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Friday, May 7, 2010

Firsts in the Statement on Monetary Policy

For those of us interested in the residential property market, the RBA today published one of its more impressive analyses in the quarterly Statement of Monetary Policy. I have left the more nerdy, economist-only content to the end. For the lay reader, the RBA begins with the finding that national home values have been rising by about 1 per cent per month since the end of the 2008 downturn. Importantly, this is consistent with the capital growth estimates supplied by RP Data-Rismark and APM. It is, however, inconsistent with the much more striking gains suggested by the ABS’s median price measure, which generated so many media headlines this week (emphasis added):

“Housing prices have risen strongly over the past year or so, reflecting both supply- and demand-side factors. Over the past 15 months, capital city housing prices have risen by an average of around 1 per cent a month, to be 15 per cent above their trough in late 2008 (Graphs 38 and 39, Table 8).”

When reading the RBA’s analysis, it is useful to bear in mind whether there are any signs of the much-mooted ‘bubble trouble’. Many media commentators would have us believe that the RBA is scared-stiff about a burgeoning housing bubble. The Statement of Monetary Policy is the RBA’s single-most significant communication forum. There is ample room to fire a few shots across the bow of any speculative fever, or to express anxiety about the integrity of the housing market’s underlying demand- and supple-side fundamentals. Here regular readers will know that I have been somewhat critical of the Bank for not talking enough about fundamentals, and focusing perhaps too much on crude jawboning of prices. Anyways, this is what the Bank had to say, in its own words (emphasis added):

“The rise in housing prices reflects a number of fundamental factors including the improved outlook for economic growth and the strong rate of population growth as well as supply-side problems, which have constrained home-building in recent years. Traditionally, the rate of home-building has exceeded the rate of population growth. However, over the past year, the population growth rate of a little over 2 per cent has been well in excess of the 1.4 per cent growth in the number of dwellings Graph 40). This reversal is evident across all mainland states.”

Okay, no signs whatsoever of bubble trouble there. The RBA then goes on to highlight the very broad-based nature of the recent recovery. As I will explain later, this analysis is enabled by a new suite of proprietary indices that RP Data-Rismark have developed for the RBA covering non-city markets, and cheap vs. expensive sub-sectors (approximately 40 per cent of all homes are not located in the capitals):

“Growth in housing prices has been apparent for both houses and apartments, both within and outside the major capitals, and across both more- and less-expensive suburbs in the capital cities. Following a modest decline in nationwide dwelling prices in 2008, the pick-up in dwelling prices was initially strongest in the least-expensive suburbs, which may have been most sensitive to low mortgage rates and the increase in grants for first-home buyers (Graph 38). The rise in dwelling prices has been strongest in Victoria, where state government supplements to first-home buyer grants, which continue to apply, have been among the largest (Graph 41).”

As we have noted here, one curious feature of the rebound in housing values has been the comparatively weak credit growth, at least by the double-digit historical standards of the last 10-15 years. While this matter has been exercising the RBA’s mind, it has offered up an intelligent explanation: compositional shifts in the market from highly-geared first time buyers, who have faded well below long-term trend levels, to upgraders with much lower leverage (read higher equity), has meant that the new finance flows can look a bit insipid compared with last year:

“The continuing buoyancy in the established housing market has been somewhat at odds with recent developments in housing finance, which has traditionally been a good indicator of housing market conditions. Housing loan approvals have declined by around 15 per cent since their peak in September last year. This divergence might be partly explained by shifts in the composition of transactions in the housing market. For example, with the recent easing of first-home buyer demand there has been a large decline in turnover in lower-priced suburbs. This may help explain the fall in loan approvals as first-home buyers are more likely than other buyers to use debt to purchase dwellings: household surveys indicate that around 90 per cent of purchases by first-home buyers involve a mortgage, while for repeat buyers only around 65 per cent of housing sales involve a mortgage.”

On the technical front, there are several historical ‘firsts’ for Australia’s central bank. As we anticipated with the public release two weeks ago of Australia’s first ‘seasonally-adjusted’ home value index data, the RBA has quickly followed suit and seasonally-adjusted its two ‘preferred’ benchmarks, the RP Data-Rismark ‘hedonic’ and APM ‘stratified median’ measures (actually, the RBA has opened my eyes to the fact that the first seasonally-adjusted proxies were published in the February SoMP).

A couple of points to observe in the first RBA chart that I have extracted below. RP Data-Rismark’s hedonic index has marginally lower volatility than APM’s median price counterpart. This is especially true when one compares the monthly ‘indicative’ estimates on a live basis, which are not illustrated here (the numbers in these figures are mostly the ‘revised’ versions that strip out the early ‘noise’). The second point worth touching on is that the RBA has again chosen to use RP Data-Rismark’s stratified hedonic indices that represent cheap, mid-market, and expensive suburbs in capital cities across Australia, which are depicted in the lower panel of the chart. And just as the luxury markets got slammed during the GFC, they have clearly outperformed in the period since.

Another ‘first’ that RP Data-Rismark can claim to have helped pioneer is the release of ‘monthly’ house price growth estimates. Prior to the launch of the monthly RP Data-Rismark hedonic index, the RBA only ever published quarterly house price estimates. Over time, however, it has become increasingly comfortable with RP Data-Rismark monthly numbers, so much so that the individual monthly outcomes are sometimes referenced following the RBA’s Board meetings.

To the best our knowledge, the next chart below is the first time the RBA has sought to explicitly highlight monthly house price performance. While the RP Data-Rismark and APM benchmarks look to closely track one another (albeit that the former has a little lower ‘noise’, as explained above), this does RP Data-Rismark a disservice.

The growth rates estimated in the first panel of this chart are the ‘revised’ numbers. For example, when APM computes its initial growth rate for January, subsequent estimates of that growth calculated in February, March and April tend to revise significantly as more sales data for January becomes available. This is why banks have stopped publishing APM’s monthly estimates—the volatility or revision bias was simply too high.

Over time, however, as more sales information is released, the January estimates settle down to levels that appear to closely approximate RP Data-Rismark’s numbers. For completeness, RP Data-Rismark’s preliminary monthly numbers, which are based on our hedonic regression approach, have strikingly lower ‘revision bias’. Indeed, some ‘preliminary’ months do not revise at all. By way of illustration, our indicative estimate for January (not seasonally adjusted) was +1.8 per cent. Today our best estimate of January’s growth is still +1.7 per cent.

Another ‘first’, albeit one published in the last Statement of Monetary Policy, is the analysis of ‘non-capital city’ markets. In Table 8 below you can see the section entitled ‘regional areas’. RP Data-Rismark built this hedonic index, which covers all non-capital city markets, explicitly for the RBA. What is most interesting is that whereas RP Data-Rismark and APM both put the national growth rate in capital cities over the 15 months to end March at 14.5 to 15.7 per cent respectively, the estimated value gains in non-capital markets are much lower.

According to RP Data-Rismark’s hedonic proxy, detached home values in all areas outside of the capital cities have risen by only 6.7 per cent over that same 15 month period (ie, by less than half their city counterparts).

Using RP Data-Rismark’s hedonic benchmarks, the RBA has also seasonally-adjusted our capital city indices in the following diagram for the first time that we are aware. And one sees a consistent empirical pattern across all conurbations whereby robust growth in 2007 was followed by a GFC-induced compression in prices. Yet the ensuing 2009-10 recovery has propelled prices beyond their previous highs.

At the end of the day, the RBA is a very successful "inflation targeter". Asset prices are only really germane from a system stability perspective, which is a topic that I will return to in the next post. More specifically, the RBA's eyebrows only seriously arch when it witnesses concurrent asset price and credit booms (notably absent today). These cycles more typically occur in commercial real estate and corporate equities and debt markets. Less frequently, one finds them in housing, such as we recently saw in the US.