February 2021 Market Update
In February, government bond yields rose sharply whilst equities experienced a volatile month. Commodity prices were strong and dwelling prices increased by 2.0%.
Taken from the CBA Global Economic and Markets Research report in publications titled "Economics: Issues", first published on 15 February 2021.
The Australian housing market is on the cusp of a boom. New lending has lifted sharply. Dwelling prices are rising briskly in most capital cities. And turnover is up significantly on year ago levels (charts 1 & 2). Near term indicators of momentum suggest conditions will further strengthen. Auction clearance rates are sitting at levels consistent with double-digit dwelling price growth (chart 3). And both the CBA home buying measure in our Household Spending Intentions series and the house price expectations index from the WBC/MI Consumer Sentiment survey have surged.
In many respects it’s a simple story. The boom is being driven by record low mortgage rates coupled with a V-shaped recovery in the labour market. Borrowing rates, which are the single biggest driver of prices in the short run, remain below the rental yield in most markets across Australia. This is an unusual situation and means that property markets across the country need to find an equilibrium. For the bulk of Australia, equilibrium will be achieved via further dwelling price rises.
We expect strong growth in national dwelling prices of ~14% over the next two years (8 capital city basis). A critical assumption underpinning our forecasts is the cash rate remaining at its record low of 0.1%, which is in line with RBA forward guidance. We do, however, factor in a modest increase in fixed rate mortgages, which will rise if the RBA removes or raises its target yield on the 3yr Australian Government bond, as we expect in the second half of 2021.
Our forecast profile is centred on prices growth of 8% in 2021 and 6% in 2022. The risks are skewed towards stronger outcomes given the strength of the demand impulse from the reduction in mortgage rates over 2020 (note that is it the percentage change in interest rates that has the greater impact on dwelling prices as opposed to the percentage point change in interest rates). There will be significant variation across the capital cities, as is always the case.
In a less common occurrence, we expect a disparity between prices growth for houses compared to apartments. We forecast national house prices to rise by ~16% over the next two years and unit prices to rise by ~9%. This note outlines our views on dwelling prices, our underpinning assumptions and the risks to our forecasts.
The negative impact that COVID-19 had on Australian property prices turned out to be much more muted than almost any forecaster expected, us included. We were earlier than most, however, to recognise this and revised our call in September 2020 to look for a smaller peak-to-trough fall and a decent lift in prices over 2021. But even then, the rapid growth in new lending over the second half of 2020 was stronger than we anticipated. The increase in new lending is now feeding into higher prices for bricks and mortar.
Dwelling prices have risen across all capital cities over the past three months (November 2020 to January 2021). And house prices have risen a lot faster than unit prices over that period (chart 4). The early data so far in February indicates prices growth has accelerated. At the time of publication the CoreLogic 5 capital city aggregate daily index has risen by 0.8% over the first two weeks of February. This points to monthly growth in dwelling prices of ~1.6% in February. It is clear that a firm uptrend in prices is underway and the factors which drive price outcomes over the short run are all pulling in the same direction.
The flow of credit (i.e. new lending) has a clear impact on dwelling prices. More specifically, the annual change in the flow of credit has a close leading relationship with the annual change in dwelling prices by around six months (chart 5).
New lending is driven by the supply and demand for credit. And the price of credit is defined by mortgage rates, which sit at record lows. The latest official ABS lending data indicates that new lending has rocketed higher over the past six months (chart 6). Our internal data paints a similar picture. Initially the lift in new lending was driven by owner-occupiers, including a big lift in lending to first home buyers. But more recently lending to investors has also accelerated (chart 6).
The effect of lower interest rates on the housing market is three-fold: (i) lower interest rates essentially mean that for a given level of income a borrower can service a bigger mortgage, all else equal; (ii) lower interest rates mean that the rental yield an investor is willing to accept is lowered; and (iii) lower interest rates shift the relative attractiveness of renting versus home ownership, all else equal.
It is reasonable to assume that the RBA’s forward based guidance on the cash rate is having a stimulatory impact on the demand for credit. Over the latter part of 2020 the RBA regularly stated that, “the Board is not expecting to increase the cash rate for at least three years”. At the February 2021 Board meeting “at least three years” had shifted to “2024 at the earliest”.
Like all asset markets, there is clearly a momentum to the property market. It is often the case that both owner-occupiers and investors wait until they see a positive momentum in the market before they transact. This of course creates a self-fulfilling dynamic – as the market firms, would-be buyers are more confident to purchase and this brings other buyers into the market. Price rises are the inevitable outcome and this creates a positive feedback loop that can continue for an extended period, particularly in an RBA easing cycle, until there is a circuit breaker (e.g. interest rate hikes, macro-prudential tightening, a negative economic shock) or general fatigue.
And over the past four months the key indicators of momentum that we monitor have all strengthened. Our CBA home buying measure in our Household Spending Intentions series, for example, has powered higher in recent months. The strength in momentum will manifest itself in higher price outcomes and it is now simply a question of how fast prices rise and over what period.
As a starting point for price outcomes in the near term we have input the latest leading indicators of the property market into our proprietary model. Our model puts the annual change in national dwelling prices as a function of the annual change in mortgage rates, the annual change in the flow of credit, auction clearance rates and the house price expectations index from the WBC/MI Consumer Sentiment survey, with varied lags. A literal read of our model implies that prices will rocket higher (chart 8). But all models have limitations and we believe that falling rents due to rising vacancy rates in some markets - notably the Sydney and Melbourne apartment markets - will temper the price outcomes that our model is signalling.
Notwithstanding, price outcomes are still forecast to be strong. Our quantitative assessment of the residential market, overlaid with our qualitative views, means that we expect national property prices to rise by around 8% in 2021 (9% for houses and 5% for apartments). We forecast dwelling prices to rise by a further 6% in 2022 (7% for houses and 4%) for apartments) taking the combined price rises over the next two years to a little over 14%.
The effect of record low mortgage rates on dwelling prices is expected to wane a little in 2022 – it is the change in rates that provides the impulse on the housing market rather than the level of rates (chart 9). But working the other way will be an expected lift in population growth as the international borders are reopened which will boost the underlying demand for housing.
Our base case for property prices in Sydney and Melbourne sees them rise by 7.5% and 7% respectively over 2021. Stronger price rises are forecast for all other capital cities. We do not produce point forecasts for regional Australia, but note that price gains in 2020 were stronger in regional Australia than in the capital cities. This trend looks likely to continue in 2021.
Table 1 details our point forecasts by capital city. There are both upside and downside risks to our forecasts, as discussed below, but overall the risks are skewed to the upside.
|Sydney||Melbourne||Brisbane||Adelaide||Perth||Hobart||Darwin||Canberra||8 capital cities|
|ann % chg to Dec 2021 (f)||7.5||7.0||9.5||9.0||10.0||9.0||12.0||9.0||8.0|
|ann % chg to Dec 2022 (f)||5.8||5.0||6.5||5.5||7.0||6.0||6.0||6.0||6.0|
|2yr % chg to Dec 2022 (f)||13.7||12.4||16.6||15.0||17.7||15.5||18.7||15.5||14.4|
Downside: In our view there are three key downside risks to our property price forecasts. First, the reintroduction of macro-prudential measures to slow the rate of growth in lending. Measures introduced a number of years ago to slow both the rate of growth in lending to investors and the rate of growth in interest-only lending were successful in slowing dwelling price appreciation. At this stage we consider the reintroduction of macro-prudential measures to be a relatively low risk in 2021. That is because we expect only a modest lift in the outstanding stock of household debt (new lending is rising but lower interest rates accelerate debt repayment – see here). However, if new lending accelerated too quickly, particularly to investors, there is a risk that the Australian Prudential Regulatory Authority (APRA) could reintroduce macro-prudential measures to slow things as they did in 2017.
Second, a lift in the RBA cash rate resulting in higher standard variable rates. That appears highly unlikely given the RBA has stated that it does not expect to increase the cash rate until, “2024 at the earliest”. But it is a risk nonetheless and must be considered given the single biggest driver of property prices in the short run is changes in interest rates.
Third, a significant outbreak/s of COVID-19 that resulted in large-scale extended lockdowns as was the case in Melbourne last year between July and October.
Upside: The key upside risk to our forecasts is sustained exuberance combined with FOMO (’fear of missing out’) which could generate a turbo-charged rise in prices. Indeed we consider this to be the biggest risk to our forecasts given the demand impulse from interest rate cuts, the level of interest rates relative to the rental yield and the recent spike in momentum indicators. History shows that prices can rise very quickly when the housing market is on a roll. Indeed it may turn out to be the case that the growth profile for price outcomes over the next two years ends up more front loaded than our current projections.
A second upside risk is any further policy changes to boost housing demand such as first-home-owner grants or lower stamp duty (to domestic or foreign buyers). This looks unlikely, however, given the current state of the market.
Finally, if the RBA do not remove or increase the target yield on the 3yr Australian Government bond that would mean that fixed rates are unlikely to drift higher in H2 2021 and 2022 as we expect. However, the risk overall of interest rates being lower than we expect is small given the cash rate is at the effective lower bound, the economy is on an entrenched recovery path and negative interest rates remain, “extraordinary unlikely”. Normally we would consider lower than expected mortgage rates to be an upside risk. But with the cash rate target, the target yield on the 3-year Australian Government bond and the interest rate on Term Funding Facility all at 0.1%, that risk is small.
Monetary policy and more specifically the cost of money impacts all asset markets, including housing. The reason that asset prices, including dwelling prices, can seemingly decouple from the economy comes down to largely one thing – central bank policy and changes in the cost of money.
The COVID-19 economic shock has resulted in the RBA taking the policy rate down to the effective lower bound. But it is easy to forget that interest rates were incredibly low before the pandemic. The RBA delivered three 25bp cuts to the cash rate in 2019 that took the policy rate to just 0.75%. As a result, dwelling prices were rising strongly when the COVID-19 shock hit.
As American economist Herbert Stein so eloquently stated, “if something cannot go on forever, it will stop.” The process of cutting interest rates to stimulate economic activity over the past 30 years has resulted in the policy rate now sitting at 0.1% (chart 10). Over that period, the increase in dwelling prices has massively outstripped income growth and the ratio of household debt to income has climbed (chart 11).
It will be incredibly hard for the RBA to raise the cash rate in any material sense from here given the level of household indebtedness. Indeed we estimate the neutral rate has fallen to around 1.0%. This means that when the next negative economic shock arrives we are unlikely to have the interest rate lever available to give households debt relief. In addition, we won’t be able to stimulate the interest rate sensitive parts of the economy with more rate cuts. This leads us to believe that we are inching towards a new paradigm that will involve some form of monetary financing in the future (i.e. a direct transfer of money from the central bank for government to spend). It may still be a long time away, but the bottom line is that the system as we know it will need to be reset and the printing press will be part of that reset.
Colonial First State is pleased to confirm that the CFS "Australian residential property prices to rise" article has been accredited for a maximum of 0.75 Continuing Education (CE/CPD) hours by Portfolio Construction Forum, the specialist, independent, investment continuing education, accreditation and certification service.
While the CE/CPD hours are confirmed, they will not formally vest in your name until you have completed the Forum’s CE quiz for this learning activity – available at the link below. This is part of the best-practice compliance program that Colonial First State has adopted to manage CE/CPD obligations in today’s higher compliance environment.
As soon as you successfully complete the CE quiz – available at the link below – you’ll receive an email from Portfolio Construction Forum. It will contain a link to immediately access your CE/CPD certificate via your complimentary Forum MyCE record on the Forum’s .edu.au online learning platform (which records any CE/CPD hours you earn from the Forum's CE Affiliates and the Forum's face-to-face and online programs) so you can:
These CE/CPD hour(s) can be used to help you meet the CE/CPD requirements of 20 governing bodies (regulators, associations, and institutes) – including ASIC, APRA, FASEA, FMA, AFA, and FPA CE/CPD requirements, to name just a few.
When you click on the above link, you may be prompted to log in.
If you have any problems, please contact Portfolio Construction Forum (phone +61 2 9247 5536 or email email@example.com).
This document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State). The information, opinions, and commentary contained in this document have been sourced from Global Markets Research, a division of Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945. Global Markets Research has given Colonial First State its permission to reproduce its information, opinions, and commentary contained in this document.
This information was first made available to CBA clients on 15 February 2021 in publications titled ”Global Economic and Markets Research - Economics: Issues".
Colonial First State is a wholly owned subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124, AFS Licence 234945 (the Bank). Colonial First State is the issuer of super, pension and investment products. The Bank and its subsidiaries do not guarantee the performance of Colonial First State’s products or the repayment of capital from any investments.
While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), to the maximum extent permitted by law, no person including Colonial First State, Global Markets Research, or any member of the Bank group of companies, accepts responsibility for any loss suffered by any person arising from reliance on this information.
This document provides information for the adviser only and is not to be handed on to any investor. This document has been prepared for general information purposes only and is intended to provide a summary of the subject matter covered. It does not purport to be comprehensive or to give advice. The views expressed are the views of Global Markets Research at the time of writing and may change over time. This document does not constitute an offer, invitation, investment recommendation or inducement to distribute or purchase securities, shares, units, other interests, or to enter into an investment agreement.
Past performance is no indication of future performance. Stocks mentioned are for illustrative purposes only and are not recommendations to you to buy sell or hold these stocks.
This document cannot be used or copied in whole or part without Colonial First State’s express written consent.
Copyright © Commonwealth Bank of Australia 2021.
Adviser use only
Adviser use only
Unless otherwise specified, this document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) based on its understanding of current regulatory requirements and laws as at the date of publication. While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), to the maximum extent permitted by law, no person including Colonial First State or any member of the Commonwealth Bank group of companies, accepts responsibility for any loss suffered by any person arising from reliance on this information. Colonial First State is the issuer of interests in FirstChoice Personal Super, FirstChoice Wholesale Personal Super, FirstChoice Pension, FirstChoice Wholesale Pension, FirstChoice Employer Super offered from the Colonial First State FirstChoice Superannuation Trust ABN 26 458 298 557. It also issues interests in the Rollover & Superannuation Fund (ROSCO) and Personal Pension Plan (PPP) offered from the Colonial First State Rollover & Superannuation Fund ABN 88 854 638 840. Colonial First State also issues other investment products made available under FirstChoice Investments and FirstChoice Wholesale Investments, other than FirstRate Saver, FirstRate Term Deposits and FirstRate Investment Deposits which are products of the Commonwealth Bank of Australia ABN 48 123 123 124, AFS Licence 234945 (the Bank). Colonial First State is a wholly owned subsidiary of the Bank. The Bank and its subsidiaries do not guarantee the performance of FirstChoice products or the repayment of capital from any investments. This document provides information for the adviser only and is not to be handed on to any investor. It does not take into account any person’s individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement (PDS) before making any recommendations to a client. Clients should read the PDS before making an investment decision and consider talking to a financial adviser. PDSs can be obtained from colonialfirststate.com.au or by calling us on 13 18 36.
From time to time, Colonial First State enters into alliance partnerships with dedicated and experienced investment specialists. Each alliance represents an agreement for Colonial First State to provide third party distribution services within the Australian Financial Services intermediary market.
Past performance is no indication of future performance.
Stocks and investment options mentioned are for illustrative purposes only and are not recommendations to any person to buy sell or hold these stocks.
Taxation considerations are general and based on present taxation laws and may be subject to change. Clients should seek independent, professional tax advice before making any decision based on this information. Colonial First State is also not a registered tax (financial) adviser under the Tax Agent Services Act 2009 and clients should seek tax advice from a registered tax agent or a registered tax (financial) adviser if they intend to rely on this information to satisfy the liabilities or obligations or claim entitlements that arise, or could arise, under a taxation law.