continue to run strong, at least at the combined capital city level, rental markets remain weak. Weekly rents have hardly moved over the past year, up by just 1.7 per cent over the past twelve months. With dwelling values rising at nearly five times the pace of rents, we are seeing a consistent deterioration in rental yields.”
• ”Diminishing affordability levels are likely blocking many price sensitive buyers such as first time buyers and low income families from the market. Additionally, lower rental yields and the prospect of tighter lending conditions for investment loans is likely to moderate the investor segment of the market as well,”

Performance of Manufacturing

• The Performance of Manufacturing index rose by 2.1 points to 49.0 in January. A reading below 50.0 indicates that the sector is contracting.
• Of the components in January: production (up 2.7 points to 48.6); exports (up 3.0 points to 54.0); new orders (up 3.9 points to 47.6); employment (down 5.0 points to 47.5); stocks (up 6.0 points to 51.4), selling prices (up 4.6 points to 49.7) and supplier deliveries (up 4.3 points to 52.9).
• The TD Securities/Melbourne Institute Monthly Inflation Gauge is designed to “provide a timely and accurate monthly measure of inflation in Australia”. The Bureau of Statistics only releases the Consumer Price Index on a quarterly basis.
• The CoreLogic RP Data Hedonic Australian Home Value Index is based on Australia’s biggest property database. Unlike the ABS Index, which excludes terraces, semi-detached homes and apartments, the CoreLogic- RP Data Hedonic Index includes all properties. Home prices are an important driver of wealth and spending.
• The Australian Industry Group and PricewaterhouseCoopers compile the Performance of Manufacturing Index (PMI) each month. The Australian PMI is the Australian equivalent of the US ISM manufacturing gauge. The PMI is one of the timeliest economic indicators released in Australia. The PMI is useful not just in showing how the manufacturing sector is performing but in providing some sense about where it is heading. The key ‘forward looking’ components are orders and employment.
• The latest economic data has shifted the balance of risks in favour of rates being left on hold. Authors of the monthly inflation gauge argue for interest rates settings to be left on hold: “we favour an unchanged 2.5 per cent cash and a shift to an explicit easing bias to offer easier policy to support to demand should that prove to be necessary.” And the authors of the home value index says that “Lower interest rates could potentially add further fuel to the housing market, particularly the investor segment, which continues to remain strong based on recent data.”
• Early evidence of the stimulatory effects of the lower Australian dollar can be gleaned from the Performance of Manufacturing index.
• Financial market pricing suggests that a rate cut is a 50:50 call at tomorrow’s Reserve Bank Board meeting.

What is the importance of the economic data?

• The TD Securities/Melbourne Institute Monthly Inflation Gauge is designed to “provide a timely and accurate monthly measure of inflation in Australia”. The Bureau of Statistics only releases the Consumer Price Index on a quarterly basis.

• The CoreLogic RP Data Hedonic Australian Home Value Index is based on Australia’s biggest property database. Unlike the ABS Index, which excludes terraces, semi-detached homes and apartments, the CoreLogic- RP Data Hedonic Index includes all properties. Home prices are an important driver of wealth and spending.

• The Australian Industry Group and PricewaterhouseCoopers compile the Performance of Manufacturing Index (PMI) each month. The Australian PMI is the Australian equivalent of the US ISM manufacturing gauge. The PMI is one of the timeliest economic indicators released in Australia. The PMI is useful not just in showing how the manufacturing sector is performing but in providing some sense about where it is heading. The key ‘forward looking’ components are orders and employment.

What are the implications for interest rates and investors?

• The latest economic data has shifted the balance of risks in favour of rates being left on hold. Authors of the monthly inflation gauge argue for interest rates settings to be left on hold: “we favour an unchanged 2.5 per cent cash and a shift to an explicit easing bias to offer easier policy to support to demand should that prove to be necessary.” And the authors of the home value index says that “Lower interest rates could potentially add further fuel to the housing market, particularly the investor segment, which continues to remain strong based on recent data.”
•  Early evidence of the stimulatory effects of the lower Australian dollar can be gleaned from the Performance of Manufacturing index.
• Financial market pricing suggests that a rate cut is a 50:50 call at tomorrow’s Reserve Bank Board meeting.