Melbourne versus Sydney

In today’s Money Morning…the argument for keeping interest rates on hold in Australia…how much are rising house prices a burden on the economy?…the RBA likely to err on the side of caution…and more…

It almost always happens.

Every time an asset finds itself in the spotlight, its price reverses.

Aussie Dollar Falls Overnight

Overnight, the Aussie dollar fell, if only slightly. After rallying strongly in US trade on Friday, out came the headlines about the currency hitting 80 US cents. It reached a high of 78.4 cents yesterday, and then fell. It finished last night’s trading session at 77.99 cents.

I don’t know where it goes from here. Although in the short term it looks like it needs a breather.

The question of where the dollar goes from here is an important one. That’s because it has an impact on interest rates, which have an impact on house prices, which have an impact on the economy.

The general view (from what I can gather, anyway) is that a strong dollar will give the RBA another reason to sit on the sidelines and not raise rates.

That makes sense. In the absence of a pickup in inflation, it’s not as if the economy really needs an interest rate rise now. Don’t forget, wages growth is flat and the cost of ‘stuff’ keeps rising (despite what the official CPI figures say).

For example, a large part of the country will soon get their winter heating bills. We’re going to be in for a shock, thanks to soaring east coast gas prices. I’m not sure what the numbers are, but it will be like getting a partial interest rate rise.

Then there are the rate rises enacted by the banks this year. That’s more money out of consumers’ pockets. Throw in a rising dollar, which hurts some of the industries the RBA would be looking at to provide growth, and you’ve got a compelling argument to keep rates on hold.

But the chief economist of Goldman Sachs thinks otherwise. As the Financial Review reports today,

While the conventional view, particularly among the big four banks, is that the Reserve Bank is firmly on hold this year and through most of 2018, Goldman Sachs Australia chief economist Andrew Boak believes the economy could weather a stronger currency following an official rate increase.

“It’s hard to find too many businesses that are struggling under the currency at current levels – you’re not seeing it weighing on survey results, confidence levels are elevated, and PMIs are high,” he said.

That makes sense, although I think the RBA are more interested in the health of the consumer than any of the above measures. By the way, ‘PMIs’ refer to a manufacturing survey. It’s a pretty small part of the Aussie economy.

Consumer spending, on the other hand, is crucial. And on this front there is cause for concern. Here are the ‘final consumption expenditure’ growth rates for the past four quarters:

June 2016:           3.2%

Sept 2016:           2.8%

Dec 2016:            2.8%

March 2016:         2.5%

In other words, consumption has been slowing over the past year. That’s despite interest rates being at record lows over that timeframe.

And it’s despite ongoing increases in house prices. While the Corelogic data that everyone follows showed a slowdown in May (which brought out calls of an end to the boom) there was really no such thing.

For some reason, there is a slowdown every May in the data. June generally shows a bounce. Sure enough, reported yesterday that Melbourne house prices jumped 5% in the month to 16 July, while Sydney prices increased 3.1%.

I wouldn’t take those figures too literally. But it’s clear house prices are not falling. Yet consumers are struggling.

House prices could be the cause

Could it be because house prices are rising?

I mean, it’s thanks to record high house prices that Australia’s debt levels are at world record highs. You simply need to borrow a huge amount to get into capital city markets. And once you do, a big chunk of your income goes towards debt servicing, and less towards more enjoyable forms of consumption.

Even if the RBA suspects this, do you think they would be willing to raise rates anytime soon? The biggest contributor to economic growth, household consumption, is slowing. The dollar is rising, as are gas and electricity prices.

A rate rise too soon would be too big a risk for the RBA to take. And we all know central bankers err on the side of caution.

We’ll get another read on the economy (June quarter date) in early September. And more inflation data. If you don’t see an improvement in consumption and/or a higher inflation number, a November rate rise won’t happen.

That means the housing bust will have to wait for another day, too. Which brings me to another point. Even though rates have increased for investors and interest only borrowers this year, it hasn’t had a big impact on house price growth.

Which brings me back to the article:

Melbourne’s monthly growth accelerated from 4.3 to 5.0 per cent in the same time despite lenders increasing interest-only mortgage rates in response to regulatory intervention designed to limit riskier lending and reduce risks arising from record household debt.

CoreLogic research analyst Cameron Kusher said interstate migration is a lot stronger in Victoria than in NSW and fuelling this is Melbourne’s cheaper property prices.

He said most of the country’s job opportunities are in Sydney and Melbourne and people are choosing the latter largely because its homes are still much more affordable.

“The interstate migration is fuelling Melbourne’s housing demand,” Mr Kusher said.

The fundamentals of any housing market are interest rates and population growth. These two things are working in favour of the major capital cities right now. A few minor interest rate tweaks are not going to change that.

I’ve said it before, and I’ll say it again. You won’t see a housing bust until interest rates rise significantly from where they are now. That’s not going to happen anytime soon.

And another thing. While I think both Sydney AND Melbourne’s house prices are crazy, I’m not sure why Sydney’s are still so much higher. In five years’ time, I wouldn’t be surprised to see it about even.

I lived in Sydney for 10 years, and I’ve been in Melbourne for five years now. As far as I’m concerned, Melbourne wins hands down. Following the Swans (and the Rugby League) is my only Sydney legacy.

Others seem to agree. The population difference is only small now, 4.8m population in Sydney versus 4.4m (and growing relatively faster) in Melbourne. As the populations even out in the years to come, so will median house prices.

And the winner is…Melbourne!


Greg Canavan,
Editor, Money Morning

Greg Canavan is a Feature Editor at Money Morning and Head of Research at Fat Tail Investment Research.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

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