Oct 14 2019
As the cash rate approaches zero, the Reserve Bank of Australia (RBA) has flagged the potential for ‘unconventional monetary policy’, including quantitative easing (QE). According to industry research firm IBISWorld, QE would likely lead to higher property prices and greater residential construction activity. Conditions in the residential construction sector are still responding to recent downturns in property values caused partly by changing macroprudential regulations. Construction pipelines have therefore been limited by low construction approval and commencement activity, which is to inflate house prices in the short term.
Housing market background
Residential property markets in Australia are entering a transitional period. Nationally, home values have increased overall for much of the past decade, driven mostly by significant growth in the Sydney and Melbourne markets.
‘The main factors fuelling this growth were low interest rates and population growth. Low interest rates have made mortgages increasingly affordable for both owner-occupiers and property investors. As a result, property developers responded to rising property prices with a significant boom in construction activity,’ said IBISWorld Senior Industry Analyst, Michael Youren.
However, residential property values have fallen nationally over the past two years. According to IBISWorld, the reasons for falling prices are varied, but largely revolve around tightened lending requirements and legislation, and new restrictions on foreign investment.
‘Property developers have responded to falling home values by applying for fewer approvals, slowing new unit and townhouse construction and house construction, and selling at lower prices,’ said Mr Youren.
Residential property markets have once again started to record localised price growth over the past three months, primarily in the Melbourne and Sydney markets. In most cases, this growth has been driven by a relaxing of restrictions on lending requirements and further falls in interest rates. After keeping the cash rate on hold at 1.5% for nearly three years, the Reserve Bank of Australia (RBA) has since reduced rates to a record low of 0.75%.
Why are rates falling, and how is this related to quantitative easing?
Australia’s stagnant economic climate has been the main contributor towards decisions to cut the cash rate. The RBA has been targeting full employment by making capital more affordable, encouraging Australian business to increase their economic activity. Furthermore, the Federal Government’s commitment to a budgetary surplus has meant that expansionary fiscal policy measures are unlikely to be introduced, forcing the RBA’s hand to enact stimulus measures.
The recent cuts to the cash rate have been broadly labelled as the first steps towards an expansionary quantitative easing (QE) policy. Among the QE measures hinted at by the RBA are the large-scale purchase of financial assets by the bank and the unprecedented step of setting negative cash rates.
‘While it is unlikely that retail banks will pass negative rates on in the form of charging interest on deposits and paying customers to take out loans, these measures will likely lead to lower interest rates charged on mortgages. Borrowers would be able to service interest on larger loans, and this would likely mean that banks will allow customers to borrow more money. Greater borrowing capacity would continue to inflate property values,’ said Mr Youren.
Another important factor to consider is that QE-style measures will decrease the returns on low-risk assets, in particular term deposits. IBISWorld expects that lower returns will likely encourage investors to consider slightly riskier assets. As residential property represents a popular form of investment, demand for houses and apartments are forecast to rise in the event of QE-style measures.
According to IBISWorld, potential QE measures would affect the supply of new homes, as lower interest rates and rising demand encourage developers to start new projects. However, new home supply is generally slow to respond to changes in demand due to the relatively long timeframes between development approval and construction completion. This lag is referred to as the construction pipeline, and means that any development decisions made now will only affect supply in the medium to long term.
These effects are shown in the graphs above.
- In the first graph, approvals and commencements have both dropped off sharply since 2017-18.
- In the second graph, the number dwellings of under construction also declined in 2018, but at a much lower rate.
- The difference between the fall in approvals and the decline in dwellings under construction suggests that lower levels of approvals are yet to fully work their way through the pipeline. As a result, construction activity is anticipated to slow further over the short term.
As QE measures take hold, demand for property is anticipated to increase. Ongoing population growth will also contribute to higher demand for residential property. As a result, house prices are forecast to rise as construction activity slows and limits the supply of new houses.
‘Developers are projected to respond to increased demand in the short term by seeking new building approvals, which would be shortly followed by a corresponding increase in dwelling commencements. However, due to the lag between dwelling approval and completion, supply conditions are only likely to improve in the longer term,’ said Mr Youren.
As the RBA is specifically targeting full employment, QE measures would likely continue for the medium to long term, as driving expansionary cyclical change can take significant time.
‘This timeframe provides developers with some certainty and supports continued investment in construction. Greater construction activity will eventually enable property supply to meet higher levels of demand. This trend will likely lead housing price growth to stabilise over the longer term,’ concluded Mr Youren.
IBISWorld reports used to develop this release:
For more information, to obtain industry reports, or arrange an interview with an analyst, please contact:
Strategic Media Advisor – IBISWorld Pty Ltd
Tel: 03 9906 3641