THE BIG PICTURE: The housing affordability mystery

One of the most poorly understood concepts in Australia is housing affordability. However to be fair, the main reason that it has been so poorly analysed and understood over time is because data has been either incomplete or inconsistent.

For instance, in the past, data on property transactions tended to focus on capital cities – and for the simple reason that the data was more readily available. The problem is that 40% of homes are outside capital cities. And, as you would expect, the price trends can differ markedly. Actually over the past year capital city house prices have risen by 9.7% whereas regional house prices have risen by just 4.7%.

Then there has been the problem of comparing the property transaction data. If there was a big increase in sales of four-bedroom homes in one month, clearly that would skew price comparisons unless an adjustment occurred for the composition of sales.

Fortunately the problem of incomplete or inconsistent home price data has been addressed. RP Data has collected figures on every property transaction in Australia. And, in conjunction with Rismark International, RP Data have adjusted price comparisons to account for compositional problems with their Hedonic Home Value index. This price index is now the primary home price index tracked by the Reserve Bank.

And when you have data on every single property transaction and then compare that with disposable income across Australia, clearly you have an accurate measure of affordability.

So how has housing affordability actually been faring? For Australia as a whole, home prices have broadly tracked incomes for the past four years. In other words, home affordability has been broadly stable.

That doesn’t mean that affordable has been stable everywhere – it almost certainly hasn’t been. For instance Melbourne home prices have risen 16% over the past year with Darwin prices up 15.6% but Brisbane prices have lifted just 4.2%. But what will tend to happen is that buyers will adjust their behaviour. Simply if a property becomes unaffordable in one area, then buyers will dry up, turn their attention elsewhere and prices will need to adjust.

So the next time you read that housing affordability is continuing to worsen, or perhaps has hit the worst levels on record, ignore the report and move on.

The week ahead

Generally economic data releases tend to get grouped together and thus follow a theme. Measures of inflation are released around the same time each quarter while labour market indicators tend to be released early in the month. But in the coming week there is no theme with a motley collection of statistics due for release.

On Monday new figures on lending are released including Reserve Bank data on credit card lending. On Tuesday the NAB business survey is issued alongside the quarterly Crop Report from ABARE. On Wednesday consumer sentiment, car sales and dwelling starts will be released. And on Thursday Reserve Bank Assistant Governor Philip Lowe delivers a speech and the Reserve Bank quarterly Bulletin and imports data are issued.

Consumers are super-conservative at present and that should be reflected in the latest credit card statistics as well as personal finance data. Still, despite their conservatism, consumers are happy enough. And that should be reflected in the consumer sentiment figures to be released on Wednesday. This will be the first survey undertaken after the election result was finalised.

Generally business and consumer confidence move together. But the last reading showed a rise in consumer confidence and a fall in business confidence to 14-month lows. The August reading for business confidence should show a modest improvement despite the on-going fluky business conditions.

Adding to the mix of patchy economic results will be figures on dwelling starts and car sales. We expect that car sales fell for the seventh time in eight months, down 1.5% in August. While the car market is reasonably healthy, the hangover effects of last year’s Government stimulus is still being felt. And dwelling starts were probably flat in the June quarter. Given the sharp fall in approvals, the likelihood is that starts have now peaked and will ease over the next six months.

In the US, investors will need to dissect a bevy of top shelf indicators. On Tuesday retail sales data is released with industrial production on Wednesday, producer prices and the current account on Thursday and consumer prices and consumer confidence on Friday.

The main attention will be focussed on retail sales and production. Economists believe that retail sales rose by around 0.3% in August after a 0.4% lift in July. And excluding car sales, again retail sales are expected to have gained 0.3%. Given the weak position of the job market, the growth in retail spending is certainly good, but you wouldn’t describe it as great.

Economists also believe that industrial production edged 0.2% higher in August after a solid 1.0% gain in July. When combined with the expected result on retail sales, the data would hardly be indicative of an economy slipping back into recession.

The other event of importance for investors occurs on Monday with the release of the latest Chinese economic indicators, including retail sales, production, inflation and investment.

Sharemarket

Investors hoping for political certainty would clearly be disappointed by the election result. Framing of legislation is likely to prove difficult under the so-called “rainbow coalition” of Labor, Greens and three independents. And there are key issues that will have to be navigated over the coming year including the National Broadband Network, mineral resource rent tax, broader tax reform measures and devising a price for carbon.

However in practical terms it means that analysts and investors will not be able to factor future legislative changes into valuations. The upshot is that current and perspective business conditions, together with company-specific factors and strategies, will continue to shoulder the burden of setting share prices.

Interest rates, currencies & commodities

Currently there is a major disconnect between financial market views on interest rates and the views of market economists. The overnight indexed swap market is factoring in a 25 basis point rise in the cash rate in a year’s time. And 90-day bank bill futures are similarly assuming that yields will be around 25 basis points higher by the end of 2011. By contrast only one of 22 economists polled by Reuters expects a 25 basis point rate hike by the end of 2011 – all other economists tip bigger rate increases. Three of the economists expect cash to reach 6.00%, with another three tipping 5.75% and the remaining forecasts are between 5.00-5.50%.

The latest coal and iron ore price negotiations serve are a wake-up call for those investors that assumed that commodity prices would continue to rise or remain at lofty levels almost indefinitely. Platts reported that the BHP Mitsubishi Alliance settled premium hard coking coal contracts with Japanese steelmakers at US$209 a tonne for the December quarter, down 7.1% from US$225/t in September. And Rio Tinto has agreed with Japanese steel makers to reduce its iron ore price for the December quarter by around 13%.

The current spot iron ore price is around US$142 a tonne. CBAs chief resources analyst Andrew Hines expects contract prices to ease to around US$119 a tonne in 2011, US$107 in 2012 and US$92 in 2013. However he notes that, with not a lot of new iron ore supply hitting the market in the next 12 months, there is an upside risk for prices.

Craig James is chief economist at CommSec.