Rates stuck at 4 per cent
But in other ways, today’s home loan borrowers are in a vastly different position to those three decades earlier.
They don’t have to worry about mortgage rates hitting 17 per cent – indeed, home loan rates appear to be stuck at about 4 per cent for the forseeable future.
And they don’t have to worry that a brutal jump in unemployment will trigger a flood of mortgagee-in-possession sales, souring market sentiment and depressing housing prices even lower.
As Lowe pointed out, the present housing market correction is unusual. “Unlike the other four episodes in which housing prices have declined in recent decades, this one was not preceded by rising mortgage rates. Nor has it been associated with a rise in the national unemployment rate.
“Instead, in NSW, where the recent decline in housing prices has been the largest, the unemployment rate has continued to trend down. It is now at levels last seen in the early 1970s.”
But there is one important respect in which the current crop of home loan borrowers are at a massive disadvantage: they can’t rely on hefty wage rises to make their mortgage repayments more affordable. Indeed, households have endured weak income growth for quite some time.
Household psychology implications
This key difference has major implications for household psychology. As Lowe noted, it’s likely that people initially saw weak income growth as temporary, and dipped into their savings to support their spending.
But, he said, “as the period of weak income growth has persisted, it has become harder to ignore it”. And as people have revised down their expectations of future income growth, it appears they’ve resigned themselves to the necessity of reining in their spending.
(It’s also possible, although Lowe does not make this argument, that people’s enthusiasm for taking on mega-mortgages has diminished as it’s dawned on them that they can’t rely on big pay rises to reduce the stress of hefty home loan repayments. Certainly, there’s been an impressive drop in the number of new home loans where the loan-to-valuation ratio is above 90 per cent.)
The central question for the Reserve Bank, however, is the extent to which feeble consumer spending will continue to weigh on overall activity, especially after the latest figures show that the economy expanded by a sluggish 0.2 per cent in the December quarter, bringing the annual growth rate down to 2.3 per cent over the year to December.
Some economists argue that there is little prospect of any short-term recovery in consumer spending. They believe that consumers have tightened their belts in response to falling house prices, and that they’ll continue to exercise spending restraint while residential property prices continue to fall.
Lowe, however, believes there is only a limited “wealth effect” from falling housing prices.
The governor banks on wages
Reserve Bank researchers, he said, estimate that a 10 per cent increase in net housing wealth raises the level of consumption by about 0.75 per cent in the short run, and by 1.5 per cent in the longer run.
The wealth effect from higher housing prices is strongest on new cars and furniture, but is negligible on other major types of spending, such as food, health and education.
In contrast, Lowe argued there is a much more substantial “wealth effect” from weak income growth, because most people see their future earning capacity as the main source of wealth. As their estimates of their future income trajectory become more pessimistic, they’re likely to become more frugal.
“Wealth effects are influencing consumption decisions”, he said, “but they are working mainly through expectations of future income growth.
“Swings in housing prices and turnover in the housing market are also having an effect, but they are not the main issue.”
Lowe’s analysis of the “wealth effect” has important implications for the next move in interest rates.
If he accepted the argument that consumer spending was slumping in tandem with falling house prices, the Reserve Bank would be much more anxious to cut interest rates in order to stabilise residential property prices.
But Lowe takes a different view. He believes that as the labour market tightens, we’re likely to see a further pick-up in wages growth and “this should boost household income and spending and provide a counterweight to the fall in housing prices”.
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