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What to do about speeding Sydney?

March 6, 2015

Sydney is the home of the Reserve Bank. From their prime location on Martin Place, the economic boffins ponder the pecuniary particulars of Australians across our large nation. But it is the property market on its own doorstep that is the Bank’s greatest challenge at the moment.

According to the ABS, Sydney property prices rose 29 per cent over the two years to December 2014.  In comparison, the growth in Melbourne – the second strongest market in recent times – was not quite half that, at 14 per cent for the same period and most other capitals saw percentage growth in the single figures.

If Sydney could be wished away, the RBA would have little compunction in cutting the cash rate aggressively to support a sagging Australian economy.  But what we see at the moment is an RBA that is still cutting, whilst showing some trepidation about what will happen to the Sydney property boom.

This two-speed economy dilemma is, of course, not new to the Bank.  It wasn’t that long ago when it faced the problem of a booming mining industry in Western Australia and Queensland on one hand and torpor almost everywhere else on the other.

For a number of reasons a policy mistake in relation to Sydney property carries greater consequences than one in regard to the mining states: New South Wales represents around 30 per cent of Australian final demand, the property sector is highly geared so can have huge repercussions for banks and the financial sector and, with the media concentrated in Sydney, any downturn could be amplified in a manner that could damage confidence nationwide.

If Sydney residential property is a problem (and I’ll return to that assumption shortly) other policy levers could be pulled that could be targeted on Sydney. The New South Wales state government could hike stamp duty and reduce first home buyer grants to dampen demand. The supply of new property could be improved through a series of measures: reducing infrastructure charges levied on developers; heavily taxing land-bankers (adopting a solution used in recent times by the Chinese government) and councils reducing the red tape around planning and redeployment of vacant sites.  Macro prudential policy could also be tailored such that banks have to observe tighter lending rules in Sydney than elsewhere in the country.

Of course, many of these actions would be unpopular in certain quarters and others would have undesirable consequences. For instance, a lax planning regime would likely exacerbate an acute issue we have with poor quality new apartments. Moreover, to work, these policy prescriptions would require a yet unseen degree of co-ordination between the various levels of Australian governments. That is clearly unlikely, particularly in the lead up to a NSW state election. But this more holistic approach is perhaps something for the future.

But might the Sydney property boom peter out in a benign way without the Reserve Bank keeping interest rates artificially high for the rest of the nation? Much of the strong price growth in Sydney is ‘catch-up.’ Even after its recent dash, prices in Sydney are only up 57 per cent since September 2003, based on ABS data, whilst Melbourne rose 89 percent in that time. To some extent, we may well be seeing a return to normal circumstances where Sydney property enjoys a 20 per cent premium over its southern counterpart due to higher incomes, a larger population and a greater scarcity of land.

Viewed through this prism, the run-up in Sydney prices is rational. And if participants are acting rationally now, it is reasonable to assume they will stop pushing up prices once a point is reached where valuations can’t be justified based on rental returns or mortgage servicing costs. Yes, we might see an overshoot and a correction. But the correction will probably be characterised by a period of stagnant prices for several quarters rather than a short sharp drop in prices. Richard Wakelin

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