2017 will bring financial conditions in Australian mortgage and housing markets never seen before. The rules of the game have changed and so will the results. The future of the mortgage and housing markets in 2017 may appear uncertain but as we have now entered an era of rising interest rates in the US, a situation not seen for almost 10 years, risks to the downside are significant and locked in.
Whilst the RBA controls Australia’s official cash rate, interest rates set by the Fed in the US are critical to Australia. Australia runs a current account deficit (CAD) and has done so for around 50 years. The CAD is funded by offshore debt to our federal and state governments, and our banks. Australia, as a rule, needs to maintain a premium on its official and actual interest rates over US, Japanese, UK and European rates to ensure that international debt providers stay put and do not withdraw their funds for better relative rates elsewhere. Capital flight would have severe impacts for the Australian financial system.
I have argued before that Australian interest rates could go significantly negative. Reality tempers this view by introducing the inflation constant and I’d change my view to Australia moving heavily into negative real rates although nominal rates could be negative as well. We already have zero to slightly negative real rates but movement into further negative territory will occur before this complex game plays out.