Historically low mortgage rates could trigger housing price bubble
Financial markets got it right during the week by predicting that there was a better than even chance of a reduction in the official cash interest rate. The Reserve Bank obliged with a 0.25 per cent per annum rate reduction to 2.75 per cent, taking the cash rate down to historically low levels.
The bank justified its decision by reference to a benign level of inflation and a modest softening in the growth rate of the Australian economy. Nevertheless, coming as it has one week before the federal budget, it creates the risk of a housing price bubble and future problems of management of the Australian economy.
The real estate industry has welcomed the rate reduction which may well prove to be correct in the short term. But with the federal government not able to control its spending and balance its budget, there are serious risks that historically low mortgage rates will lead to a housing price asset bubble.
Canada’s recent experience highlights the extent to which low interest rates encourage borrowing for property investments at the same time as it discourages saving. Gearing property investments provides a means of increasing returns when interest rates are at or even below the yields of assets.
Both investors and owner occupiers receive larger tax incentives to invest in geared property assets because of the unlimited tax deductions for negative gearing and the tax-free capital gains on owner occupied housing. The rate reduction provides a bonus for high income earners now being restricted and even penalised when their income exceeds $300,000 per annum from investing in super.
Younger investors especially have very sound reasons for looking elsewhere than superannuation for their investments with the constant speculation about rule changes. Despite the huge cost to the budget of negative gearing and the exemption of capital gains on the family home, the chance of a change in the relevant tax rules is minimal.
If the federal government were to surprise us next week with a tax on capital gains on houses worth say more than $2 million and limits to the negative gearing deductions, Australia would be able to avoid the Canadian rush into property. The more likely situation is the government will continue to discourage super for high income earners and continue to provide unlimited assistance to property investments.
It is worth noting that during the global financial crisis, over investment in property brought down several economies including Spain and Ireland.