Australia’s Booming House Prices Spark Concern; Low Interest Rates May Be Boosting Property Speculation; The Central Bank Is Concerned

October 3, 2013, 5:06 a.m. ET

Australia’s Booming House Prices Spark Concern

Low Interest Rates May Be Boosting Property Speculation; The Central Bank Is Concerned

JAMES GLYNN And SHANI RAJA

SYDNEY—Samantha Walton and her fiancé Simon Cleary feel their dream of buying an apartment in Sydney’s trendy eastern suburbs is slipping out of reach. They have secure jobs and live with Ms. Walton’s parents, an arrangement that has helped them save money for a deposit over the past year. Their ambitions are modest: a one-bedroom property worth 500,000 Australian dollars (US$470,000), well below the average for a new Australian home.But house prices are on the move—spooking first-time home buyers and worrying central bankers, who fear record-low interest rates and looser mortgage lending are boosting property speculation, which could potentially derail a fragile economic recovery.

For Mr. Cleary and Ms. Walton, what had been a five-year plan to get to the first rung on the property ladder looks like it could take up to a decade.

“I don’t think in five years we’ll be paying A$500,000 for a one-bedroom apartment,” said Mr. Cleary, a 23-year-old information-technology support worker. “I think it will be a lot more than that. With houses so expensive, and they’re only going up in price, it makes us a bit wary of actually purchasing a house.”

They aren’t alone. The strong rebound in home values this year—particularly in cosmopolitan cities like Sydney—has made saving enough for a deposit harder for the average Australian working couple. And it may get tougher as low interest rates spur monthly gains in mortgage lending that threaten to put the housing market out of step with the rest of the economy as it nears the end of a long mining boom.

Australian house prices jumped more than 5% in the second quarter from a year earlier, the fastest pace in three years, while auction-clearance rates and home-loan approvals have risen steadily. Data this week showed capital-city house prices climbed to a record high, led by properties in Sydney and Melbourne.

Investors are betting that rising home values will outpace other asset classes in Australia and overseas. New lending to investors surged by almost 26% in July from a year earlier, the steepest gain in six years, according to government data. In contrast, loans to owner-occupiers increased at half that rate.

For Chris Fellas, a Sydney-based financial adviser, that has set off alarm bells. The 42-year-old recently sold a house in the leafy inner-city suburb of Paddington for around A$2.5 million, but plans to stay out of buying property for at least the next few months. “I think the market is quite hot,” he said.

The International Monetary Fund has urged governments to prevent house prices from rising too steeply, recalling the experience of 2008, when reckless lending helped to trigger the global financial crisis. Australian house prices last spurred a sharp increase in borrowing that gave the central bank pause in 2003, when it raised rates to avert a banking crisis.

The central bank last week warned the nation’s lenders against offering mortgages too freely, citing the risk of a dangerous surge in speculative home buying. It said excessive speculation posed a threat if house prices were to suddenly drop sharply.

It has lowered interest rates eight times in two years, hoping to spur other parts of the resource-dominated economy and contain swelling unemployment as mining firms cut jobs. At its last policy meeting in early September, it kept interest rates at 2.5% and didn’t rule out further reductions.

But it faces a dilemma. While the low rates are needed to cushion the economy from the resource slowdown, and despite home buyers stimulating sectors like construction, retail and manufacturing, the bank doesn’t dare let prices rise unchecked. A housing crash would rapidly undo what little progress has been made reigniting the rest of the economy.

“It would be difficult to nip a house-price boom in the bud when the economy is weak and jobs are being lost,” said Michael Blythe, Sydney-based chief economist at Commonwealth Bank of Australia, one of the country’s biggest mortgage lenders. “It could be a nasty choice one way or the other.”

Low interest rates have had a modest impact on other industries. Reports this week showed retail sales rose by more than economists expected, and manufacturing expanded for the first time in more than two years following sharp falls in the Australian dollar. Consumer and business confidence has also risen since last month’s election of a new conservative government.

Still, some economists are looking for more evidence that a broad-based recovery is under way given that retail sales grew at their weakest pace in half a century in the year through June and manufacturing has only just expanded after 26 months in contraction. In the second quarter, the economy grew by 2.6% from a year earlier, compared with quarterly expansion rates as high as 4% in early 2012.

The housing story is much more compelling. RP Data-Rismark’s property gauge, which tracks median house prices across the nation’s major cities, rose 1.6% on month and 5.5% on year in September—to a record high.

“There is activity far beyond what we have seen in more recent times,” said Scott Kennedy-Green, McGrath Estate Agents’ chief auctioneer for the last 16 years, based in Sydney.

Meanwhile, government figures show the number of mortgages approved by lenders has risen each month so far this year. Along with retail, housing is among the most rate-sensitive sectors, and recoveries in both have led previous expansions.

“A sustained period of below-average interest rates could increase speculative activity in the housing market and encourage marginal borrowers to increase debt,” the central bank said last month. Its remarks, and a briefing it had on New Zealand’s central bank, which faces similar pressures, reinvigorated the debate over whether there is now a risk of a bubble.

Warwick McKibbin, a professor of economics at Australian National University and a member of the central bank’s board until two years ago, said it is possible. Strongly rising house prices against the backdrop of a slowing economy spells danger, he said.

“You might think houses prices are higher than fundamental value, which is a bubble, but it’s hard to see it until it bursts,” he said. “If a shock comes from overseas, you don’t want to be in a situation where a whole bunch of bubbles start to burst.”

For others, the continuing house-price surge is nothing to be too alarmed about, and may even be necessary to allow other sectors to take up the slack from the mining slowdown.

“There are a lot of people in Australia that believe housing either booms or collapses and does nothing in between,” said Adam Boyton, chief economist at Deutsche Bank in Sydney. “I think the reality is we have a recovery in housing and that’s essential in getting a rebalancing in the economy.”