Why rising rates could actually boost house prices even further: Gottliebsen

Tomorrow’s Melbourne Cup Day deliberations by the Reserve Bank board present issues far more complex than most commentators are canvassing.

If the Reserve Bank directors are not very careful, higher interest rates could actually increase long-term dwelling prices – the direct opposite of what the central bank intends.

The conventional commentary explains that Australia is performing much better than expected and that will be confirmed by today’s economic statement. Interest rates are lower than normal as part of an economic stimulation that is no longer required so we must restore interest rates to more conventional levels.

Inflation is breaking out in some areas, particularly state government charges, so it is necessary to act quickly on the rate front. And so the market expects interest rates to rise by at least half a percentage point in the next three months and to keep rising during 2010. Treasury warns that the Bank should not move too quickly because the Government is withdrawing stimulus so there is a risk that the twin blows to the economy will halt the recovery, particularly given recent trends in the US.

That sounds pretty straightforward. But the debate then focuses on the games that try and pick the trend on a month by month basis, which I leave to those who specialise in short-term predictions.

If only the issues were that easy. While the above is the public agenda of the Reserve Bank, its hidden agenda is that it is deeply concerned that the recent sharp rise in dwelling prices and the bank fears that a new bout of housing affordability issues and an eventual price bubble is looming as Australian housing prices move outside world trends. The rising dwelling prices are pushing the central bank towards lifting interest rates more sharply, despite Treasury caution.

Then enter Harry Triguboff – the largest owner and builder of apartments in Sydney and a major force in Queensland.

Understandably many discount Triguboff’s conclusions because he clearly has an axe to grind. But over the years I have found that the base trends that Triguboff isolates are right nine times out of 10, but his remedies are uncomfortable. When Sydney was booming he said the city was dying, but then declared it would not die because eventually the politicians and local councils would start making sensible decisions. It’s taken eight years but they are now listening to him.

Triguboff points out that for the last five years the construction of Australian housing has been half the demand created by rising population, so a huge backlog has developed.

Triguboff now says: “If the Reserve Bank insists on raising interest rates in the hope of suppressing prices, then they must understand that they will in turn suppress construction”.

“Banks are still very cautious and will insist on decent margins of profit, otherwise they will not advance loans to developers. I know that the Reserve Bank does not want to do it, but they have to make up their minds. Interest rates should not rise until building activity increases significantly. That is the true reasons for raising interest rates – stop oversupply. But all the evidence and rents and prices point to undersupply for the foreseeable future.”

What Triguboff is highlighting is that the dramatic rises in Australia’s population complicate the interest rate argument. The Reserve Bank will not halt interest rate rises because of the Triguboff warning, but they need to understand that their current decision making process may create the opposite of what they expect in long-term dwelling prices.

This article first appeared on Business Spectator.