Housing finance turns up… and why interest rates will remain lower

Lending for housing finance expanded 5.1% in July 2019, compared with the prior month, lifting to AUD17.896 billion as lending to Owner Occupiers lifted by 5.3% to AUD13.253 billion. The value of loans to investors also rose, but by a more muted 4.7%, as commentators argued over the extent to which the successive interest rate cuts were responsible for the lending increase.

Over the longer term, despite the monthly tick up, the total value of dwelling loans is still 11.8% lower than in July 2018, as the chart below shows. But the best news is that the annualised declines have slowed, and may have been arrested.


Fig 4

To go straight to the dashboard and take a closer look at the data, click here.

The value of loans to First Home Buyers grew ‘on trend’ in July, lifting 5.2% to AUD3.367 billion. It is not immediately clear in the chart, but the really good news is that is the highest level seen since January 2012, and in July, these loans accounted for 18.8% of the total value of loans. Household formation, which First Home Buyers generally represent, is the lifeblood of new building activity in Australia.

Fig 5

To go straight to the dashboard and take a closer look at the data, click here.


We can see in the chart that the number of loans to First Home Buyers has been higher in recent times, but at 9,258 loans in July 2019, they accounted for 28.7% of total number of loans. Value is one thing (18.8% of the total), but presence in the market is another, and is just as valuable.

It is also easily observable that the average value of loans to First Home Buyers has grown for most of the last year. At AUD363,664, First Home Buyers appear to have taken advantage of the interest rate cuts and pushed their borrowing a little harder to get into the market. Just how long and deep that market is remains to be seen, but in this space and at this time, any growth is good growth.

As we wait for what now seems to be the inevitable next interest rate cut, in the context of housing markets it is very helpful to also be operating with latent demand.

A ‘neutral’ interest rate? Get used to lower rates, they appear to be structural

The neutral interest rate – the estimated natural rate of interest that supports full employment, assuming stable inflation growth – declined by around 1.5% between September 2007 and September 2017.

Based on modelling of demographic changes and especially the balance between workers and retirees, the outcome feeds into the view that lower interest rates are likely now, and into the long term. There is an element of this research which could be self-serving for central banks that have been forced to reduce interest rates to historic lows over the last decade.

However, as the RBA research points out, slowing population growth, increased life expectancy and trend increases in employment (fuelled by higher participation rates and later retirement) can have the following effects:

·         Capital/asset holdings are higher as savings increase to fund longer retirements – described as the ‘precautionary saving motive for workers’;

·         Marginal production of capital is lower, due to increased savings, causing a significant downward adjustment of the neutral interest rate;

·         Life expectancy and lower interest rates reduce households’ marginal propensity to consume, from their higher incomes.

The really telling point is the second of the items above. With higher asset holdings, people living longer will continue to save, even where interest rates (their income) is lower. That in turn reduces consumption at the macro level, which suppresses inflation. It continues the cycle of lower interest rates.

But, that lower interest rate is acceptable within the economy because it is all that is needed to sustain full employment of those who are still in work.

Ultimately, the output of this modelling is that consumption and investment shares of total income are adjusted downwards by 300 basis points (3.0%) from 1950 to 2000 and by 10 basis points (1.0%) from 2000 to 2050.

If nothing else, this research indicates that lower interest rates are more likely in the future, rather than less likely.

RBA research paper