Property bubble ahead?

More rate cuts could lead to a bubble in Australia’s property market say analysts.

With the official cash rate already at an unprecedented low of 2.75% and expectations of further rate cuts by the end of this year, home buyers have become very active. Australian Finance Group (AFG), the largest mortgage broker group in the country says it processed 25% more mortgages in July than it the previous year.

Capital city prices have risen 6.5% since May last year, with Sydney itself up 3.7% in the last quarter, and 6.5% for the year, with the median house price sitting at $570,000. But it’s not first home buyers who are doing the buying. According to AFG, 35% of new mortgages are coming from refinances, as people move up the property ladder, and investors use the existing equity in property to purchase additional houses.

While the RBA wants to get the construction sector going, it may have the unintended consequence of creating a housing bubble. The issue with rate cuts so far is that they have failed to have a meaningful impact on the building and construction sector. For building materials companies like Boral Limited (ASX:BLD), Brickworks (ASX:BKW), CSR Limited (ASX:CSR) and Adelaide Brighton (ASX:ABC), the tough times look set to continue unless interest rates fall further.

Data from the Australian Prudential Regulation Authority (APRA) last week showed that the RBA’s rate cuts were starting to boost lending, with credit growth at its highest level in close to 12 months.

With the government sending a shock through the banking system with its planned deposit insurance levy, an estimated $546 billion sitting in term deposits could be looking for a new home. Analysts have suggested it would shift into higher-yielding assets such as equities and property. That could compound the effect of lower interest rates, with a wall of money flowing into the housing market, artificially pushing up home prices.

Foolish takeaway

The RBA has noted that it is watching very carefully for signs of a property bubble, but the speed of the rise could shock even the central bank. What the RBA could do then is a tough question, as raising rates would have the effect of dampening the economy and slowing down growth. In a worst case scenario, that could lead to a recession.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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