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Australian Mortgage Holders Sensitive to Interest Rate Movements – CoreLogic RP Data

An article by Cameron Kusher, CoreLogic RP Data senior research analyst highlights that according to data from the Reserve Bank the ratio of household debt to disposable income is 153.8% and the ratio of housing deb to disposable income is 140.3% both of which are record highs.

Each quarter the Reserve Bank (RBA) publishes selected household finance ratios which show some key statistics about the level of debt held by Australian households. Although Australia has relatively low levels of public debt, private debt is extremely high and unlike many other countries there hasn’t been a decline in that debt in the aftermath of the financial crisis.

The latest household finances data from the RBA shows that in December 2014, the ratio of household debt to disposable income was 153.8%, its highest level on record. Housing debt accounts for 91% of total household debt and is recorded at a record high ratio of 140.3%. The chart shows that the level of debt has been relatively unchanged since 2005 but is now heading higher.

Focussing on the housing component of this debt, of the 140.3% ratio, 92.2% of that figure was owner occupier housing and 48.0% was investor housing. Once again, both are currently at record high levels. As with total housing debt, both had been relatively unchanged over recent years but have lifted over the past couple of years. It is important to note that the gap between owner occupier debt and investor debt is at near record high levels too.

Although household debt is high, the value of household assets is much higher than the debt. According to the data from the RBA the ratio of household assets to disposable income is 813.8%, much higher than the ratio of household debt at 153.8%. From the housing perspective, the ratio of housing assets to disposable income is recorded at 444.0% compared to a ratio of 140.3% for housing debt to household income. The chart shows that the ratio for both household and housing assets had been higher before the financial crisis however, both are now clearly trending higher again.

The data also shows that the ratio of household debt to household assets is 16.7% while the ratio of housing debt to housing assets is 28%. This highlights that although household and housing debts are high, the value of those assets is substantially higher than the level of debt. While this may be true at a national level it doesn’t mean that everyone is immune from the effects of an economic and/or housing market downturn.

Although these figures would provide some comfort that most households have the ability to sell assets to repay debt if they hit trouble, it is important to remember that it is a national view. There are areas of the country where households are much more susceptible to housing and economic downturns. Some specific areas and household types are recent first home purchasers, areas where there has been very little home value growth in recent years, single industry townships and areas where households have re-drawn a large proportion of their home’s equity.

With regards to the recent increases in household and housing debt, obviously very low interest rates (which have just got lower) are encouraging increased borrowing, particularly for housing. On the other hand, saving is not attractive because there is virtually no returns available. While most households can comfortably meet their mortgage requirements with mortgage rates at these levels, it is important to remember that a mortgage is usually a 25 to 30 year commitment and mortgage rates can fluctuate significantly over that time. The fact that household debt levels merely flat-lined rather than reduced following the financial crisis creates some concerns about what will happen once mortgage rates start to normalise (whenever that may be). Furthermore, the rate cut delivered this week may encourage even further leveraging into the housing market.

These are of course average figures across all household. However, as we have shown already, if you segment the household base, you discover that household debt is concentrated in different segments. Some are well able to cover the debts they owe, even if rates were to rise, but others are, even in the current low rate environment close to the edge, and with incomes static, vulnerable even to small rises in interest rate.

Basel IV – Is More Complexity Better?

In December 2014, The Bank For International Settlements issued proposed Revisions to the Standardised Approach for credit risk for comment. It proposes an additional level of complexity to the capital calculations which are at the heart of international banking supervision.  Comments on the proposals were due by 27 March 2015. These latest proposals, which have unofficially been dubbed “Basel IV”, is a continuation of the refining of the capital adequacy ratios which guide banking supervisors and relate to the standardised approach for credit risk. It forms part of broader work on reducing variability in risk-weighted asset. We want to look in detail at the proposals relating to residential real estate, because if adopted they would change the capital landscape considerably. Note this is separate from the proposal relating to the adjustment of IRB (internal model) banks. Whilst it aspires to simplify, the proposals are, to put it mildly, complex

For the main exposure classes under consideration, the key aspects of the proposals are:

  • Bank exposures would no longer be risk-weighted by reference to the external credit rating of the bank or of its sovereign of incorporation, but they would instead be based on a look-up table where risk weights range from 30% to 300% on the basis of two risk drivers: a capital adequacy ratio and an asset quality ratio.
  • Corporate exposures would no longer be risk-weighted by reference to the external credit rating of the corporate, but they would instead be based on a look-up table where risk weights range from 60% to 300% on the basis of two risk drivers: revenue and leverage. Further, risk sensitivity would be increased by introducing a specific treatment for specialised lending.
  • The retail category would be enhanced by tightening the criteria to qualify for the 75% preferential risk weight, and by introducing a fallback subcategory for exposures that do not meet the criteria.
  • Exposures secured by residential real estate would no longer receive a 35% risk weight. Instead, risk weights would be determined according to a look-up table where risk weights range from 25% to 100% on the basis of two risk drivers: loan-to-value and debt-service coverage ratios.
  • Exposures secured by commercial real estate are subject to further consideration where two options currently envisaged are: (a) treating them as unsecured exposures to the counterparty, with a national discretion for a preferential risk weight under certain conditions; or (b) determining the risk weight according to a look-up table where risk weights range from 75% to 120% on the basis of the loan-to-value ratio.
  • The credit risk mitigation framework would be amended by reducing the number of approaches, recalibrating supervisory haircuts, and updating corporate guarantor eligibility criteria.

Real Estate Capital Calculation Proposals

The recent financial crisis has demonstrated that the current treatment is not sufficiently risk-sensitive and that its calibration is not always prudent. In order to increase the risk sensitivity of real estate exposures, the Committee proposes to introduce two specialised lending categories linked to real estate (under the corporate exposure category) and specific operational requirements for real estate collateral to qualify the exposures for the real estate categories.

Currently the standardised approach contains two exposure categories in which the risk-weight treatment is based on the collateral provided to secure the relevant exposure, rather than on the counterparty of that exposure. These are exposures secured by residential real estate and exposures secured by commercial real estate. Currently, these categories receive risk weights of 35% and 100%, respectively, with a national discretion to allow a preferential risk weight under certain strict conditions in the case of commercial real estate.

Residential Owner Occupied Real Estate

In order to qualify for the risk-weight treatment of a residential real estate exposure, the property securing the mortgage must meet the following operational requirements:

  1. Finished property: the property securing a mortgage must be fully completed. Subject to national discretion, supervisors may apply the risk-weight treatment  for loans to individuals that are secured by an unfinished property, provided the loan is for a one to four family residential housing unit.
  2. Legal enforceability: any claim (including the mortgage, charge or other security interest) on the property taken must be legally enforceable in all relevant jurisdictions. The collateral agreement and the legal process underpinning the collateral must be such that they provide for the bank to realise the value of the collateral within a reasonable time frame.
  3. Prudent value of property: the property must be valued for determining the value in the LTV ratio. Moreover, the value of the property must not be materially dependent on the performance of the borrower. The valuation must be appraised independently using prudently conservative valuation criteria and supported by adequate appraisal documentation.

The current standardised approach applies a 35% risk weight to all exposures secured by mortgage on residential property, regardless of whether the property is owner-occupied, provided that there is a substantial margin of additional security over the amount of the loan based on strict valuation rules. Such an approach lacks risk sensitivity: a 35% risk weight may be too high for some exposures and too low for others. Additionally, there is a lack of comparability across jurisdictions as to how great a margin of additional security is required to achieve the 35% risk weight.

In order to increase risk sensitivity and harmonise global standards in this exposure category, the Committee proposes to introduce a table of risk weights ranging from 25% to 100% based on the loan-to-value (LTV) ratio. The Committee proposes that the risk weights derived from the table be applied to the full exposure amount (ie without tranching the exposure across different LTV buckets).

The Committee believes that the LTV ratio is the most appropriate risk driver in this exposure category as experience has shown that the lower the outstanding loan amount relative to the value of the residential real estate collateral, the lower the loss incurred in the event of a default. Furthermore, data suggest that the lower the outstanding loan amount relative to the value of the residential real estate collateral, the less likely the borrower is to default. For the purposes of calculating capital requirements, the value of the property (ie the denominator of the LTV ratio) should be measured in a prudent way. Further, to dampen the effect of cyclicality in housing values, the Committee is considering requiring the value of the property to be kept constant at the value calculated at origination. Thus, the LTV ratio would be updated only as the loan balance (ie the numerator) changes.

The LTV ratio is defined as the total amount of the loan divided by the value of the property. For regulatory capital purposes, when calculating the LTV ratio, the value of the property will be kept constant at the value measured at origination, unless an extraordinary, idiosyncratic event occurs resulting in a permanent reduction of the property value. Modifications made to the property that unequivocally increase its value could also be considered in the LTV. The total amount of the loan must include the outstanding loan amount and any undrawn committed amount of the mortgage loan. The loan amount must be calculated gross of any provisions and other risk mitigants, and it must include all other loans secured with liens of equal or higher ranking than the bank’s lien securing the loan. If there is insufficient information for ascertaining the ranking of the other liens, the bank should assume that these liens rank pari passu with the lien securing the loan.

In addition, as mortgage loans on residential properties granted to individuals account for a material proportion of banks’ residential real estate portfolios, to further increase the risk sensitivity of the approach, the Committee is considering taking into account the borrower’s ability to service the mortgage, a proxy for which could be the debt service coverage (DSC) ratio. Exposures to individuals could receive preferential risk weights as long as they conform to certain requirement(s), such as a ‘low’ DSC ratio. This ratio could be defined on the basis of available income ‘net’ of taxes. The DSC ratio would be used as a binary indicator of the likelihood of loan repayment, ie loans to individuals with a DSC ratio below a certain threshold would qualify for preferential risk weights. The threshold could be set at 35%, in line with observed common practice in several jurisdictions. Given the difficulty in obtaining updated borrower income information once a loan has been funded, and also given concerns about introducing cyclicality in capital requirements, the Committee is considering whether the DSC ratio should be measured only at loan origination (and not updated) for regulatory capital purposes.

The DSC ratio is defined as the ratio of debt service payments (including principal and interest) relative to the borrower’s total income over a given period (eg on a monthly or yearly basis). The DSC ratio is defined using net income (ie after taxes) in order to focus on freely disposable income. The DSC ratio must be prudently calculated in accordance with the following requirements:

  1.  Debt service amount: the calculation must take into account all of the borrower’s financial obligations that are known to the bank. At loan origination, all known financial obligations must be ascertained, documented and taken into account in calculating the borrower’s debt service amount. In addition to requiring borrowers to declare all such obligations, banks should perform adequate checks and enquiries, including information available from credit bureaus and credit reference agencies.
  2. Total income: income should be ascertained and well documented at loan origination. Total income must be net of taxes and prudently calculated, including a conservative assessment of the borrower’s stable income and without providing any recognition to rental income derived from the property collateral. To ensure the debt service is prudently calculated, the bank should take into account any probable upward adjustment in the debt service payment. For instance, the loan’s interest rate should (for this purpose) be increased by a prudent margin to anticipate future interest rate rises where its current level is significantly below the loan’s long-term level. In addition, any temporary relief on repayment must not be taken into account for purposes of the debt service amount calculation.

Notwithstanding the definitions of the DSC and LTV ratios, banks must, on an ongoing basis, have a comprehensive understanding of the risk characteristics of their residential real estate portfolio.

The risk weight applicable to the full exposure amount will be assigned, as determined by the table below, according to the exposure’s loan-to-value (LTV) ratio, and in the case of exposures to individuals, also taking into account the debt service coverage (DSC) ratio. Banks should not tranche their exposures across different LTV buckets; the applicable risk weight will apply to the full exposure amount. A bank that does not have the necessary LTV information for a given residential real estate exposures must apply a 100% risk weight to such an exposure.

Basel-4-RE-WeightingsSome points to note.

  1. Differences in real estate markets, as well as different underwriting practices and regulations across jurisdictions make it difficult to define thresholds for the proposed risk drivers that are meaningful in all countries.
  2. Another concern is that the proposal uses risk drivers prudently measured at origination. This is mainly to dampen the effect of cyclicality in housing values (in the case of LTV ratios) and to reduce regulatory burden (in the case of DSC ratios). The downside is that both risk drivers can become less meaningful over time, especially in the case of DSC ratios, which can change dramatically after the loan has been granted.
  3. The DSC ratio is defined using net income (ie after taxes) in order to focus on freely disposable income. That said, the Committee recognises that differences in tax regimes and social benefits in different jurisdictions make the concept of ‘available income’ difficult to define and there are concerns that the proposed definition might not be reflective of the borrower’s ability to repay a loan. Further, the level at which the DSC threshold ratio has been set might not be appropriate for all borrowers (eg high income) or types of loans (eg those with short amortisation periods). Therefore the Committee will explore whether using either a different definition of the DSC ratio (eg using gross income, before taxes) or any other indicator, such as a debt-to-income ratio, could better reflect the borrower’s ability to service the mortgage.
  4. There are no specific proposal to treat loans that are past-due for more than 90 days.

 Investment Loans

Bearing in mind that 35% of all loans are for investment purposes in Australia, the proposals relating to loans for investment purposes are important. So how will they be treated under Basel 4?

There are a number of pointers in the proposals, though its not totally clear in our view. First, we think the proposals would apply to separate loans where repayment is predicated on income generated by the property securing the mortgage, i.e. investment loans rather than a normal loans where the mortgage is linked directly to the underlying capacity of the borrower to repay the debt from other sources. Such loans might fall into a special commercial real estate category, specialist lending category, or a fall back to the unsecured category, each with different sets of capital weights.

The Committee proposes that any exposure secured with real estate that exhibits all of the characteristics set out in the specialised lending category should be treated for regulatory capital purposes as income-producing real estate or as land acquisition, development and construction finance as the case may be, rather than as exposures secured by real estate. Any non-specialised lending exposure that is secured by real estate but does not satisfy the operational requirements should be treated for regulatory capital purposes as an unsecured exposure, either as a corporate exposure or other retail exposure, as appropriate.

Specialised lending exposure, would be defined so if all the following characteristics, either in legal form or economic substance were met:

  1. The exposure is typically to an entity (often a special purpose entity (SPE)) that was created specifically to finance and/or operate physical assets;
  2. The borrowing entity has few or no other material assets or activities, and therefore little or no independent capacity to repay the obligation, apart from the income that it receives from the asset(s) being financed;
  3. The terms of the obligation give the lender a substantial degree of control over the asset(s) and the income that it generates; and
  4. As a result of the preceding factors, the primary source of repayment of the obligation is the income generated by the asset(s), rather than the independent capacity of a broader commercial enterprise.

On the other hand, in order to qualify as a commercial real estate exposure, the property securing the mortgage must meet the same operational requirements as for residential real estate. If the loan is a commercial real estate category, the risk weight applicable to the full exposure amount will be assigned according to the exposure’s loan-to-value (LTV) ratio, as determined in the table below. Banks should not tranche their exposures across different LTV buckets; the applicable risk weight will apply to the full exposure amount. A bank that does not have the necessary LTV information for a given commercial real estate exposure must apply a 120% risk weight.
LTVBasel-4-Commercial-LTVNote, if this LTV refers to market value, the threshold should be set at a lower level: eg 50%.

Where the requirements are not met, the exposure will be considered unsecured and treated according to the counterparty, ie as “corporate” exposure or as “other retail”. However, in exceptional circumstances for well developed and long established markets, exposures secured by mortgages on office and/or multipurpose commercial premises and/or multi-tenanted commercial premises may be risk-weighted at [50%] for the tranche of the loan that does not exceed 60% of the loan to value ratio. This exceptional treatment will be subject to very strict conditions, in particular:

  1.  the exposure does not meet the criteria to be considered specialised lending
  2. the risk of loan repayment must not be materially dependent upon the performance of, or income generated by, the property securing the mortgage, but rather on the underlying capacity of the borrower to repay the debt from other sources
  3. the property securing the mortgage must meet the same operational requirements as for residential real estate
  4. two tests must be fulfilled, namely that (i) losses stemming from commercial real estate lending up to the lower of 50% of the market value or 60% of loan-to value (LTV) based on mortgage-lending-value (MLV) must not exceed 0.3% of the outstanding loans in any given year; and that (ii) overall losses stemming from commercial real estate lending must not exceed 0.5% of the outstanding loans in any given year. This is, if either of these tests is not satisfied in a given year, the eligibility to use this treatment will cease and the original eligibility criteria would need to be satisfied again before it could be applied in the future. Countries applying such a treatment must publicly disclose that these and other additional conditions (that are available from the Basel Committee Secretariat) are met. When claims benefiting from such exceptional treatment have fallen past-due, they will be risk-weighted at [100%].

Implications and Consequences

We should make the point, these are proposals, and subject to change. But it would mean that banks using the standard approach to capital could no longer just go with a 35% weighting, rather they will need to segment the book based on LTV and servicability at a loan by loan level. Investment loans may become more complex and demand higher capital weighting. The required data may be available, as part of the loan origination process, but additional processes and costs will be incurred, and it appears net-net capital buffers will be raised for most players. The capital would be determined using two risk drivers: loan-to-value and debt-service coverage ratios with risk weights ranging from 25 percent to 100 percent. Investment loans may require different treatment, (and the RBNZ discussion paper recently issued may be relevant here, where investment loans are handled on a different basis.)

Finally, a word about those banks on IRB. Currently, under their internal models, they are sitting on an average weighting of around 17% (compared with 35% for standard banks). There are proposals to lift the floor to 20% minimum, and the FSI Inquiry recommend higher. Indeed, Murray called for the big banks to lift the average mortgage risk weighting to a range of 25% to 30%. This would bring them closer to the average mortgage risk weighting used by Australia’s regional banks and credit unions, though as described above, these, in turn, may change. Incidentally, the Bank of England thinks 35% is a good target. Basel 4 will also reduce the variance between standardised banks and those using their own models by requiring the internal models not to deviate from the RWA number in the standardised model by a certain amount: the so-called “capital floor”.

Interestingly the US is focussing on an additional measure, The Tier 1 Common measure, which is unweighted assets to capital, and has set a floor of 5%, or more.  The Major Banks in Australia carry real, or non-risk-weighted, equity capital of just 3.7% of assets. Some banks are leveraged over seventy times the equity capital to loans, which is scarily high, but then the RBA (aka the tax payer) would bail them out if they get into trouble, so that’s OK (or not). This means that just $1.70 in assets will now support a $100 loan.

We wonder if the ever more complex models being proposed by Basel are missing the point. Maybe we should be going for something simpler. Many banks of course have invested big in advanced models to squeeze the capital lemon as hard as they can. But stepping back we need approaches which allow greater ability to compare across banks, and more transparent disclosure so we can see where the true risks lay. Certainly capital buffers should be lifted, but we suspect Basel 4, despite the best of intentions,  is going down the wrong alley.

Economic Implications of High and Rising Household Indebtedness

The Reserve Bank of New Zealand just published an interesting report on this important topic. High and rapidly rising levels of household debt can be risky. A high level of debt increases the sensitivity of households to any shock to their income or balance sheet. And during periods of financial stress, highly indebted households tend to cut their spending more than their less-indebted peers. This can amplify a downturn and helps to explain why many advanced economies since the 2008-09 crisis have had subdued recoveries. Financial institutions can suffer direct losses from lending to households, although these losses are rarely enough on their own to cause a systemic banking crisis. The sustainability of household debt can be assessed best by looking at data detailed enough to build a picture of how debt and debt servicing capacity is distributed across different types of borrowers.

Households, either individually, or in aggregate, can ‘over-borrow’, and financial institutions can ‘over-lend’ to them. A high level of household debt can affect both the financial system and the economy in several ways that are explained in this article.

Two sets of comparative data makes interesting reading. First, household debt-to-disposable income ratio – by country. Cross-country comparisons of debt levels need to be treated with caution, given a variety of measurement issues and different institutional features. That said, the rise in household debt in New Zealand over the last cycle was not exceptional compared to other countries, and Australia is higher.RBNZ-Household-RatioSecond, Household debt-to-income ratios – selected countries. The Reserve Bank comments that “in quite a few countries there was no domestic financial crisis and little sustained fall in house prices. Policymakers in several of these economies, including New Zealand, have subsequently become concerned by household sector developments over the past several years – developments underpinned by low interest rates and an easing in lending standards. Household debt levels have started to increase from already high levels, while house prices are growing from a starting point of ‘over-valuation’.

RBNZ-Debt-To-Income The implementation of an LVR speed limit in New Zealand reflected emerging developments in the housing market that if left unchecked, could have threatened future macroeconomic stability. Some other jurisdictions have also used new macro-prudential tools, in combination with improving the existing underlying prudential framework. In addition to LVR restrictions, other measures include: maximum debt servicing-to-income limits, maximum debt to-income limits, higher risk weights on banks’ housing loans and prudent (or responsible) lending guidelines.

They conclude that:

“This article has focused on the various channels through which household debt can affect the financial system and broader economy. In this sense, households can ‘over-borrow’, although this is often not apparent in ‘real time’ and excess debt levels can lead to, or aggravate, economic downturns or periods of financial distress. The relationship between household indebtedness and consumption volatility is important for the macroeconomy, because it means that the behaviour of highly indebted households during periods of financial duress can amplify downturns. While historical evidence suggests losses on household lending are rarely the sole factor in systemic banking crises, housing-related credit booms and busts often occur alongside booms and busts in other sectors such as the (much riskier) construction and commercial property sector. It is also worth noting that, over time, housing loan portfolios have become a larger share of bank lending in many countries, including New Zealand, increasing their potential to play a larger part in future financial crises. Thus household debt is an important area of focus from a financial stability perspective.

Good micro-level household data provide an important window into how debt and debt servicing capacity is distributed across the household sector, and are also helpful for carrying out simple stress-tests of the sector using a range of large, but plausible shocks. New Zealand’s data in this area are improving. Data from the Household Economic Survey show a rise in the proportion of borrowers with a high LVR and high debt-to-income ratio, thereby supporting the view that LVR speed limits have been appropriate to curtail risks to financial stability. The Reserve Bank will continue to develop its framework for analysing household sector risk and vulnerabilities.”

New Zealand’s Potential New Capital Rules on Investor Mortgages are Credit-Positive – Fitch

Fitch Ratings views positively the Reserve Bank of New Zealand’s (RBNZ) consultation on the capital treatment for mortgages to residential property investors. Higher capital requirements for investor loans combined with the existing loan to value ratio (LVR) limit could help protect banks against material losses in the event of a property price correction.

The RBNZ proposes to modify existing capital rules by requiring banks to include investor mortgages in a specific asset sub-class, and hold appropriate regulatory capital for those assets. Investor mortgages in New Zealand have performed similarly to owner-occupied mortgages but the experience in other markets has shown weaker asset quality performance in a downturn. The consultation paper seeks to define the terminology of investor mortgages in order to make policy decisions by end-April 2015. Currently investor mortgages are treated the same as owner-occupier mortgages for regulatory capital purposes in New Zealand.

The introduction of higher capital rules for investor mortgages may also slow the growth rates of property prices, particularly in Auckland. Increased investor demand and a rise in investor mortgages appear to be a contributor to this strong growth, and the RBNZ’s proposed limit could address some of the risks associated with these loans. The agency expects banks to charge higher interest rates on investor mortgages to offset the higher capital requirements which may deter some of the more marginal investment activity in the market. Price rises in Auckland have exceeded 10% per annum over the last 24 months which is unlikely to be sustainable in the long-term.

Investor mortgages typically have lower LVRs relative to owner-occupier loans and therefore are less susceptible to the RBNZ’s existing LVR restrictions, introduced in October 2013. Banks are only allowed to underwrite a maximum of 10% of new mortgages with an LVR in excess of 80% which has reduced some potential risk in the banks’ mortgage portfolios.

The new measures could also indirectly help to limit growth in household indebtedness by reducing house price appreciation closer to income growth. New Zealand’s household debt, measured as a percentage of disposable income stood at 156% at end-September-2014, which is high relative to many peer countries and has increased by 5pp since 2012. Although interest rates are still low compared to the historical long-term average, a rise in the official cash rate could place borrowers at risk of being unable to service their mortgages, and may eventually lead to asset quality problems for the banks. However, this risk is partly mitigated through bank affordability testing, which includes adding a buffer above the prevailing market interest rate when assessing serviceability.

 

RBA Trading Economic Growth Against Sydney Property

In Glenn Stevens Opening Statement to House of Representatives Standing Committee on Economics today, we get a glimpse of the drivers to lower interest rates. In addition, they are prepared to cut rates even if it leads to more growth in the Sydney property market to drive growth, even if that lever is now less powerful than previously.

Since the hearing in August last year, the economy has continued to grow at a moderate, but below-trend pace. Inflation as measured by the CPI has been affected by movements in energy prices and government policy changes, but even aside from these effects, inflation is low and appears likely to remain so.

The international context is one in which the global economy likewise is growing, but according to most observers at a pace a little below its longer-run average. There are some notable differences in performance by region. The US economy has picked up momentum, growing above trend with a falling unemployment rate. China’s economy met its growth target in 2014. A slightly lower target seems likely to be set for 2015, perhaps something like 7 per cent. But that would still be robust growth for an economy of China’s size. On the other hand, the euro area and Japan have recorded lower growth rates than expected a year ago.

Commodity prices have fallen, in some cases quite sharply. These trends appear to reflect primarily major increases in supply, with some moderation in demand playing a role. That would appear to be the case for iron ore and oil prices (and, prospectively, liquefied natural gas prices, which are typically tied to oil prices). Base metals prices, where few significant supply changes have occurred, have fallen by much less.

So there has been what economists refer to as a ‘positive supply shock’: more of the product is available with lower prices. The effect of this on individual countries will vary, depending on whether they are a producer or a consumer of such raw materials. On the whole for the global economy, however, this is a positive development.

Inflation is quite low in a range of countries, and very low in some. The decline in energy prices is temporarily pushing headline CPI inflation rates even lower.

The very low interest rates in evidence around the world when we last met have fallen further. This has been most pronounced in Europe, where yields on long-term German sovereign debt have fallen to be about the same as those in Japan. German sovereign debt has recently traded at negative yields for terms as long as 5 years. Official deposit rates are negative in the euro area, and the European Central Bank has announced a large-scale asset purchase program – colloquially referred to as ‘quantitative easing’. The euro has depreciated. Some surrounding countries to which funds tend to flow in anticipation of further depreciation – such as Switzerland – have reduced interest rates to significantly below zero and indeed 10-year Swiss government debt has traded at a negative yield. The Swiss National Bank took the decision to remove the cap on the Swiss franc, as it assessed that the size of the intervention likely to be required to hold it was becoming just too large. This move occasioned considerable turbulence in foreign exchange markets.

Meanwhile, the US Federal Reserve, faced with a strengthening US economy and having ended its asset purchase program last year, is expected to begin a gradual process of lifting its policy rate in a few months from now. So the monetary policies of the major jurisdictions look like they will be heading in differing directions. This means there is ample potential for further turbulence in financial markets this year.

The falls in prices for key export commodities are lowering Australia’s terms of trade and hence the purchasing power of our national income. This is a well-understood mechanism and has been the subject of much discussion. It will continue to constrain income growth for households and mining companies, and revenues for both state and federal governments, over the period ahead.

Resource export shipments are increasing strongly, as the capacity put in place by the period of high investment is put to use. At the same time, the high levels of capital spending by the resources sector, which had been a strong driver of domestic demand for several years, peaked during mid 2012 and turned down. All indications are that this downswing will accelerate this year. That has always been our forecast. The recent declines in commodity prices don’t change it, though they do reinforce that this trend is well and truly under way.

The various areas of domestic demand outside mining investment are mixed. Dwelling construction is rising strongly and commencements of new dwellings will reach a new high over the coming 12 months. Consumer spending is responding both to income trends and financial incentives, which are pulling in different directions. Growth in wages, by historical standards, is quite subdued. This and the fall in the terms of trade is working to restrain growth in disposable incomes. Working the other way, the fall in petrol prices, assuming it persists, is adding noticeably to the real incomes of consumers. Increased asset values, which push up gross measures of wealth, and low interest rates are also working to push consumption up relative to income. The net effect of these opposing forces is producing moderate, though not strong, consumption growth.

Meanwhile, at this point non-mining business investment spending is still very subdued. While several key fundamentals are in place for stronger performance, clear signs of a near-term strengthening remain unconvincing at this stage. This is a weaker outcome than we had expected six months ago. Public sector final spending – about one-fifth of aggregate demand – is fairly subdued, and the intent of governments, as you know, is to restrain their own spending over the period ahead. The lower exchange rate is likely to help export volumes outside the resources sector, and of late better trends have been observed in some services export categories including tourism and education.

Overall, growth in non-mining economic activity has picked up, but is still a little below average. Our expectation had been that a further pick-up would occur in 2015. When we reviewed our forecasts in late January, we didn’t feel that growth in the recent past had been materially different from what we had estimated a few months ago. But when we tried to look ahead, we concluded that there were fewer signs of a further pick-up in non-mining activity than we had hoped to see by now. As a result, the revised forecasts we took to the February Board meeting embodied a longer period of below-trend growth, and a higher peak in the rate of unemployment, than earlier forecasts. They also suggested that inflation was likely to remain pretty low over the forecast horizon. The inflation outlook was revised slightly lower, in part reflecting the effect of declining oil prices as well as the weaker outlook for economic activity.

At its meeting in February the Board considered that this revised assessment – that is, sub-trend growth for longer, a higher peak in the unemployment rate, slightly lower inflation – warranted consideration of some further adjustment to monetary policy, after a fairly long period during which the cash rate had remained steady. These were incremental changes to the outlook but all in a consistent direction.

Another factor in our consideration was dwelling prices, which have continued to increase. Price rises in Sydney are very strong, and they are pretty solid in Melbourne. On the other hand they are much more mixed elsewhere. Excluding Sydney, the rise for Australia as a whole over the past year was about 5 per cent. That is a healthy pace but not alarming, and some cities have seen price falls. Developments in the Sydney market remain concerning, but in the end we did not see these trends as overwhelming a case for a further easing in monetary policy that was made on more general grounds.

I note that, on the regulatory front, APRA has announced its supervisory approach to managing the potential risks posed by the rise in lending to investors in housing. This involves more intense scrutiny of investor loan portfolios growing at over 10 per cent per year, with the possibility, ultimately, of additional capital being required if APRA deems it necessary. APRA has also reiterated its expectations for other elements of lending standards such as interest rate buffers and floors. And ASIC has begun a review of interest-only lending in the context of consumer protection legislation. The Bank welcomes these steps and will keep working with other regulators in these areas.

The Board is also very conscious of the possibility that monetary policy’s power to summon up additional growth in demand could, at these levels of interest rates, be less than it was in the past. A decade ago, when there was, it seems, an underlying latent desire among households to borrow and spend, it was perhaps easier for a reduction in interest rates to spark additional demand in the economy. Today, such a channel may be less effective. Nonetheless we do not think that monetary policy has reached the point where it has no ability at all to give additional support to demand. Our judgement is that it still has some ability to assist the transition the economy is making, and we regarded it as appropriate to provide that support.

The forecasts published last week in the Statement on Monetary Policy assume a lower path for interest rates and a lower exchange rate than both earlier forecasts and the ones the Board responded to at the February meeting. These are assumptions rather than forecasts or commitments to a course of action.

It is worth noting that, despite concerns at various times about whether the exchange rate would adjust appropriately to our changing circumstances, it has been doing so over the period since we last met with the Committee. Against the US dollar it has fallen by around 17 per cent since our last hearing. The US dollar itself has been rising against all currencies, of course, so much of this movement is an American story rather than an Australian one. Against a basket of relevant currencies the Australian dollar has fallen by less, but the decline is still about 11 per cent since August. Further adjustment is probably going to occur.

One other development since our last meeting with the Committee was the final report of the Financial System Inquiry. This was quite a wide-ranging report and there is now a further period of consultation. I simply note that the Inquiry did not find major problems in the financial system, but did make recommendations about capital, to enhance the resilience of the banking system, and about loss-absorbency more broadly in the context of resolution. These will be mostly in the province of APRA to consider. The Inquiry also made some observations about payments matters, generally supporting the steps the Payments System Board has taken since its inception in 1998, and pointing to some areas where further steps may be appropriate. The Payments System Board will be considering these matters at its meeting next week.

RBA Lowers Growth Forecast

The RBA published their statement on monetary policy today.  They point to a lower than expected growth and inflation forecast, but higher rates of unemployment. GDP is now projected at 2.25 per cent to June, and a quarter percent lower by the end of the year than their last projection.  They are expecting unemployment to remain higher for longer, and above 6 per cent during 2017. Inflation is forecast at a headline level of just 1.25 per cent, thanks to lower oil prices, although the bank’s favoured core inflation measure still sits within its 2-3 per cent target.

Looking at the economic drivers, the banks said that the 9 per cent fall in exchange rates had yet to flow through into higher prices, and the fall in oil prices are estimated to have increased real household disposable income by 0.25 per cent over the last half of 2014, and will lift spending power by an additional 0.5 per cent over the first three months of this year.

“While growth in non-mining activity has picked up a little over the past two years, all components except dwelling investment look to have grown at a below average pace over the past year,” the RBA said.

The ABS capital expenditure survey suggests that there will be only very modest growth in non-mining investment in 2015.

The most significant comment for me related to the behaviour of households who have experienced significant lifts in wealth thanks to rising house prices, yet may not be turning this into higher rates of consumption.

“However, another possibility is that ongoing buoyant conditions in housing markets will have less of an effect on consumption than previously. In particular, in recent years fewer households appear to have been utilising the increase in the value of their dwelling to increase their leverage or trade up”.

This cuts to the heart of the problem. Their core strategy was to allow housing to expand, to lift wealth, to encourage spending, to drive growth, until the business sector kicks in. However, there is mounting evidence that households are not convinced, and are unwilling or unable to spend. Retail is still below trend, and as interest rates of savings fall, households become more conservative. It could be that their core thesis is flawed.  Indeed, they had previously acknowledged

“we shouldn’t expect consumption to grow consistently and significantly faster than incomes like it did in the 1990s and early 2000s, given that the debt load is already substantial”.

In our recently published household finance confidence index we noted a consistent fall. No surprise then households are not performing as expected.

How The Mining Boom Lifted Living Standards

In the RBA Bulletin for December 2014, there is a detailed analysis and modelling to show how the mining boom impacted the Australian economy. This is important because as we know the boom is fading, and the RBA has been looking for the housing sector to take up the slack.

The world price of Australia’s mining exports more than tripled over the 10 years to 2012, while investment spending by the mining sector increased from 2 per cent of GDP to 8 per cent. This ‘mining boom’ represents one of the largest shocks to the Australian economy in generations. This article presents estimates of its effects, using a macroeconometric model of the Australian economy. It summarises a longer research paper, which contains further details and discussion of the results (see Downes, Hanslow and Tulip (2014)). The model estimates suggest that the mining boom increased Australian living standards substantially. By 2013, the boom is estimated to have raised real per capita household disposable income by 13 per cent, raised real wages by 6 per cent and lowered the unemployment rate by about 1¼ percentage points. However, not all parts of the economy have benefited. The mining boom has also led to a large appreciation of the Australian dollar that has weighed on other industries exposed to trade, such as manufacturing and agriculture. However, because manufacturing benefits from higher demand for inputs to mining, the deindustrialisation that sometimes accompanies resource booms – the so-called ‘Dutch disease’ – has not been strong. Model estimates suggest that manufacturing output in 2013 was about 5 per cent below what it would have been without the mining boom.

Graph 3 also shows an estimate of the increase in the volume of goods and services produced arising from the boom. Higher mining investment directly contributes to higher aggregate demand. Furthermore, higher national purchasing power boosts consumption and other spending components. Higher mining investment also increases the national capital stock and hence aggregate supply. There are many further compounding and offsetting effects. The estimated net effect is to increase real GDP by 6 per cent.

RBABoom1The mining boom raises household income through several different channels within the model (Graph 8). As of 2013, employment was 3 per cent higher than in the counterfactual, largely due to the boost to aggregate demand. Real consumer wages were about 6 per cent higher, reflecting the effect of the higher exchange rate on import prices. Property income increased, reflecting greater returns to equities and real estate. A larger tax base led to lower average tax rates, all of which helped raise real household disposable income by about 13 per cent. As can be seen in Graph 8, household consumption is estimated to initially rise more slowly than real household disposable income. That is, the saving rate increases. This reflects inertia in consumption behaviour, coupled with a default assumption that households initially view the boom as temporary. In the medium to long run, as it becomes apparent that the change in income is persistent, savings return toward normal and consumption rises further. In the long run, consumption will adjust by about the same proportion as the rise in household disposable income.

RBABoom3Changes in the composition of consumption are an important determinant of how the mining boom affected different industries (Graph 9). Demand for motor vehicles and other consumer durables are estimated to have increased strongly, reflecting lower import prices and strong income growth. Relative price changes for most other categories of consumption were smaller, with consequently less effect on their relative demand.

RBABoom4 The mining boom can be viewed as a confluence of events that have boosted mineral commodity prices, mining investment and resources production. This combination of shocks has boosted the purchasing power and volume of Australian output. It has also led to large changes in relative prices, most noticeably an appreciation of the exchange rate. The combination of changes in income, production and relative prices has meant large changes in the composition of economic activity. While mining, construction and importing industries have boomed, agriculture, manufacturing and other trade-exposed services have declined relative to their expected paths in the absence of the boom. Households that own mining shares (including through superannuation) or real estate have done well, while renters and those who work in import-competing industries have done less well.

Property Momentum On The Slide

We just updated the DFA household surveys, with data to end November, and there are some interesting transitions in play, which taken together with potential action on foreign buyers, suggests we will see property momentum easing in the next few months. This actually may be a “get out of jail card” for the RBA and provide reasons why macroprudential may not be required after all, and why interest rates may need to be cut further next year, not lifted. Today we look at our cross segment summaries. You can read about our segment definitions and survey approach here. This update will later be incorporated on the next edition of the Property Imperative Report.

We begin with the updated estimate of the number of households by DFA segment. We find that there are 6.5 million households who are property active, and 2.25 million households who are property inactive (meaning they live in rentals, with family, friends or other accommodation). Those who are inactive continues to increase, with 26% of all households in this group now.

Of those who are active, we split them out into those with owner occupied property, those with investment property, and those who invest via SMSF. This is the national picture, to end November 2014. Of those households who are property active, 68.2% are owner occupiers, 31% have investment properties, and 0.8% have property investments via SMSF.

SegmentCountsDec2014Looking at the cross segment results, we are seeing a steady decrease in those saving in order to enter the property market. This includes the Want-to-Buys and the First Timers, the latter who are to some extent active in market exploration. Up-Traders and Down-Traders are saving a little more, but the lack of momentum in savings means households are less likely to try and enter the marker later. Three factors have influenced this trend. First, low deposit interest rates, second lower disposable incomes, and third, a view that prices are so high they will never be able to enter the market.

SavingDec2014Looking at the need to borrow, we see a continual rise in the demand for loans from those expecting to transact. Only Down-Traders are less likely to borrow. The need to borrow more is a reflection of higher prices in many states, though as we highlighted yesterday, there appears to be a change in the wind with regards to property prices. Lending for investment property will continue, so we may see additional controls on this type of lending coming though in due course as part of the regulatory review, but overall demand is unlikely to grow significantly beyond this.

BorrowMoreDec2014In our surveys, we see a consistent lowering of expectations, across the segments in relation to whether prices will rise in the next 12 months. Property investors are also a little more sanguine on house price growth, though still more optimistic that owner occupiers. That said, more than half across the board still are expecting a further rise, despite stretched loan to income ratios and high benchmarks.

PriceExpectationsDec2014So, turning to question of whether households will transact in the next year, we see falls in several significant segments – Portfolio Investors, and Down-Traders are most likely to transact. In sheer volume terms, it is the Down-Traders who are most likely to keep the property ship afloat as they attempt to liquidate some of the capital locked away in their property. We see a supply/demand re-balancing ahead, and as a result, a slowing in house price growth. If investors get cold feet, prices will fall from current levels.

Transact12MonthDec2014In the next few days we will delve into our segment specific results.

RBA’s Outlook for Australia’s Economy

In a speech today, Christopher Kent, Assistant Governor (Economic) outlined the current state of global and local economies, and commented on the outlook.  Significantly he stressed that the RBA was looking for household expenditure to trickle through to stimulate business investment and thus lead to a lift in the labour market. However, noting the fall in average real income, and waning consumer confidence, we think this will take a long time, even at current very low interest rates. In addition, we have very high loan to income ratios, and this is absorbing household wealth significantly. Raises an interesting point, are the underlying economic assumptions valid this time around?

Our expectation is that growth will continue to be a bit below trend for a time, picking up gradually to be a bit above trend pace by 2016. And the unemployment rate is likely to remain elevated for some time.

The near-term weakness reflects a combination of three forces: a sharper decline in mining investment over the coming quarters than seen to date; the effects of the still high level of the exchange rate; and ongoing fiscal consolidation at state and federal levels. In contrast, resource exports are likely to make a further strong contribution to growth, with LNG exports expected to begin ramping up over coming quarters. At the same time, very low interest rates are working to support growth of household expenditure. In time, growth of household demand and the impetus to domestic demand provided by the exchange rate depreciation we have seen since early 2013 are expected to spur non-mining business investment.

Given this outlook, I want to touch on two relevant aspects of the business cycle that are important sources of uncertainty for our forecasts. One is related to household consumption, the other to business investment.

Household consumption

At this phase in the business cycle, it’s natural to worry about the possibility that consumption will be weighed down by slow growth in household incomes, driven in turn by the subdued state of the labour market. It is true that stronger growth of employment and wages would provide more support for consumption. However, that dynamic usually kicks in later in the cycle. In the meantime, it’s reasonable to expect that very low rates of interest will enable and encourage households to shift some expenditure from the future to now, including via higher asset prices. This would see a decline in the share of disposable income that households save (i.e. a lower saving ratio). There are limits to this, and it would be unwise to build a recovery on a foundation of a sharp decline in the saving ratio.

Our latest forecasts, however, suggest that there will be a gradual decline in the saving ratio over the next couple of years, of the same order of magnitude as we’ve already seen over the past couple of years.

A decline in the household saving ratio would be consistent with the tendency for labour market developments to lag developments in economic activity, including consumption, by a few quarters. Consumption and GDP growth tend to pick up ahead of an improvement in employment growth, which would in turn be expected to occur before we see wage growth start to return to more normal levels. This was the case during the recessionary episodes of the early 1990s and following the global financial crisis.

sp-ag-131114-graph8

Non-mining business investment

I’ve spoken at length recently about the factors that might have led to subdued non-mining business investment over recent years.

In short, I concluded that this outcome had been consistent with a period of greater uncertainty and below-average confidence. Both of these have changed for the better more recently, yet firms still seem reluctant to take on risks associated with substantial new investment projects. If the appetite of businesses (and shareholders) for risk were to improve, investment could pick up. It’s hard to know when such a turning point in spirits might take place. But it is more likely when the fundamental determinants of investment are in place as they seem to be now. The ready availability of internal and external finance, at very low cost, is one such element of that. Also, there is the stronger growth of demand across the non-mining parts of the economy over the past year or so and measures of capacity utilisation have increased to around long-run average levels. So there is a reasonable prospect of business investment picking up, in time.

Even so, let me note some reasons why the anticipated recovery in non-mining business investment might not be quite as strong as in earlier episodes. But I will stress at the outset that if that comes to pass, it does not mean that growth of activity or of our prosperity need suffer.

One reason why investment in the non-mining sector might be lower than in the past is that service industries account for an increasing share of our economy – rising by about 12 percentage points in terms of the employment share over the past three decades. This is relevant to investment because service industries, on average, have much lower levels of capital relative to labour. So, in an economy in which services account for a higher share of economic activity, other things equal, the optimal (non-mining) capital stock should be lower  than it otherwise would be (as a share of that economy). However, that doesn’t imply that GDP growth will be lower, nor does it suggest that the economy will be a less prosperous one. What matters for these things is whether we are taking advantage of profitable opportunities and using labour and capital in the most productive ways that we can. Also, it is worth emphasising that many services require high levels of human capital – in the form of education and training – which does not get picked up in investment as measured by the national accounts.

sp-ag-131114-graph9

Investment today might also be lower (as a share of nominal GDP) than in the past for another reason. Over time there has been a sizeable decline in the price of many types of machinery and equipment (particularly those related to information and communications). So, businesses are able to spend less to obtain a given level of capital services. For example, they can purchase a lot more computing power for a given level of nominal spending. Once again, if this leads to lower investment (as a share of nominal GDP) than in the past it does not imply less output growth or lower prosperity. Indeed, given that Australia imports much of our machinery and equipment, a lower price of that capital is to our benefit.

Conclusions

The major advanced economies are in different stages of the business cycle. The recovery from recession is well established in the United States, but has a long way to go in the euro area. Japan has made some progress in reducing the extent of spare productive capacity, but inflation is still some way from the Bank of Japan’s target. Nevertheless, growth of Australia’s major trading partners has actually been around average for some time now and, as best we can tell, it is likely to remain at that rate in the year ahead.

Australian GDP growth has been a bit below trend pace over the past couple of years, consistent with a gradual rise in the unemployment rate. Much of the growth this past year owed to rising resource exports, although growth outside the mining sector also picked up. However, with mining investment set to fall more sharply over coming quarters, GDP growth is expected to be below trend for a time before gradually picking up to an above-trend pace by 2016.

The very low level of interest rates is supporting, and will continue to support, growth of household expenditure. In time, this is expected to support a recovery in non-mining business investment, and the economy more broadly, including an improvement in conditions in the labour market. If history is any guide, the recovery is likely to proceed in that order, from household expenditure to business investment to labour market conditions. History also suggests that a pick-up in business investment (outside of the resources sector) will come, in time. The fundamental forces are in place to support that recovery. And while I have suggested some reasons why business investment might not be quite as strong as past episodes of recovery might suggest, these don’t imply that the economy overall will be less strong than otherwise, but rather just one element of expenditure that we measure via the national accounts.

Why Mortgage Loans Are Growing Slower Than House Prices

The RBA, in today’s monetary statement discusses the relationship between loan growth and house prices. They conclude that factors including fear of unemployment, low supply, high loan to income ratios and stamp duty are all contributing factors, as well as price hikes themselves.

Indicators of conditions in the established housing market, such as housing prices, housing turnover and new borrowing, are interrelated and often move together quite closely (Graph A1). However, in recent years, housing turnover and loan approvals have risen by less than housing prices when compared with previous cycles in the housing market.

RBAA1

Turnover and loan approvals are closely linked. Each new housing loan represents a new transaction in the housing market (as long as it is not used to refinance an existing property or construct a new dwelling). Hence, the value of new borrowing will grow at about the same rate as the value of turnover as long as the average loan-to-valuation ratio does not change too much. In Australia, it turns out that the relationship between new borrowing and turnover has been quite stable for the past decade or so (Graph A2).

RBAA2

Housing prices and turnover might move together over time for a number of reasons, although the relationship may not be quite as tight as that between turnover and loan approvals (and it is possible for prices to rise with only limited turnover). One strand of research has found that an increase in housing prices causes an increase in turnover because higher housing prices increase the net wealth of homeowners. This allows those owners who did not previously have a large enough deposit to trade up to a more expensive dwelling, thereby increasing turnover. A complementary strand of research has found that the causality can also run in the other direction, from turnover to housing prices.

It suggests that some vendors might discern a rise in housing demand by observing a rise in turnover, thereby encouraging them to raise their reserve prices.

Turnover and housing price growth have moved together over time, although the relationship appears to have weakened somewhat in recent years. The change is most evident in Sydney and Melbourne, where growth in housing prices has been strongest of late (Graph A3). The rate of turnover has remained low in those cities, both in terms of their longer-term averages and relative to growth in housing prices.

RBAA3

It is difficult to know why the turnover rate has remained relatively low compared with its history and compared with prices. There is tentative evidence to suggest that existing homeowners have become more reluctant to borrow against increases in their net wealth to trade up homes. For example, the survey of Household Income and Labour Dynamics in Australia (HILDA) suggests that in 2011 and 2012 (the two most recent survey years) a smaller share of households bought larger homes than in any of the previous nine survey years. Also, there has been unusually low participation of owner-occupiers in housing market transactions recently (Graph A4). The reasons are not clear, although it partly reflects the fact that state government incentives for first home buyers have been redirected away from established dwellings towards new dwellings.

RBAA4

One possibility is that a reluctance to trade up homes reflects households generally becoming less willing to take on additional debt in recent years. Following the increase in leverage over the 1990s and early 2000s, the debt-to-income ratio has been stable at high levels. Although interest rates are currently low, the expected repayment burden on loans is at 10-year average levels, when calculated using a longer term interest rate to account for the expectation that variable interest rates will move up over time. Indeed, in New South Wales and Victoria, which have experienced the greatest disparity between housing prices and turnover relative to historical norms, the share of current income required to service an average loan over the next 10 years is close to historical highs.

Another consideration is that homeowners may be less willing to borrow more because growth in labour income has slowed. Nominal labour income has grown at an average annual rate of 2.7 per cent over the past two years, compared with a decade average of 6.2 per cent. And the widespread expectation is that wage growth will remain subdued for a time. Moreover, the Westpac-Melbourne Institute survey suggests that the share of households expecting more unemployment a year ahead has been at above-average levels since late 2011, which is an unusually long time by the historical standards of the survey.

Repayment obligations, in combination with uncertainty about future labour income, are an important consideration for homeowners. According to liaison with banks, one consequence of this environment is that an increasing share of owner occupiers is opting for interest-only loans to increase repayment flexibility.

A reluctance to trade up homes might also stem from increases in effective stamp duty rates. In some states, including New South Wales and Victoria, the nominal housing price thresholds at which higher rates of stamp duty apply have not changed for a number of years. As housing prices have risen, more buyers have fallen into the higher stamp duty brackets, acting as a disincentive to purchase housing. In New South Wales, for instance, the stamp duty paid on a median-priced home has grown to around 25 per cent of annual disposable income per household, from close to 10 per cent in 1991.

Finally, the relationship between turnover and housing prices can be affected by developments in housing supply. Additions to the housing stock have been relatively low in some states over recent years, which would weigh on the rate of turnover as it is currently measured, while low supply relative to demand would also put upward pressure on prices.