Sydney property prices keep the Reserve Bank of Australia awake at night

“Since 2016, the RBA’s focus on financial stability has held them back from further rate cuts as they wait for wages and inflation to recover,” said Daniel Blake, a strategist at Morgan Stanley in Sydney, who expects nationwide house prices to drop 10 to 15 per cent. “In 2019, we see their focus turning to monitoring the negative wealth effects from a housing market adjustment.”

The housing slump could take some time to unwind. Historically, corrections have been triggered by very tight policy; the cash rate went above 17 per cent in the pre-recession downturn, whereas now it’s 1.5 per cent. With no scope for deep rate cuts to draw buyers back to the market, and prices still at astronomical levels, it could take some time for affordability to return.

Yet at the same time, the economy is still growing just above its speed limit and the jobless rate is at 5 per cent, the lowest in more than six years. Lowe said he suspects unemployment could fall to 4.5 per cent without seeing rapid wage growth. With inflation low, the economy is in a relatively healthy position.

“This is to some extent uncharted territory to see this sort of dynamic play out in an environment where — as of now at least — the macro economy is traveling at a reasonable place,” RBA No. 2 Guy Debelle said earlier this month. “Nearly all other house price falls have occurred in environments where there’s been recessions and the like.”

The RBA would ideally like to see household incomes start to enjoy a strong, sustainable increase to help the property market find a bottom quicker, and for that to flow through to faster inflation. Such a smooth transition would set the scene for the first rate increase since 2010, but it’s also pretty unlikely.

The worst case would be a multi-year property downturn in Sydney and Melbourne — the second-largest city — and stagnant wages. That, together with a slowdown in global growth, could force the RBA to deploy its remaining ammunition and push rates toward zero.

Money markets were pricing in about a 12 per cent chance of a rate cut in the next six months and a 20 per cent chance through to the end of 2019, in Sydney at 8 a.m. on Wednesday. There was about a 44 per cent chance of a hike by the end of 2020.

Bloomberg

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