Sunday, June 20, 2004
Housing lessons from Down Under
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

The economy has been growing for 12 years, its longest expansion in modern times. But consumers are getting over-exuberant — house prices and consumer debt have virtually doubled in four years — and the central bank is getting worried.

Its governor, having described the housing market as “clearly aberrant”, has started to talk openly about falling house prices. While insisting monetary policy is “directed at the economy as whole”, he has been increasingly concerned about house-price inflation and the risk of a “damaging correction”. There is already strong evidence, he said, of an abrupt cooling of the housing market. Interest rates are up.

As you may have guessed, despite my attempts at disguise, I am not talking here about about Britain but another Anglo-Saxon economy. Australia, its reserve bank, and Ian Macfarlane, its governor, have faced many of the problems being confronted by the Bank of England.

We should take heed of what is happening Down Under, and not just because of the ties of Empire, Commonwealth and sporting rivalry. New Zealand, after all, gave us the idea of setting inflation targets.

When it comes to housing and interest rates, some believe Australia may be the shape of things to come here. Mervyn King, Bank of England governor, grabbed the front-page headlines last week by warning that house prices could fall, while subsequently denying he was saying they will fall. Some of his colleagues are privately less circumspect, believing prices will fall.

In Australia, Macfarlane certainly believes house prices are already falling. While the evidence is mixed (another parallel with Britain), he chose in recent testimony to the House of Representatives to highlight surveys showing Sydney prices down 7.5% and Melbourne’s falling by 12.9% in the first quarter.

These were, he said, signs that the housing market was going through a “much-needed cooling phase”, and this provided an opportunity for potential homebuyers to resist the “blandishments” of the banks and estate agents. He appears keen to talk down the market because it takes the pressure off him. The shift from boom to mild bust in the Australian housing market has been achieved, it seems, with only the mildest dose of monetary medicine.

Although Australian interest rates hit a trough two years ago, rising then from 4.25% to 4.75%, nothing more happened until the end of last year, when there were two back-to-back quarter-point hikes in November and December, taking rates to 5.25%. That, of course, is in the same range that most people expect from the Bank of England.

The Australian experience raises a number of interesting issues. For one thing, consumers and homebuyers appear to have been unusually sensitive to interest rates. A small touch on the monetary tiller has made a big difference. But should the Bank of England welcome a fall in house prices? As long as it did not get out of hand it would puncture overconfidence even more usefully than King’s warning. Some monetary policy committee (MPC) members are starting to think that a drop in prices could actually be useful.

There is another aspect of the experience Down Under that we should consider. Mark Austin, currency strategist at HSBC, points out that Australia’s house-price fall has pushed its currency lower after a prolonged rise. The perception that interest rates no longer need to rise has cut the props from under the currency. Sterling, for similar reasons, or simply because Britain will stop raising rates sooner than most other countries, is likely to fall by 10% to 12% against the euro over the next 12 months or so, predicts Austin.

Ed Stansfield of Capital Economics, who first pointed to the housing comparison between Australia and Britain, concedes the parallels are not perfect. The rise in household debt has hit harder there, with debt-serving payments reaching record levels at the end of last year. In Britain, by contrast, the market has been supported by the fact that, despite rising debt, mortgage payments are well below previous peaks as a proportion of income. Another difference is housing supply. The shortage of new properties is much less of a problem in Australia.

On the face of it, another very big difference is that neither the housing market nor consumers generally seem to be responding to higher rates in Britain. House prices are up by more than 20% on a year ago, while official figures last week showed retail sales steaming ahead, up 0.8% in volume last month, and 7.4% up on May last year.

The question is whether, like King, we interpret recent straws in the wind as a sign that the housing market is indeed cooling. The National Association of Estate Agents, in opposing this month’s rate rise, said it was unnecessary because the housing market was already slowing. Steven Andrew, an economist with Isis Asset Management, said the latest survey by the Royal Institution of Chartered Surveyors, which shows a gap opening up between instructions to sell and new-buyer enquiries, suggests a significant slowdown is looming. Figures on Friday showed mortgage lending last month was £1 billion down on April.

Could it turn, as in Sydney and Melbourne, into something worse? And what would the Bank do about it? In Australia, the central bank has used the evidence that its medicine is working in the housing market as a reason to stop raising rates.

The position here is slightly different — rates were cut more aggressively and are still below what the Bank regards as a neutral level. But some analysts think housing will be the factor that intervenes to stop the Bank raising rates much more. A falling pound would be a complicating factor, although the MPC will be comforted by evidence showing the “pass-through” from a lower exchange rate into inflation is weaker than in the past.

This is a difficult time. The Australians appear to have achieved an almost perfect response, with barely a lag between the decision to raise rates and its effect. In Britain the Bank faces lags that will lead to the temptation to keep on raising interest rates until something gives. In these circumstances, calibrating exactly how much rates need to rise is the Bank’s big challenge.

PS: Not everybody celebrates good news in the jobs market. Figures last week showed a drop in the claimant count to 862,000, down 12,000 on the month to just 2.8% of the workforce. That’s well within the conventional definition of full employment — 2%-3% unemployment. The wider Labour Force Survey measure of unemployment fell to 1.43m. Employment is at a record 28.3m.

But according to the Chartered Institute of Personnel & Development (CIPD), which holds its annual recruitment and retention conference this week, the flipside of this is that firms are having increasing problems in finding staff. In a survey of nearly 1,000 employers — private and public — 85% reported recruitment difficulties in the past year.

When organisations cannot recruit the people they want, they respond in a number of ways, often by taking on staff without the right qualifications and then training them. Increasingly, though, the CIPD survey suggests more are responding by paying higher salaries. With official figures already showing average earnings rising by more than 4%, excluding bonuses, there will be some concern about this.

Ministers, while happy to have got unemployment down, are now trying to deal with the more difficult problem of getting more of the “economically inactive” back into jobs. That includes pilot programmes to steer some of the 2.7m on incapacity benefit into work. Initial results have been encouraging. The message from employers is that extra labour supply cannot come soon enough.

From The Sunday Times, June 20 2004

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