This morning, largely for my own small-minded recreation, I thought I’d draw up a chart or three to look at the correlation or otherwise between lending for property investment activity in New South Wales and adjustments to the official cash interest rate by the Reserve Bank.
The first chart details the movements in the official cash rate in Australia as determined by the Reserve Bank of Australia (click to enlarge), with five separate periods wherein interest rates were dropped:
The tremendous reduction in the cash rate from nosebleed levels in February 1990 to just 4.75% in July 1993 mirrors the below dynamic, whereby the raging rate of inflation was essentially brought under control.
After a period of rates reverting upwards, another series of interest rate cuts from 7.50% to 4.75% followed between July 1996 and December 1998.
Around the turn of the century was a rocky period for market sentiment as the tech stock or dotcom bubble burst, met by a rapid series of rate cuts from 6.25% to 4.25%, all delivered in the calendar year 2001.
Although such corrections tend to look less dramatic in the rear view mirror, Australian stock valuations suffered a couple of nasty falls in 2001 and through 2002-3 (which is circled in the middle of the equities markets corrections circled below).
The below chart (click to enlarge) represents lending finance to property investors in New South Wales across a similar time horizon to the cash rate history chart.
Note that due to their nature the monthly figures tend to be highly volatile and therefore I’ve charted them on a rolling 12 monthly basis to smooth out the volatility.
(1) Property investment may have been less popular a quarter of a century ago than it is today, but the first major salvo of interest rate cuts from 1990-1993 eventually resulted in an upturn in property investment lending.
The impact looks less than dramatic in the chart above since the numbers are not inflation-adjusted, but the rolling 12 monthly value of investment lending did increase.
The early 1990s was a period of great uncertainty with the dissolution of the Soviet Union in 1991 and Australia sliding into recession (and in any case, interest rates were much higher than they are today, dampening the impact) but lower interest rates did ultimately have some effect.
(2) A series of rate cuts between 1996 and 1998 resulted in a material pick-up in property investment loans.
(3) The next major salvo of rate cuts experienced from 2001 also appears to have had a marked response on property investor activity.
The first smattering of red asterisks on the above chart represent the following cash rate adjustments:
-7 February 2001 – 50 bps to 5.75%
-7 March 2001 – 25 bps to 5.50%
-4 April 2001 – 50 bps to 5.00%
-5 September 2001 – 25 bps to 4.75%
-3 October 2001 – 25 bps to 4.50%
-5 December 2001 – 25 bps to 4.25%
The result was a huge investor-led property boom in Sydney from exactly that time through to the early part of 2004.[sam id=40 codes=’true’]
(4) Thereafter, following a long half decade of disinterest from investors, the harbour city experienced a mini-boom in lending for property investment in 2009 in response to emergency interest rate cuts related to the subprime crisis and ensuing global financial meltdown (from which Australia was to some extent shielded by a boom in mining investment).
However, this bout of exuberance was quite quickly brought under control by a series of seven consecutive 25 bps hikes in the cash rate from October 2009 to November 2010.
(5) The second peppering of asterisks on the chart represents the following adjustments to the cash rate, which were brought about largely by various government debt crises and related shocks to global sentiment:
-1 November 2011 – 25 bps to 4.50%
-6 December 2011 – 25 bps to 4.25%
-1 May 2012 – 50 bps to 3.75%
-5 June 2012 – 25 bps to 3.50%
-2 October 2012 – 25 bps to 3.25%
-4 December 2012 – 25 bps to 3.00%
-7 May 2013 – 25 bps to 2.75%
-6 August 2013 – 25 bps to 2.50%
Clearly bringing down the cash rate to generational lows has had a tremendous impact on property investment lending in New South Wales, although notably the impact of investor lending has been less intensely felt in other cities.
On five separate occasions, then, cuts in the cash rate have resulted in a boost to property investment lending.
The absolutely key point is that credit markets did not dry up during those periods in Australia.
Clearly where an economy falls into recession and credit markets are short-circuited, the outcome is completely different: interest rate cuts delivered fail to rescue real estate markets in the absence of liquidity and the result is likely to be a crash in property prices, such as experienced in the US and parts of the UK during the financial crisis.
A functioning property market clearly requires a healthy balance between homebuyer activity, upgraders, investors to provide dwellings for renters, social housing and so on
The current situation is that the majority of lending in NSW is for investment activity thus elbowing the markets into disequilibrium and sending prices sharply upwards (the respective roles of dwelling undersupply and foreign buyers are debates to be carried out another day).
Should the current spate of promising economic data continue, the cash rate will eventually be moved back towards a neutral level and lending for property investment would then tail off.
However, interbank cash rate futures markets are presently pricing in a scenario which assumes that interest rate hikes are still some way away (perhaps even more than a year), and therefore in the absence of macro-prudential measures or other regulatory intervention the current unbalanced situation may yet have quite a period of time to run.