Watch Australia's Property Sector for Clues of Global Slowdown

 | Jun 20, 2017 | 8:00 AM EDT
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The minutes of the Australian central bank do not rank very high on today's agenda for investors, but they deserve attention. Together with other data and events, they cast a light on what happens when investment in residential property ebbs after a strong surge.

While their direct impact on Australia's property market is quite small, Chinese investors have contributed to strong rises in housing prices in major property hotspots such as the U.S., Canada and the U.K. Some countries acted to slow down this trend. In Vancouver, Canada, authorities introduced a 15% tax on foreign purchases last year, which sent home prices tumbling.

Australia's residential property prices skyrocketed as the appetite for investment in housing boomed due to record-low interest rates. Interest by investors from China who were seeking to shelter funds from the weakening yuan also played a part. While Australian legislation dictates that foreigners are only allowed to buy existing homes to live in them, those buying off-plan properties do not face these restrictions.

Increasingly aware of the risk posed by the growing housing bubble, Australia earlier this year tightened macroprudential legislation, restricting the use of interest-only mortgages to 30% of total new residential lending in the country.

Interest-only mortgages are particularly risky because investors only pay the interest on the loan, needing to come up with the money to pay the principal at the end of the mortgage. They were essentially a bet that house prices will keep rising and used to make up nearly 40% of total residential mortgage lending by banks.

The Reserve Bank of Australia's minutes of its June 6 monetary policy meeting try to sound optimistic, saying that conditions in the housing market "varied considerably" around the country:

"Housing prices had been rising briskly in some markets, although there had been some signs that price pressures were starting to ease. In the eastern capital cities, a considerable additional supply of apartments is scheduled to come on stream over the next couple of years. Growth in housing debt had outpaced the slow growth in household incomes."

House prices in Australia increased by around 2.2% in the first quarter, in line with expectations. Performance varied among hotspots such as Sydney, where they were up more than 14%, and Melbourne, up 13%, and cities such as Perth (down 3.5%) and Darwin (down 5.9%).

Paul Dales, chief economist for Australia and New Zealand at think-tank Capital Economics, wrote in recent research that the first quarter of this year "will probably go down in history as the point at which house price inflation peaked."

"Policymakers have engineered the slowdown that appears to be underway, but there's surely a risk that it goes too far too soon," Dales stated.

On Monday, June 19, Moody's cut by one notch to Aa3 the ratings of Australia's four largest banks -- Australia & New Zealand Banking Group Ltd., Commonwealth Bank of Australia, National Australia Bank Ltd. and Westpac Banking Corp.

"Risks associated with the housing market have risen sharply in recent years," the rating agency's statement said. "The tail risk represented by increased household sector indebtedness becomes a material consideration in the context of the very high ratings assigned to Australian banks."

As with many bubbles, it would take very little for a housing bubble to deflate. A slowdown by Chinese investors in real estate all over the world already is happening, and it probably would contribute to a slower rise in Australian property prices, if not to their reversal.

Because of the risk that a sharp housing downturn would pose to the wider economy, the Reserve Bank of Australia will not be able to raise interest rates if inflation pressures flare up. For investors wondering how central banks will walk the line between preventing consumer price rises and a housing market crash, Australia is the perfect environment to watch.

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