Capital Growth and Interest Rates


More to capital growth than just low interest rates

Mortgage rates have been moving lower since late 2011, however the stimulus is only driving dwelling values substantially higher in Sydney and Melbourne. This week we investigate why the stimulatory effect of low mortgage rates is being most felt in the two largest capital city markets while housing markets in other cities are far less affected.

Across the combined capital cities it would seem that reductions in official interest rates (and the subsequent cuts to mortgage rates) are responsible for growth in home value. The combined capital city results certainly indicate this fact, however when you break the data down further it is clear that only Sydney and Melbourne are seeing significantly higher home values on the back of these rate cuts.

To set the scene we need to look at how official interest rates were positioned at the beginning of 2008 before the financial crisis really hit. At the end of 2007, the cash rate was recorded at 6.75% and rose to 7.25% between March and August 2008. By the end of the year the cash rate had been slashed to 4.25% and went even lower, reaching 3.0% in April 2009 and remaining there until the RBA started to once again lift rates in October 2009. By November 2010 official rates had reached 4.75% and remained there until October 2011. In November 2011 the RBA once again embarked on an easing bias, cutting the cash rate by 50 basis points over the last two months of 2011 and by a further 125 basis points in 2012, 50 basis points in 2013 and finally another 25 basis points in February this year to bring the cash rate to its current level of 2.25%.

com         In 2008 home values fell across all capital cities with the magnitude and the length of decline varying between cities. Across the combined capital cities, home values peaked in March 2008 and fell by -6.1% to their low point in December 2008. Sydney (-6.2%), Melbourne (-8.3%) and Perth (-6.2%) recorded the greatest falls. Ever since the end of 2008 Sydney and Melbourne have recorded the strongest increases in home values. Across the combined capital cities, home values have increased by a cumulative 37.9% since the beginning of 2009, however, Sydney (56.9%) and Melbourne (51.8%) have led the way with Darwin a distant third strongest performer (24.0%). Interest rates are the same around the country so why is the growth so much a Sydney and Melbourne story?

The two largest cities have seen a significant increase in employment since the beginning of 2009. Sydney has created 3,045 new jobs a month over the period and Melbourne has created 3,511/month. Job creation in Perth (2,606/month) has also been strong while cities such as Brisbane (1,090/month), Adelaide (386/month) and Hobart (24/month) have seen much softer job creation over the period. The greater job creation and the fact that most large corporations are headquartered in either Sydney or Melbourne has likely been a contributor to the growing housing demand in these cities.

Although Sydney and Melbourne have had the strongest levels of job creations, they have had to because if we assume the state data is a proxy for the capital cities, they have also shown the largest increase in population due to migration. NSW and Vic have consistently attracted the greatest number of overseas migrants but migration has been particularly strong since the financial crisis. Of course new migrants spend money which has a multiplier effect throughout the economy, creating jobs.

While job creation and overseas migration in NSW and Vic has been strong since the end of 2008, NSW and Vic have also lost far fewer residents to other states. NSW and Vic have typically recorded a net outflow of residents to other state, however, since December 2008, Vic has consistently recorded a positive inflow of residents and is currently at a record high net gain. NSW still records a net outflow of residents but its outflow is at a record low. As a result, Qld is seeing far fewer interstate migrants. Much like overseas migration, a higher rate of net interstate migration results in more retail spending and subsequently more jobs in the state.

Lower interest rates have certainly contributed to growth in home values in Sydney and Melbourne. They haven’t driven growth exclusively, in fact job creation and demographic factors along with the associated retail spending have also contributed to the much stronger growth in these cities compared to all other Australian capital cities.

Demographics are favourable for housing demand in these cities and lower interest rates will likely further encourage an increase in demand and subsequent home value rises. APRA and the RBA have highlighted that they are now somewhat concerned about the growth in home values, particularly in Sydney. As a result, it is looking more likely that APRA may need to introduce explicit macroprudential tools to curtail the level of growth.


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