<html><body>
The Reserve Bank of Australia is officially in 'wait-and-see' mode after it first downward adjustment to its target cash rate back to a notionally neutral 4.5%. In its 72-page Statement on Monetary Policy released on Friday, the bank cut all of its growth and inflation projections. I was asked by a friend before the statement what I thought it would say. My response was: 
“I expect all core [inflation] forecasts to be between 2.5% and 2.75%, with possibly a 3% in 2013. The RBA is highly unlikely to give any direction in the SMP given it does not know itself what it will be doing with rates following the fourth-quarter CPI release in late January. Thus, the SMP is likely to be vague/open-ended… I think RBA will be very eager to emphasise "neutrality" as the main policy objective.”
The RBA made all the anticipated downgrades, while signalling uncertainty about its longer-term expectations by offering a 2.5% to 3% inflation range in 2013. So while the RBA 'hopes' for on-target core inflation of 2.5% per annum in 2011 and 2012, it believes the balance of risks are skewed to higher results in 2013. In addition, the RBA says these forecasts presuppose a rebound in Australia’s productivity performance in concert with wage restraint over the next three years. It would privately acknowledge that these could prove to be optimistic assumptions.
I’ve previously noted here that the RBA does not believe it can forecast inflation with any high degree of accuracy, and the Statement on Monetary Policy lends weight to that view. Despite a rising path of core inflation over the five consecutive quarters to June 2011, the RBA’s hawkishness has been cauterised by a triumvirate of: (1) the lowest underlying inflation outcome in September since way back 1997 (based on the 'trimmed mean' measure); (2) marked changes to the way the ABS calculates its inflation numbers; and (3) conflicting revisions to the ABS’s past inflation data (eg, the second quarter going from +0.9% to +0.6% and then +0.8%).
After accounting for the ABS’s new inflation smoothing and weighting methods, the RBA now thinks that year-on-year underlying inflation in Australia is around 2.25 per cent to 2.5 per cent, or slightly below the mid-point of its target, through-the-cycle objective of 2% to 3% per annum.
Don't be fooled by the artificial precision here. Just as the RBA has in various research reports and speeches conceded that it cannot project future inflation outcomes to single decimal places, likewise it does not like being held to a 'point estimate' target.
In the governor’s words, the name of the RBA’s game is keeping core inflation to “two point something” as frequently as it can while acknowledging that there may be tax changes and other supply shocks, such as natural disasters, that temporarily knock it off course (eg, by lifting headline inflation).
To understand the RBA’s current state of mind, you need to wrap your head around the following dynamics.
First, if one simply looks at the underlying inflation numbers in year-on-year terms, one can conclude that prices are rising at a modest pace, in contrast to what the RBA had earlier thought.
As a contradictory aside, in Friday’s SMP the RBA observed that core inflation had risen at an above-average rate over the first half of 2011. This defuses claims made by some folks that Australia’s core inflation spike was limited to just the first three months of the year.
Nevertheless, by using the year-on-year numbers the RBA can maintain that underlying inflation is anodyne. On the potentially anomalous September print, the RBA does hedge its bets by noting that the “quarterly” data need to be interpreted with “care”. Once bitten, twice shy. For all the RBA knows the low third quarter result could be revised back up in late January, as both the December 2010 and June 2011 data were.
A second insight is that 2011 has undermined what remaining faith the RBA has in its own projections. Crucially, this means that is has no choice but to drop its 2010-11 experiment with genuine monetary policy “pre-emption”.
The theory goes that the RBA sets interest rates on the basis of its inflation forecasts for the next two years. So even when the current inflation pulse is weak, the RBA has every right to lift the price of money in order to keep future price pressures within its target band. On this basis, current inflation numbers are only relevant insofar as they affect the RBA’s projections.
This theory has unravelled for two reasons. First, the RBA has discovered that trying to make a case for higher interest rates amidst middling economic conditions is an awfully difficult practical exercise. There was a tremendous backlash in 2011 against the RBA’s hawkish sentiments, even with the confirmatory evidence of the high core inflation results over the first half of the year.
You can see this challenge manifest in the RBA’s actions. The RBA ended up ignoring the first and second quarter inflation data, which were in line with its hawkish expectations, but cut rates the second it got one low print.
I used to think the RBA had an intrinsic bias towards tighter policy or higher interest rates; that is, it would prefer to undershoot rather than overshoot its 2% to 3% per annum target given its past performance. There is now a case to be made that the RBA’s policy bias runs the other way: ie, towards tolerating slightly higher inflation given its community constraints.
The other issue with pre-emption is that the RBA cannot set interest rates today based on its expectations of the future if those expectations are faulty (or subject to high uncertainty).
So we are now left with a simpler decision-making process. Once Australia’s cash rate is sitting at neutral, the RBA will be practically guided by what the data tells it is actuallyhappening in the real economy.
Turning back to the RBA’s current headspace, a fourth observation from the SMP would be that the bank unmistakably believes that the distribution of risks is tilted to the downside over the near term.
While it has slowly come to this perspective, I suspect that Glenn Stevens’ recent trip overseas, much like Bill Evans’ 180 degree turn following a North Atlantic jaunt, has infused the governor with a deeper appreciation of the challenges that confront the big developed economies. Recall that it was a similar trip to New York at the height of the GFC that compelled Wayne Swan to the view that Australia needed massive fiscal stimulus in order to protect it from the impending storm.
To summarise, the RBA knows that it has positioned the price of money at an innocuous place. Today you can get variable rate home loans for as little as 6.39%. There are one-year fixed-rate deals going at 5.89%. Save a desire amongst some on the RBA’s board to perhaps tweak the cash rate down one notch further, the bank genuinely has no idea when, and in what direction, the next move will be. 
This will depend on three things: what the January inflation data tells it about the pulse of consumer prices over the second half of 2011; what other tier-1 activity data, such as wages, GDP, unemployment and house prices, tell it about the speed at which the economy is advancing; and, finally, what is happening in North America and Europe.
One former RBA board member, and an eminent global economist, Adrian Pagan, has been critical of the RBA’s decision to “trim” rates by one-quarter of a percentage point. Specifically, Pagan argued:
“I can’t see the reason why you would cut interest rates by 25 basis points – I don’t believe in 25 point cuts. I think that’s a silly situation we got into with making such small adjustments…And I don’t think the international situation is as bad as everyone thinks it is, but 25 basis points is not a response to that. If you really thought it was bad, you wouldn’t be doing 25, you’d be doing 50 or 75...”
While Pagan might be technically correct, I would make a couple of comments.
First, whether the RBA likes it or not, this will not, in practice, be a small adjustment to monetary policy. Almost everything in economics hinges on expectations: that is, what we planon doing. The average Australian family expected at least two to three rate hikes over 2011-12, and a big chunk of the community – around 25-30 per cent – were budgeting on four hikes or more.
The RBA’s about-face is going to have a tremendous impact on these expectations, which will swing from hikes, to stable rates or cuts. That is, the expectational effect of the RBA’s decision is more like two to three rate cuts. This will be especially powerful in interest rate sensitive sectors of the economy, such as housing.
Second, it is, to be sure, easy to construct a case that the RBA did not need to shave rates by 25 basis points, especially when, in the RBA’s words on Friday, “underlying inflation…is expected to pick up a little towards the end of the forecast period, with a greater likelihood that it will be in the top half of the target range than in the bottom half.”
All else being equal, this opinion combined with the risks signalled in the RBA’s 2013 projections, imply that it has a slight tightening bias, if it is setting policy today on the basis of its forecasts of the future.
However, the RBA is being more tactically nuanced than this. First it needs to manage the six independent business executives that sit on its board, who are not instinctively disposed to embracing higher rates. Make no mistake: if and when inflation does eventually rear its foul face again, the RBA is going to have a huge task on its hands.
The doves will argue that the RBA got it wrong in 2011. (As a matter of pure fact, the RBA forecasts were arguably right in the first and second quarters, but wrong in the third quarter.) Nonetheless, the optics here are that the RBA has had to undertake a policy reversal. Getting its wider board to trust its decision-making will not be a fait a compli.
This is why I believe the RBA will need demonstrable historical evidence (ie, data) that inflation is on the rise again before it has the fortitude to lift rates. That may mean waiting for at least six months of data before tightening its monetary policy screws.
As a more general comment, long-term forecasting of rates and inflation is, as I argued forcefully <a target="_blank" href="https://christopherjoye.blogspot.com/2009/11/forecasting-future">here</a>, a mug’s game. The world is too complex, with too many interdependencies, to have any chance of consistently getting the long-term estimates right. What analysts and investors should concentrate on is understanding, as best they can, the RBA’s decision-making framework, and how the bank responds to new events.
Christopher Joye is a leading financial economist. The above article is not investment advice.
This article originally appared on <a href="https://www.businessspectator.com.au/bs.nsf/Article/interest-rates-Reserve-Bank-RBA-monetary-policy-ec-pd20111107-NCTXW?OpenDocument&amp;src=sph" target="_blank">Business Spectator</a>.
 
 
</body></html>

chrisjoye-JYhJsTrNRC

The RBA's inflation reality check

<html><body>
Do you get a fair return on your savings? And what returns do the major banks earn over and above the interest rate they pay you on your cash? Indeed, why do the banks “cap” the returns on your savings accounts at all? These are all interesting questions that I will use to prime today’s column.
We have become so conditioned to being subject to a fixed cap on our savings rates — either via a term deposit or through variable rates that adjust in line with the RBA’s target cash rate — that the notion of not having an interest rate cap seems positively odd.
But imagine if a bank turned around to you and said, “Instead of fixing your 12-month term deposit rate at, say, 5%, we are going to target giving you a 5% return, and if we can earn more on our lending and investing activities, we will pay you more. In this way, when the bank does well, you do well”.
Today the banks are implicitly saying the opposite: namely, “We will pay you 5% per annum fixed, and everything we earn above that we are keeping 100% for ourselves and our shareholders”.
To get to the bottom of this you need to first understand your relationship with the banks. When you put your money on deposit you are actually lending to them. In fact, legally and economically, you are a senior-ranking “creditor”. You are in the same position as the bank is when it lends money to you to buy a home. It is funny how nobody thinks of savings like this!
Yet on almost all your “at-call “or “transactional” savings accounts, you get little if any return (i.e., the banks usually pay zero interest rates). However, the longer you are willing to commit to lend to, or finance, the banks, the higher the interest rate they will normally offer you. Now this makes sense. The price of money ordinarily rises with the term of the loan.
What then do the banks actually do with your money? At its most basic level, they take the cash you lent them, which, formally, is a “liability” the bank must repay you, and use that money to make new loans to small businesses, corporations, and households. Roughly 60% of your money will be invested in residential and investment property loans. The remaining 40% will be lent to businesses, from SMEs to large companies.
The bank then generates two forms of return over and above the (much lower) interest rate it pays you. First, it charges businesses and households substantially higher rates than those which you earn on your savings accounts.
According to RBA data, the average “discounted” home loan rate following Tuesday’s cut should be around 6.8% per annum. In comparison, the average bank pays a 0% interest rate on your transaction account. If we take the average “bonus” savings account, the typical bank is paying you about 5.2%.
In this case, therefore, the spread between the interest rate the bank earns on its home loans and the interest rate it pays you on your cash is about 1.6% per annum.
Remember, however, that 40% of your money is being lent to businesses. Again using RBA data adjusted for Tuesday’s cut, the average small business pays a 9.7% per annum interest rate on its bank loans. If the small business offers up a home as security for the loan, the interest rate will be just under 9%.
So when it comes to small business lending, the interest rate the banks earn (or “spread”) beyond that which they pay you in your “bonus” savings account are between 3.6% and 4.5% per annum.
What about the rates the banks charge on personal loans and credit cards? According to the RBA, the average personal loan rate is around 15% per annum, while the average “discounted” credit card rate is 13.2%.
Once again, the banks are earning substantial interest rates beyond what they pay on your savings. In fact, multiples more in the case of personal loans and credit cards, even after accounting for loan losses.
All told, the RBA estimates that the average net interest rate the major banks generate beyond the interest they pay on their funding is about 2.4% per annum.
Regional banks earn a materially lower 1.6% per annum spread, or “net interest margin”. Why do they do worse? They pay higher rates to the people that fund them. So why do they have to pay more than the majors? Because their “credit ratings” are lower. This means their perceived risk is higher.
(As an aside, I have previously argued that the risk of catastrophic loss in a simple, “narrow” bank like a “regional” is less than that associated with a much more complex conglomerate like the majors, which are stretched across Australian and foreign operations, and all manner of other activities, including funds management, and proprietary trading.)
The average 2.4% interest rate the majors generate above their cost of funds is then boosted significantly further by “non-interest income”, which mainly refers to “fees”.
 
<hr class="system-pagebreak">
 
That’s the easy part. The much more complex aspect of the business of banking is that these enterprises take the cash (or “equity”) they get from their shareholders and use it to make loans to businesses and home owners that are worth multiples of that equity. That is, they are highly “leveraged”.
More specifically, they borrow for the relatively short term from people like you and me, and from institutional investors (roughly 50% of their money comes from mums and dads, 40% from institutions and 10% from shareholders), and then lend that money out for up to 30 years as home loans.
This begs the question: what happens if I want my money back? If, for example, I have put $100 in my savings account, and the bank has used that money to offer 30-year home loans, how can the bank possibly repay me my money?
The short answer is it can’t. The business of banking is based on what is known in the jargon as an “asset-liability mismatch". Every once in a while mums and dads decide they don't trust the bank anymore, and rush to withdraw their cash en masse. At the same time, the institutional investors that lend the banks the other 40% of their funding for terms ordinarily less than five years may also refuse to roll over these loans.
Under the law, if you do not have a reasonable expectation of meeting your current liabilities (e.g., repaying your depositors), you are, by definition, trading insolvent. So if there were ever a “run” on a retail bank, with large volumes of depositors asking for their money back, the bank would be legally insolvent in the absence of some other support from taxpayers.
In order to address this flaw at the heart of banking, which every few decades tends to lead to banking crises (in the 1890s around 90% of all private banks in Australia failed), governments have developed a number of safeguards.
The first protection was to create a taxpayer bank that was explicitly established to lend to the banks, and thus supply them with so-called “liquidity”, during crises. This is known as the Reserve Bank of Australia, and a self-described part of its mandate is to serve as a “lender of last resort” to the banking system.
A second, more recent, protection was to supply a minimum taxpayer guarantee of retail deposits. That is, if the bank fails, the government will guarantee that a minimum dollar sum will be repaid to you.
A third protection used during the global financial crisis (for the first time) was to have Australian taxpayers guarantee the banks’ institutional debts. That is, the government told the banks’ institutional lenders that if the banks ever defaulted on these loans, taxpayers would step in and pick up the tab.
If you think through this carefully, you start wondering about what is a fair distribution of returns between banks and their creditors (i.e., you and me). You ask yourself the question, "With all this taxpayer support, should I be expecting more bang for my buck on my savings?"
We have learnt today that ignoring all the fees banks produce on their products, they are able, on average, to generate net interest rates of around 2.4% per annum beyond what they pay their funders: viz., savers and their institutional lenders.
In thinking about the question of fairness, I will leave you with one chart. It was recently published by the Reserve Bank of Australia, and it shows the major banks’ “returns on equity”. In the last half-year, these annualised at close to a 20% rate. 
Regional banks manage to attract shareholders with much lower, early-teen, returns on equity. We need more give, and less take.
<img src="/images/stories/nov3.gif">
Christopher Joye is a leading financial economist. The above article is not investment advice.
 
 
</body></html>

More give, less take from banks

<html><body>
The net effect of yesterday’s decision by the RBA to normalise its official target cash rate back to 4.5% is to hand back to borrowers the large top-ups the major banks added to the RBA's November 2010 rate hike. Privately the RBA was surprised by the magnitude of these top-ups. 
On the 21st of October <a href="https://christopherjoye.blogspot.com/2011/10/thre-great-inflation-debate">I anticipated that they would do exactly this</a> should the third-quarter inflation data print less than 0.6%: 
“I suspect the RBA would not be opposed to "normalising" the level of interest rates… If the third-quarter inflation numbers print on the very low side, they will hammer the final nail in the coffin of the current inflation debate. There will be no evidence that price pressures are accelerating. With a still high currency, this will then denude the rationale for holding the cost of money at the RBA's "mildly restrictive" level (assuming that the RBA is able to revise down all of its currently-elevated inflation forecasts out to 2013). By bringing the price of money back to what the RBA considers to be a "neutral" level, it can signal to the community that it is not going to unnecessarily punish it on the basis of a misguided pursuit of inflation-fighting zealotry. In doing so, it builds up more goodwill with the public that can be expended when the RBA has a real inflation battle to fight. A genuinely low core inflation print next Wednesday…might give the RBA sufficient ammunition to justify a pleasant Melbourne Cup Day present.” 
As it turned out, we got a double surprise: while the third-quarter inflation results were much, much lower than economists or the market expected, the earlier ABS downgrade to the second-quarter numbers, from +0.9% to +0.6%, was revised back up again to +0.8%, which to the RBA’s mind is unacceptably high (since it annualises at over 3%). 
As I have been at pains to explain here before, this second revision to the June quarter inflation data eviscerated the argument that core inflation had been decelerating since March 2011. In fact, the ABS’s best guess at Australia’s underlying inflation track now looks like this (see chart).
Click to enlarge
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/nov2.gif"><img src="/images/stories/nov2thumb.gif"></a>
One of the more important remarks in the RBA's statement yesterday was a confirmation of this particular interpretation. More precisely, the RBA observed that "underlying inflation started to pick up in the first half of the year." Note the reference to the "first half of the year". There is no “first quarter”, or intimation towards disinflation over the second and third quarters. 
On the basis of the initial downward revision to the second quarter inflation data from 0.9% to 0.6%, which The Australian's David Uren described this week as a "bombshell", the RBA rather radically altered its inflation outlook. This was meant to be confirmed by the third-quarter data. Unfortunately, policymaking never seems to be that easy. Instead, the RBA got great news in the form of a downside surprise to price pressures over July, August and September, but bad news via yet another change to the ABS’s analysis of the inflation track in the first half of the year. 
Unfortunately, the decision the RBA made yesterday could only be justified by one lonely quarter of inflation data, which stands out as a striking anomaly when juxtaposed against the information contained in the preceding quarters, as illustrated in the chart above. This is positively ironic given the RBA had ignored very high, consecutive core inflation prints of +0.85% and +0.9% in the first and second quarters on the basis that it “needed more information”. It arguably tells us something significant about the way the institution operates: it would seem to find raising rates much more difficult than cutting them. 
An independent observer might respond that is a statement of the obvious. The extraordinary community resistance to the spectre of higher rates in the first half of 2011, when the level of rates was statistically indistinguishable from 15-year averages, highlights the obstacles this notionally “independent” organisation faces when trying to control the price of money. 
Yet RBA aficionados had thought that the bank had a forward-looking, so-called “inflation-targeting” approach to setting policy. What we learnt yesterday was that the RBA’s short-lived experiment with pre-emption, as exemplified by its November 2010 decision, has been abandoned. The RBA has more or less admitted that it is awfully difficult to forecast future inflation with any degree of accuracy. The change to its official forecasts out to 2013, which will be published on Friday, will underline this point. Yesterday’s decision to adjust policy in response to one quarter’s worth of data, when other contemporaneous information, such as the unemployment rate (ironically not materially different to where it was in October 2010), GDP growth-adjusted for the floods, domestic demand, retail sales, capex intentions, and so on, all imply the economy is chugging along at a trend-like rate. 
The question then becomes what the RBA thinks will happen in the future. The subtle message from yesterday is that the RBA is no longer going to take brave punts about what may or may not transpire. It will wait for historical data to guide policy into genuinely restrictive territory. 
 
<hr class="system-pagebreak">
 
So what then are the near-term implications of today's decision? The first will be a massive, and immediate, boon for Australia's highly interest rate sensitive housing market, which, as everyone knows, has been soft for most of the year. Over the nine months to end September, national dwelling values are down by 3.6%. After the RBA’s move, one should be able to find discounted variable home loan rates a tad higher than 6.5%, which is below the 6.9% average since the RBA started tracking this data. 
As previously explained, the housing market had been weighed down by consumer expectations of two to three more rate increases over the year ahead, which, of course, never materialised. Prior to the "double tap" in November 2010, we had been forecasting flat-to-negative capital growth in 2011 and more rate increases. We got a bit more than we bargained for in November. And it would seem that the conviction among Australian households that they would be slammed with another two to three hikes in 2011 did the RBA’s job for it. As Mark Bouris <a href="https://www.businessspectator.com.au/bs.nsf/Article/interest-rate-cut-RBA-Reserve-Bank-Yellow-Brick-Ro-pd20111101-N6V8K?OpenDocument&amp;src=srch">noted in his column yesterday</a>, the de facto rate hikes in 2011 crushed consumer sentiment and housing demand. 
Now that the RBA has reversed course, I expect confidence to rise. We are not simply talking about a shift in rates from “mildly restrictive” to “more neutral” (in the RBA’s words), as I had predicted would happen following a low third-quarter inflation result. No, the RBA’s decision is much more important than that. While key media proxies, like Alan Mitchell and Terry McCrann, are confidently declaring today that this was a once-off adjustment to the RBA’s monetary policy settings and is not going to be followed by a sequence of cuts, the fact is that the community had been literally budgeting (i.e., saving and spending) as if they were certain to get several more rate increases. As late as August, an amazing 30% of Australians felt they would get four or more rate hikes over the ensuing 12 months. 
So the RBA’s decision will engender a substantial shift in consumer expectations. Quantitatively, the median expectation will move by around 50 basis points, or two rate cuts’ worth. This will be reinforced by “market pricing”, which is far more negative than either the RBA or the average economists’ forecast. At the time of writing, the interest rate futures market is pricing a remarkable 100% probability that the RBA will cut rates another 25 basis points in December. While this is conceivable, it would only occur if there were a very serious deterioration in conditions across the North Atlantic. 
The RBA will be especially loath to shift rates before it gets the vital fourth-quarter inflation data, which will be released in late January. This will be critical for both confirming the calendar year track of inflation, and, more specifically, that the low third-quarter result was not simply a once-off. That is, it will want to verify that there are no material revisions to the past data. It is possible, for example, that the third-quarter data is revised up a touch (as the December 2010 quarter data was from 0.4% to 0.6%), and that the ABS’s new “smoothing” methodologies generate a surprisingly high fourth-quarter number. 
The one thing we know with certainty is that no one, including the RBA, can reliably forecast Australia’s inflation data: neither the financial markets nor economists got remotely close to the first- and second-quarter outcomes, nor the ultra-low third-quarter numbers. Accordingly, I don't share Terry McCrann’s confidence that everything will be benign in January. It seems the one constant with Australia’s inflation rate is uncertainty. 
So, we have learnt that yesterday’s rate cut is perhaps more stimulatory than it might appear at first sight, because it will trigger a big change in consumer views of the future. It will also likely knock the wind out of the sails of the Aussie dollar, at least for the next three months. The Aussie dollar has plunged four US cents since before the RBA’s decision, and is currently trading at 1.029 US cents. 
Currencies ordinarily price off global interest rate differentials. The financial markets are punting on many more rate cuts, so it is hard to see how this is going to afford much support for our exchange rate given that peer economy rates have already hit their “lower bound”. 
This will be a tremendous relief to Australia’s exporters, who should benefit from a relative price cut, and import-competing industries, which will face more expensive substitutes. 
Another possible source of stimulation is the long-term price of money. On the back of the RBA’s decision and further global risk aversion, three year government bond rates (prices) have declined (risen) some 35 basis points. 
As I have explained before, the reduction in longer-term interest rates has been the motivating force behind the banks’ willingness to in turn cut the cost of three-year fixed-rate home loans to as low as 6.2% (cf. Suncorp today).
The average three-year fixed-rate home loan in Australia since January 1995 has been 7.41% (see chart below). So current three-year rates are probably around a full percentage point below the decade-and-a-half benchmark, which, in anyone’s books, is stimulatory.
Click to enlarge
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/nov21.gif"><img src="/images/stories/nov21thumb.gif"></a>
In summary, we had been expecting flat-to-negative house prices in 2011. Care of two rate hikes in November 2010, and two to three de facto increases in 2011, national dwelling prices are off by 3.6%. Once we accounted for consumer expectations of further rate hikes, our internal models did not project a genuine recovery in housing activity until mid-2012.  At the same time, the ABS reports that disposable household incomes have been expanding at a very rapid 8% per annum pace. This has led to a sharp fall in Rismark’s (and the RBA’s) estimate of the national dwelling-price-to-income ratio over 2010-11, and hence an improvement in affordability before we consider interest rates. 
Yesterday’s bold decision by the RBA to cut rates is a “game changer” for Australia’s housing market. Our models imply that we should see a rebound in activity one quarter earlier than expected (i.e., in the first three months of next year). Any further rate cuts will only embolden this dynamic. 
For over a year now we have argued that Australia’s housing market would be a good hedge against adverse economic outcomes. We believed that if the RBA’s terms of trade, or “Chindia”-driven, resources story did not play out as planned, then the bank will not hesitate to slash rates. The most direct and immediate beneficiaries of these cuts would be the four million-plus Australian households with fully adjustable rate mortgages that price off the RBA’s cash rate. That is, households that have been earning solid wages and solid disposable income growth, and have capitalised on a nearly fully employed labour market. 
In contrast to the extraordinarily volatile share market, a well-diversified portfolio of Australian housing has proven to be an exceptionally resilient store of wealth. Through the cycle, dwelling prices track disposable incomes closely. In fact, the cost of Australian housing has actually fallen slightly when deflated by disposable incomes since 2003. On a year-on-year-basis, there will be some inevitable variability. But over the medium term, the proposition that changes in purchasing power exert a very strong influence over prices tends to remain true. 
A final comforting thought for the housing market, is that, contrary to Steve Keen’s hysterical claims, there is absolutely no evidence of a catastrophic plunge in credit growth causing precipitous falls in dwelling prices. The hard empirical fact is that housing credit growth has stabilised at a rate in line with purchasing power, as we would expect. This point is illustrated by my final chart.
Click to enlarge
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/nov22.gif"><img src="/images/stories/nov22thumb.gif"></a>
Christopher Joye is a leading financial economist. The above article is not investment advice.
</body></html>

Expect rebound after RBA's bold decision, a game changer for housing

<html><body>
You read a lot in the media about the financial markets' "pricing" of RBA cash rate changes, or "probabilities" of a rate change in any given month. 
There are a number of ways to work these numbers out, but probably only one exact method. The ASX/SFE has listed a specific "interbank futures contract" that settles on the basis of the average RBA cash rate in the month in question (e.g., March 2012). Thus the pricing of this futures contract reflects the weighted-average expectation of the RBA's cash rate in the relevant settlement month. 
So take the November 2011 contract. The contract's price fluctuates daily. The price is the financial market's best guess at what the RBA's cash rate will be in November 2011. Working out the actual expectation is easy: it is simply 100 less the current futures price. So if the SFE's November 2011 interbank futures contract is, say, 95.25, then 100 less 95.25 equals 4.75. That means the market thinks the RBA's average cash rate over the month of November will be 4.75% (ie, no change). 
On Friday this particular contract closed at 95.455. Accordingly, the market was telling us that it felt the RBA's cash rate in November would be 4.545% (to be precise!), or lower than the current cash rate. More specifically, the market was pricing in 82% of one full 0.25 percentage point reduction in the RBA's cash rate from its current 4.75% level. 
With this background in mind, we can make sense of some interesting analysis. My first chart below shows the daily changes in the price of the November 2011 SFE interbank futures contract since the start of 2011 (i.e., the SFE contract that tries to predict the RBA's cash rate in November). 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/nov11.gif"><img src="/images/stories/nov11thumb.gif"></a>
Click to enlarge
The black dotted line is the current 4.75% cash rate, which relates to the left-hand-side axis. The red line is the market's prediction of the RBA's cash rate in November 2011. You can see that this has been as high as 5.1% in February 2011 (ie, 0.35 percentage points, or 35 basis points, above the current 4.75% level). 
More usefully, look how far the red line has plummeted below the black line at various times. Every time the red line goes below the black line, the financial markets are saying that the RBA is going to cut rates by November. They did this in March 2011, and have been doing so consistently since June 2011. The magnitudes of the cuts are striking. On different days the financial markets' best guess of the November 2011 cash rate has been as low as 3.57%, or nearly five standard RBA rate cuts of 0.25 percentage points, or 25 basis points, a pop.
The green bars denote the implied RBA cash rate change by November 2011 relative to the current 4.75% cash rate. This is measured in basis points (or fractions of a percentage point), and pertains to the right-hand-side axis. So currently the financial markets reckon we will get about 0.20 percentage points worth of cuts by November 2011, or, as noted before, 82% of a normal 0.25 percentage point cut. 
To make this pricing clearer, my next chart shows the probability of one normal 0.25 percentage point RBA rate cut. If the probability of a cut is 200%, the market is telling us that it expects two 25 basis point cuts, or 50 basis points in total. The big spike in the red line corresponds to the US and Euro crises when the financial markets somehow convinced themselves that the cash rate would be more than 1.2 percentage points lower than its current level. Of course, they were proven wrong, and by a rather wide margin! 
 <a title="Click to enlarge" rel="shadowbox" href="/images/stories/nov12.gif"><img src="/images/stories/nov12thumb.gif"></a>
Click to enlarge
My final chart expresses the financial markets' pricing in terms of a normal RBA cash rate move. In the first couple of months of 2011 we had more than one RBA hike priced by November. Then in March there were no hikes, and, in fact, a small chance of a cut. By May the probability of hikes had surged again. Then in August the market dived from pricing in hikes to a series – of nearly five – RBA cash rate reductions. This coincided with the US debt ceiling and European sovereign debt crises. Since that time the probability of cuts has consistently fallen to less than one today. 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/nov13.gif"><img src="/images/stories/nov13thumb.gif"></a>
<p-->Click to enlarge
As the RBA has recently noted, and I have previously explained, financial market pricing for rate changes can get "technically" distorted by other influences. For example, if the global central banking community decides to diversify holdings of US, UK and Euro sovereign debt by allocating higher weights to very safe, AAA-rated Australian government bonds, there will be a tremendous increase in the demand for our debt. Central banks can hold this debt to maturity, and so don't, therefore, necessarily care about its price: they are much more focused on the high yields offered by Aussie bonds. This can have the effect of driving up all bond prices, and thus driving down market yields. Since the yield curve gives us the market's expectation of the future price of money, these estimates may be biased downward by an increase in the demand for the otherwise small stock of Australian government debt. 
So what do economists think will happen on Tuesday? In general, economist forecasts tend to be far less volatile than the financial markets’ pricing. They normally publish a view and stick to it until there is overwhelming evidence suggesting they should change it. Based on the latest Bloomberg survey results, economists slightly favour an RBA cut in November, with 15 forecasting a cut and 11 predicting no change.
Christopher Joye is a leading financial economist. The above article is not investment advice.
</p-->
</body></html>

Financial markets versus the RBA

<html><body>
There is a lot of talk about house prices in Australia. We hear much less about rental costs. Importantly for the inflation debate, house prices, which tell us the cost of buying an asset (namely a home), are not included in the ABS's measures of inflation.
However, the cost of securing accommodation in this country – that is, rents – are naturally a key component of the inflation data. Indeed, rents alone make up 6.7% of the overall inflation index. (There are other housing-related costs in the inflation data, such as the cost of new dwellings excluding land, and the cost of making major improvements to homes.)
The cost of renting is relevant to owner-occupiers, investors and renters. When you buy a home, you save paying rent to another person. Alternatively, think about it this way: when you purchase a property and choose to live in it, you are foregoing the rental income you could earn if you rented it out. In the jargon, this is known as "imputed rents".
For investors, rents are a critical share of their total income, or "total return", which comprises capital gains (i.e., changes in the market value of the asset) and the income they get paid by the tenant.
Finally, for those who do not own the actual asset and decide to rent, changes in rents are important because they reflect changes in the cost of putting a roof over your head. Again, in the jargon, economists like to refer to this as the cost of "consuming housing services".
I have dived into the ABS's inflation data to see what has been happening to rents over time. And, as the chart below shows, it is clear that there has been a structural increase in rents since the early 1990s (click to enlarge).
<a href="/images/stories/oct31.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/oct31thumb.gif"></a>
Prior to about 2007, annual rental increases never exceeded 4% per annum. That changed in 2007 and peaked in December 2008 when rental costs rose to 8.4% per annum (refer to the red line in the chart above). While they pulled back over 2009 and 2010, rental costs have stabilised at a high 4% plus pace, which is well above the 2.3% per annum average rate between 1992 and 2007 (see the orange line).
More worryingly, since the end of last year, the cost of renting has started escalating again with the year-on-year growth rate hitting 4.6% per annum in the September quarter. The explanation for this structural change likely lies in an underinvestment in housing supply, which is something the RBA (more recently) and I (since 2003) have been banging the table about for a while.
</body></html>

The great Australian rental inflation

<html><body>
After the 0.3% core inflation result yesterday  (technically, the average of the perfectly consistent “weighted median” and “trimmed mean” prints), which was presumed to have followed decelerating core inflation over the first (0.85%) and second (0.6%) quarters this year, a rate cut next Tuesday should be a done deal. 
Most of the RBA’s song birds have evidently been told so. An increasingly emboldened Peter Martin, from Fairfax, who previously broke the news about the hugely significant downward revision to the ultra-high second-quarter inflation results, confidently describes a cut next week as “more than a certainty”. 
Another would-be RBA proxy, News Limited’s Terry McCrann, who on his day can be a market mover and was once known simply as the “shadow governor” because of his uncanny ability to predict RBA decisions, declared, “We are now headed for a Cup Day official interest rate cut and the banks will pass it on in full and quickly to borrowers.  Both these predictions are at Black Caviar odds and just as certain.” 
 
Finally, we have those persistently prescient financial markets (not!), which have put 100% probabilities on rate cuts on several occasions over the past 12 months and are yet again telling us that November is in the bag. In fact, after the CPI yesterday, the probability of a rate cut rose to more than 100% because the market was saying that there was a chance the RBA might go by more than the standard 25 basis points. 
Along these lines, Stephen Koukoulas, former economic advisor to Julia Gillard, who boldly forecast a rate cut in October, which was never likely given the RBA was always going to wait for the CPI, has been even bolder this time around, projecting not one, but two rate cuts next week. 
On the basis of the information above, any reasonable person would conclude that an easing next week looks like a sure thing. But I suspect the situation is a little trickier than this. In the minutes after the CPI I thought a cut was government-guaranteed. But when Bloomberg published the historical revisions (see below), my probabilities attenuated somewhat.
On reflection, I would put the odds of the RBA reducing its target cash rate next week at around 70%. This contrasts with the 100% certainty claimed by Peter Martin, Terry McCrann, Stephen Koukoulas and the markets. So while a cut is very likely, there are superficially credible reasons why the RBA should, in theory, continue to exercise the option to wait. Let’s walk through them. 
First, after three attempts at estimating the RBA’s two preferred “core” inflation measures for the second quarter, it turns out that all the hoopla generated by economists, the RBA and journalists about a major “turnaround” in Australia’s inflation rate, which involved a rapid deceleration in underlying inflation from 0.9% in the first quarter to 0.6% in the second quarter, was, according to the ABS’s latest numbers, wrong. 
Recall that the first estimate of core inflation in the second quarter was 0.9%. After the similar 0.9% result over January through March (subsequently revised to 0.8%), this appeared to make the case for a hike in August a certainty.  The view that the pace of inflation was slowly rising in line with the RBA’s projections was reinforced by revisions to the December quarter numbers, which have now increased from an initial estimate of 0.4% to 0.5% and, as of yesterday, to 0.6%. Starting in June last year, the quarterly rate of inflation prior to yesterday's numbers looks like: 0.45%; 0.55% (revised to 0.5%); 0.4% (revised to 0.6%); 0.85% (revised to 0.8%); 0.9% (revised to 0.8%). 
Combined with worryingly low labour productivity, a very robust current and expected global inflation pulse driven out of both developing countries and politically inspired zero interest rate policies and money printing in North America, the UK and Europe, and the fact that we have private investment equivalent to 12% of GDP projected to take place in 2011-12 alone, you can understand why the RBA has assumed that Australia will likely have a major inflation challenge in the years ahead. 
The crucial point to acknowledge here is that yesterday’s 0.3% core inflation print did emphatically not reinforce a decelerating inflation trend, as media commentators and the RBA had previously thought. This is because the ABS remarkably revised, for a second time, the important second-quarter numbers back up to an unacceptably high 0.8%. This came after the ABS had revised down the initial print of 0.9% to just 0.6%, which what triggered the recently dovish rhetoric. 
The repeated revisions cast doubt over the reliability of Australia’s inflation data generally. And make no mistake, they are surprising: you would think that with a three full months over which to measure price changes (cf. the house price data that is calculated monthly) and reportedly more than 100,000 price inputs, the ABS could furnish us with some dependable insights. Instead, we are getting quite radically different conclusions ranging from “we have a major inflation problem” to “inflation pressures are dissipating” to “we seem to have problems again”, at least over the first half of 2011. 
If there had been no further revisions to the second-quarter numbers, one would find unconditional unanimity in relation to a rate cut next week. The devil of the detail, however, has thrown a small spanner in the works. 
This pickle is highlighted in the chart below. It illustrates that the third-quarter numbers, which will be presumably subject to revision, like their predecessors, are very much the odd man out. And the thesis that there is risk, albeit lower probability risk, that the RBA remains on hold, has been lent additional weight by Alan Mitchell’s column in the AFR today. In contrast to his media peers, Mitchell argues that there is no guarantee of a cut. And Mitchell is credible: he has been covering the RBA for decades and has yet to be sensationally wrong-footed by the bank, an observation that does not apply to his more confident colleagues.
<a href="/images/stories/oct27.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/oct27thumb.gif"></a>
Given the substantial changes to the ABS’s core inflation measures in recent times, any objective decision-making process would exercise considerable care in assessing yesterday's results. Indeed, the RBA would note that third-quarter “ex-volatiles” inflation number was a high 0.8%, and has average 0.7% per quarter (or 2.8% annualised) over the first nine months of 2011. “Non-tradeable” (i.e., domestic) goods and services inflation printed even higher at 1.2% in the quarter, and has averaged 1.1% over 2011. Sure this data is not seasonally adjusted, and the non-tradeables will have been affected by the floods. But, at some point, the supply shock that was the floods was meant to be reserved out. And seasonal adjustments simply smooth out intra-period data: over the duration of an entire year, the seasonally adjusted and raw data should converge. 
The second reason for pause is that the RBA has ostensibly established its own “decision rule”, claiming in the October board minutes that it would only ease interest rates “to provide some support to demand, should that prove necessary”. 
Well, we know that Q2 real GDP printed at a stonking 1.2% with private demand growing at a 5% plus annualised pace over the first six months of 2011. We also know, interestingly, that there have been consistent upward revisions to Q4 GDP, which is now estimated to have risen by a trend-like 0.8% even having suffered, in the RBA and Treasury’s opinion, a loss of about 0.5 percentage points from the effects of the east coast floods. That is, the final quarter of last year would have printed at a very high 1.1% or 1.2% had the floods not occurred. 
And then we know that the recent activity data has been solid. Using the broader GDP survey, real consumption grew solidly in the second quarter. According to Westpac’s leading indicator index, economic growth is projected to be well above trend over the next six to nine months. Unemployment has remained low at around 5%. The monthly retail spending data has ticked up recently and expanded at a 7% annualised pace over the last two months. And there has already been a de facto easing of interest rates via substantial reductions in fixed-rate home loans to as low as 6.3% today, modest tapering in the price of variable rate loans, and a softening of the currency from its 2011 highs. 
A third observation is that if the RBA did not hike after initial core inflation results of 0.9% in Q1 and 0.9% in Q2, which after three recalculations have stayed at 0.8% apiece (thus annualising core inflation at a well-above-target 3.2% over the first half of the year), why would a forward-looking, inflation-targeting central bank cut rates on the back of one anomalously low core number in Q3? 
As others have argued, 25 basis points here or there is not going to make a world of difference to the RBA’s inflation outlook. And there are considerable reputational risks for the RBA if its cuts in November only to confront a high fourth-quarter core inflation outcome in January (perhaps followed by an upward revision to the Q3 numbers). What does it do then? Say “Oops, we got it wrong (again), and want to be back at “mildly restrictive”.” What is the RBA’s much-mooted “policy of least regret” as an avowedly inflation-targeting central bank? (And I have refrained from discussing the RBA’s inflation forecasts too much here simply because the RBA itself knows they have limited explanatory power.) 
One case for cutting next week is that the RBA has clearly created expectations among journalists, and thus the community, that it would do so on the back of a low result. As I have noted too many times to count, this practice of pre-judging board meetings and wording-up journalists is hazardous for both the Bank and the individuals in question. Terry McCrann, in particular, has now been humiliated by the RBA on two occasions in the last 12 months. 
Today McCrann claims in his column that any suggestion there was “disunity” on the RBA board over monetary policy is a “myth”. This is plainly incorrect. It has been clearly reported that at least one external Board member voted for hikes in the first half of 2011, only to be rolled by the wider board. 
It has been further speculated that other board members have, at various times this year, argued for cuts. We know from the RBA’s board minutes after the first-quarter inflation results that the board felt there were arguments for and against raising rates, which was inferred to mean a lively “debate”.  And we know that the board explicitly considered doing so as recently as its August meeting. Finally, we know that after a decade serving on the board, Warwick McKibbin has, following his resignation, been critical of the make-up of the board, highlighting the risk of conflicts from intrinsically dovish private sector representatives, and recommending that its composition be changed.
McKibbin has also intimated towards political conflicts given the presence of the Treasury Secretary on the board, a criticism that was reinforced by freedom of information releases showing senior Treasury officials strongly disagreed with the RBA’s monetary policy decisions in 2008, and damagingly described the bank as "schizophrenic" in discussions with important partners, such as representatives of the US government.
Questions swirling around the RBA’s political independence were also reaffirmed when the Treasurer, Wayne Swan, broke with decades of convention and controversially took away the pay-setting powers of the RBA’s independent board members on the basis that he felt they were paying senior RBA staff too much. In an attempt to persuade Swan not to make this change, the longest-serving member of the RBA board, Jillian Broadbent, wrote to him and warned, “The board believes that the current remuneration framework for the bank is crucial to the bank's continuing capacity to carry out its duties to the standards required, and would see any move to unwind it as undermining the capacity of the Bank to do so." Swan ignored her. 
If the RBA cuts next week, we will learn a great deal more about the way this institution works. A cut will be a political exercise in building community goodwill in the event the RBA does have to raise rates to fight a more serious inflation problem down the track. A cut will confirm that the RBA finds it much more difficult to hike rates than reduce them. A cut will imply that the RBA is worried about its political independence, and treads especially carefully in the formulation of restrictive policy. A cut will tell us that the RBA does not have a Bundesbank-style policymaking bias towards keeping inflation low, but rather contextualises policy decisions against the risks to its recently won independence in a world in which most of its central banking peers are losing a grip on theirs.
Christopher Joye is a leading financial economist. The above article is not investment advice.
</body></html>

RBA independence on the line in complex Cup Day scenario

<html><body>
The second-in-command at the RBA, Ric Battellino, has delivered a balanced and thoughtful <a href="https://www.rba.gov.au/speeches/2011/sp-dg-251011">speech</a> in which he gives the bank's take on local and global economic developments. I would summarise my analysis of this speech as follows: 1. The RBA's base case is for the global economy – a crucial variable for setting Aussie monetary policy – to grow at a trend pace, with unusually high (but equally unknowable) downside risks at this juncture. 2. However, the RBA is not going to forecast these downside risks, because that's an impossible task. It will watch and wait for the world to confirm what is actually going to happen. 3. The central story around the Aussie economy remains intact in terms of the secular private investment boom. The floods combined with sundry offshore crises temporarily knocked the local economy off balance during the first half of 2011. Subject to the aforementioned global risks, the future should not be radically different to what the RBA previously expected, which, I suspect, means a forecast for gradually rising core inflation with the path determined by today’s third-quarter CPI combined with previous revisions. 4. The Aussie economy is, as I have argued here before, already getting the benefit of "notable" stimulation via reductions in fixed-rate loans to 6.3% or less, reductions in variable rate loans (by 10 to 15 basis points), and a depreciation in the currency from its USD1.10 highs. 5. As my CPI preview anticipated, everything really hinges on the third-quarter numbers and what this tells the RBA about the pulse of inflation. A very low number (similar to what New Zealand got yesterday, which is typically well-correlated with the Aussie results) would allow the RBA to pull down its inflation forecasts to 2013 to within the target 2% to 3% per aannum band, albeit on a still rising trajectory (perhaps it would keep a 3-handle in 2013). 6. To one school of thought, this would in turn enable the RBA to make a once-off technical adjustment to the cash rate to bring it back to "neutral" at the November board meeting. Complicating this decision is the fact that a lot of the recent data flow has been very healthy, and an inflation-targeting central bank would not ordinarily mind having a "mildly restrictive" rate setting given its longer-term view of the world (and the fact that rate changes today target prices over a two-year horizon). I would venture that any technical adjustment is going to be much more motivated by tactical and political considerations (mainly building up long-term goodwill for when the real inflation battle begins); 7. The argument against a technical adjustment is that it is not going to make a big difference to anything (ie, one 25bps move), it is not going to be passed on fully by the banks (thus we are probably only talking about 15-20bps), and the RBA may look very silly if Q4 core prints high, which is a risk, and it needs to start bumping rates back up again. The bottom line is that as Battellino notes, monetary policy remains extremely complex, and he and RBA governor Glenn Stevens are earning every dollar of their way-below-major-bank-standard pay packets (i.e., for a top 15 major bank executive). To be clear, Battellino is not preparing the market for cuts in particular. He is seeking to give the RBA as much room to move as possible. Right now, flexibility is the name of the game. The RBA board members don't want to look like idiots irrespective of whether they have to cut, hold, or, heaven forbid, hike.
Christopher Joye is a leading financial economist. The above article is not investment advice.
</body></html>

All eyes on third-quarter inflation numbers

<html><body>
We are often asked about the impact of maintenance and capital improvements on direct residential property returns. More specifically, what are the annual performance leakages attributable to these costs? Today’s column will try and shed some analytical light on this murky subject. 
As an aside, I will not examine how the same issues afflict the far smaller “commercial property” sector – there is less than $300 billion of commercial, industrial and retail real estate compared with circa $3.6 trillion of housing – which nevertheless assumes far higher weights in institutional investor portfolios to the latter’s detriment. 
The very poor performance reported by Australian super funds in recent years has been in part driven by unnecessarily high exposures to risky listed property trusts (or REITs) and unlisted commercial property. As but one illustration, my first chart below compares the performance of Australian houses (capital growth plus 50% of gross rents to control for costs), which is the red line, with the ASX/LPT Accumulation Index, which captures all REITs and is denoted by the blue line.
Click to enlarge
<a href="/images/stories/oct251.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/oct251thumb.gif"></a>
For some reason, Australian super funds have loaded up on the blue line but completely overlooked the red one. Go figure. And which of these two lines gives more pause in relation to the perennially emotive “bubble trouble” question? We read so much crap about “house price bubbles”, but almost never hear about the far bigger bubbles that one finds in commercial property prices. The hard data suggests that the real “irrational exuberance” was attributable to institutional investors, like super funds, chasing too much commercial, as opposed to residential, property. 
Commercial property advocates try to dismiss the highly liquid “market pricing” afforded by the ASX LPT index and point to the much lower volatility (risk) numbers that derive from indices that purport to track “unlisted” portfolios of commercial real estate. The problem with these measures is that they are heavily influenced by “non-market” human valuations that typically ignore distressed sales (i.e., those properties selling at discounts during times of crisis) and thus artificially smooth returns. That’s akin to saying, “We are going to remove all the really badly performing companies listed on the ASX because they are distressed.” 
But enough venting. Let’s return to my central task today: quantifying the impact of capex and maintenance on residential property returns (the results are similar for commercial property). Some house price proxies, such as “median price” or “stratified median price” indices – of the kind reported by APM and the ABS – make no attempt to control for the bias induced by capital improvements (viz., renovations) and the other maintenance required to preserve the value of the underlying assets included in the index to mitigate depreciation. 
The repeat-sales indices reported by Residex are probably hampered by similar problems: rather than plucking the median or middle sales observation every quarter, Residex only looks at homes for which it can find both a purchase and sale, and then measures buy-and-hold returns via a regression-based index. This approach has the obvious drawback of excluding all newly built homes. Another problem is that over the average owner’s holding period of seven to eight years, many will carry out some structural improvements in order to boost the value they extract from that asset, and/or to offset the effects of the inexorable depreciation of the dwelling. 
Standard repeat-sales indices do not directly deal with this problem, and are therefore biased measures of house price changes over time. In the academic research literature, there are a number of modifications one can make to the basic repeat-sales methods used by the likes of Case-Shiller in the <country-region><place>US</place></country-region> to statistically control for non-linear changes in a dwelling’s value, which, it is assumed, arise as a function of capex (or depreciation in the absence of capex). But these are inherently imperfect. 
Unfortunately, we cannot know exactly what Residex does because, unusually for a supplier of house price indices, it has historically refused to provide specific details on the methodology it uses. 
Within Rismark’s library of house price index products, we privately produce all of the known techniques, including adjusted repeat-sales models that control for the abovementioned biases. 
By far the best, and most direct, way to address the problems induced by capex on time-series measures of housing costs is through the use of “hedonic” indices. These benchmarks are RP Data-Rismark’s preferred tools for evaluating changes in housing costs over time, and have become the gold standard for the RBA and most banks. 
Critically, a hedonic index explicitly controls for the exact attributes of all the homes included in the index, ranging from their precise location, number of bedrooms, number of bathrooms, the property’s type and land size, whether it has a garage or pool, and its view, among other things. 
As a filter in RP Data and Rismark’s data processing method, we also insist on being able to confirm the specific attributes of all homes within six months of the sales data that is used in the index. In this way, we know that the characteristics that the index relies upon – such as number of bedrooms, bathrooms, land size, etc – are up-to-date. 
Hedonic indices are designed to very explicitly compare like with like. They effectively take the highly heterogeneous “apples and oranges” that are the homes that transact over time, and normalise them such that we can identify the true underlying rates of capital growth attributable to regions, cities and the national market. 
This brings me back to my original question about the return leakages deriving from both high-value structural capital investments (i.e., development application-approved renovations), and other lower value, or non-DA approved, maintenance. 
 
<hr class="system-pagebreak">
 
In what follows, I will try and quantify these for you. It is important to bear in mind that these costs need to be weighed against the asset’s total returns: that is, both capital growth and normal or imputed rental incomes. They should not be deducted exclusively from one or the other. 
The ABS reports two measures of the value of alterations and additions (A and A) on a quarterly basis. The first is the Construction Work Done Series and leverages off the ABS’s Building Activity Survey. The Building Activity Survey (BAS) supplies estimates of the value of work done on alterations and additions with an approval value of $10,000 or more as collected via DAs submitted to Australian councils. 
In the ABS National Accounts a second, far broader measure of residential A and A is published. In particular, the National Accounts upwardly adjusts the BAS estimates to reflect the fact that a substantial amount of alterations and additions activity is not covered in the BAS survey (eg, work under $10,000, and work not done with permits). The National Accounts also boost the BAS A and A by an “undercoverage adjustment” to control for some reporting biases (eg, DAs tend to be undervalued). 
Our previous correspondence with the ABS suggested that the overall National Accounts adjustment factor, which varies on a state-by-state basis, is between four and five times. 
In the chart below we show the <personname>sma</personname>ller BAS estimate of A and A as a share of the value of the total private residential housing stock since 1986. This is calculated by multiplying the number of private dwellings each quarter with RP Data-Rimark’s measure of the all regions, all property types median dwelling price. Since 1986 the average BAS A and A has been 0.26% per annum. Click to enlarge
 
<a href="/images/stories/oct252.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/oct252thumb.gif"></a>
In the next figure we move to the more comprehensive A and A proxy reported in the National Accounts. Consistent with our prior correspondence, this total A and A estimate is on average 4.95 times larger than the BAS result (see the penultimate figure below). That is, the ABS believes that all forms of dwelling maintenance and capital investments, excluding the construction of new buildings, amount to about 1.26% per annum. Click to enlarge
<a href="/images/stories/oct253.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/oct253thumb.gif"></a>
<a href="/images/stories/oct254.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/oct254thumb.gif"></a>
A useful sanity test of these A and A estimates is to look at the value of depreciation as a share of the housing stock. In its National Accounts, the ABS spends considerable time computing the annual value of the depreciation of the private residential dwelling stock owned by individuals. In the final figure we have taken this depreciation proxy and divided it by the same estimate of the total housing stock value used above.
<a href="/images/stories/oct255.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/oct255thumb.gif"></a>
Unsurprisingly, depreciation, which averaged 1.2% per annum between 1986 and 2011, is almost exactly the same as average capital expenditure. In fact, it also tapers off during the 2000s, just as capex appeared to do. And it reconciles almost perfectly with the ABS’s estimate of the average dwelling life of 88 years. 
To summarise, this analysis suggests that the total value of maintenance and A and A as a share of the value of the dwelling stock is around 1.2% per annum (rounded down), all else being equal.
Christopher Joye is a leading financial economist. The above article is not investment advice.
</body></html>

How much value renovating adds to your home

<html><body>
At precisely 11.30am next Wednesday you should be able to work out whether the RBA will give borrowers an interest rate break at its November board meeting.
Why? Because that is when the ABS releases the all-important third-quarter inflation data, which tracks movements in “headline” and “underlying” consumer prices between June and September 2011.
The official headline number will not have much influence on the RBA board's decision since the bank believes that it has been biased by the see-sawing associated with various flood-affected prices.
This is one reason why the official figures have been so high over the last six months, expanding by 1.6% in the first quarter and by another 0.9% in the second quarter. What the RBA will be focusing on is the average of its underlying or “core” inflation estimates that strip out both rapidly rising and rapidly falling prices.
The two top guys at the RBA have both publicly commented this year that setting monetary policy – that is, the process by which the RBA, which is an independent, taxpayer-owned, central bank to our private banks, changes its "target cash rate" in order to influence the actual interest rates we receive on our savings and pay on our loans – has been the most difficult they can recall since the early 1990s.
That particular period is an important marker since it denotes the time when the RBA adopted a new policy approach called "inflation-targeting". In brief, the RBA decided that the smartest thing it could do was to try and influence the interest rates prevailing in markets in order to keep the change in the price of consumer goods and services between 2% and 3% per annum as frequently as possible (or, in the jargon, "through the cycle").
This 2% to 3% per annum inflation target, which is a little higher than the bands adopted by most other developed countries, was selected by the RBA simply because it was the rate at which consumer price inflation settled following the painful 1991 recession. While most 20- and 30-somethings will have forgotten, unemployment peaked at around 11% in 1991 in part because the RBA had lifted borrowing rates to an incredible 17%.
The 2% to 3% per annum band has been kept deliberately wide by the RBA’s boffins since they don't believe, frankly, that they can accurately forecast inflation to a single decimal place, nor, therefore, hope to be held to such an exact goal. This explains why the head of the RBA, Glenn Stevens, refers to the RBA’s objective as keeping the rate at which consumer goods and services prices rise to “two point something”.
The RBA's job has been particularly difficult this year because it had projected elevated inflation over 2011, 2012, and 2013, which, it understandably assumed, would necessitate higher rates.
These forecasts appeared uncannily accurate when the ABS released its official inflation data for the first and second quarters. Specifically, the RBA's preferred core inflation benchmarks averaged about 0.85% for the first six months of the year. This is considered well above the RBA's "acceptable rate", and would ordinarily have led to reflexive hikes.
While it came very close to pulling the rate trigger as recently as August – the decision not do so incidentally cost arbitrageurs billions of dollars – the RBA exercised the option to wait. Why? Well, there were three main reasons.
First, the devastating floods caused a major 0.9% real contraction in economic growth over the first three months of the year.  The RBA did not think it would be politically smart to lift rates during this period.
Incidentally, even with the floods reportedly lopping 0.5% off growth in the final quarter of 2010, GDP still managed to print at (an upwardly revised) 0.8% – or 3.2% annualised – which gives you a sense for the strength of the economy. Following the June quarter data, we know that domestic demand in the first half of 2011 has been running at a very healthy 5% per annum pace.
The floods were then followed by an unprecedented sequence of crises, from the earthquakes in New Zealand to the Japanese tsunami-cum-nuclear catastrophe (no small deal for Australia's second-biggest trading partner and the world's third-largest economy), then the adverse oil price shock invoked by a series of Middle Eastern revolutions, and, finally, the European and US sovereign debt crises. It is hard to conceive of more going wrong in any half-year period absent the outbreak of a global war.
Finally, there was the Australian dollar, which soared to what would have, until recently, seemed like unimaginable levels. The RBA's research implies that an increase in the value of our exchange rate pulls down the cost of imported goods and depresses activity in export and import-competing industries. All told, this helps to attenuate inflation.
So there were certainly credible reasons for the RBA to think very hard about its 2011 decisions. After the experience of 2007-08 when Australia's underlying inflation rate surged to 4% to 5% per annum, the RBA was keen to avoid a repeat of this episode. One quarter of bad data amidst the aforementioned headwinds was, to be sure, forgettable. But the even stronger second-quarter numbers appeared to make hikes a certainty.
Since wages and a host of other things are "indexed" to the official inflation numbers, the ABS gets the willies if anyone starts talking about "revisions" to its data (check out this <a href="https://www.abs.gov.au/ausstats/abs@.nsf/mediareleasesbyReleaseDate/43D82029B57A002FCA25790D0003B123?OpenDocument">press release</a> scolding such talk). Formally, there are never revisions: the official numbers are the raw headline estimates, and they never change. Yet since these are affected by modifications to tax rates and once-off shocks like the floods, the RBA, and its financial market acolytes, get to mostly ignore them. They concentrate on the "cleaner" core measures of price changes discussed above.
While the ABS happily released its shocking core inflation numbers just before the RBA's August board meeting, what nobody in the public domain knew – save possibly two well-informed journalists at Fairfax – was that the ABS would subsequently publish substantial revisions to these numbers one to two months later.
These controversial "revisions" came in two forms. The first was a change to the way in which the ABS "smooths" the inflation data to manage clearly identifiable "seasonality". The ABS used to only smooth 20 of the 90 consumer price categories. It has now increased this to 64 classes of goods and services. This increased the historical rate of inflation a touch, but, more significantly, materially cut the (already smoothed) second quarter "core" inflation proxies from 0.9% to just 0.6%.
This really changes everything. Rather than a demonstrably accelerating rate of underlying inflation over 2010 and the first half of 2011, we have just one stand-out result in the first quarter after the ABS’s rehashed numbers.
The second revision was a change to the weightings that each of the consumer goods and services categories get in the overall make-up of the CPI. These weightings are adjusted every six years, and, according to the RBA, the new weights reported by the ABS (combined with an additional change to the way in which financial services inflation is calculated) further lower the underlying rate of inflation over the last year. These numbers might sound small, but they all add up.
The net effect of the revisions is that the underlying pace of inflation over the year to June 2011 fell from the RBA’s original estimate of about 2.75% to somewhere between 2.25% and 2.5%. To be clear, that is in the bottom half of the RBA's target band and has big consequences for the way in which we think about inflation.
Given the RBA's public statements following the original publication of the ABS’s second quarter inflation results, which characterised core inflation as "troubling", "broad-based", and, more importantly, caused the RBA to lift its underlying inflation forecast from 2.75% over 2011 to an unpalatably high 3%, it is unlikely that the bank fully understood the impact of these adjustments before they were released.
While it is not constructive to waste much time debating this point, we know, as a matter of record, that prior to the two revisions, the RBA had upgraded its official inflation projections, canvassed raising rates at its August board meeting, and made numerous remarks to the effect that it was worried by the data it was seeing, fingering, in particular, a rise in the cost of workers (or “unit labour costs”) as a culprit.
After the ABS revisions, the RBA has decidedly changed its tune, and argued that there is evidence to suggest that inflation might not be as strong as they had first thought.
For an institution that is paranoid about its credibility, this insinuates that there was, for some reason, a disconnect between the ABS and the RBA on the subject of the revisions.
This itself is no surprise given the two organisations have had a frosty relationship, with the ABS for years refusing to publish the RBA's preferred measures of underlying inflation. (This, as an aside, led investors into an analytical “arms race” after the release of the ABS's official inflation data to see who could first work out what the RBA's measures would actually be.)
Another wrinkle layered on top of all this is, I suspect, that the RBA would not be opposed to "normalising" the level of interest rates in view of its new information. If the third-quarter inflation numbers print on the very low side, they will hammer the final nail in the coffin of the current inflation debate. There will be no evidence that price pressures are accelerating. With a still high currency, this will then denude the rationale for holding the cost of money at the RBA's "mildly restrictive" level (assuming that the RBA is able to revise down all of its currently-elevated inflation forecasts out to 2013).
By bringing the price of money back to what the RBA considers to be a "neutral" level, it can signal to the community that it is not going to unnecessarily punish it on the basis of a misguided pursuit of inflation-fighting zealotry. In doing so, it builds up more goodwill with the public that can be expended when the RBA has a real inflation battle to fight.
A really low core inflation print next Wednesday of equal to or less than 0.6% might give the RBA sufficient ammunition to justify a pleasant Melbourne Cup Day present. It is hard to know what the bank would do if the core numbers come out at between 0.6% and 0.8%. One can be more confident that a core print of 0.8% or higher would significantly reduce any chance of interest rate accommodation, at least for the time being. Of course, all of this is subject to the usual condition that “bad stuff” can, and does, happen.
Christopher Joye is a leading financial economist. The above article is not investment advice.
</body></html>

Next week’s inflation numbers will determine the RBA’s next rate move

<html><body>
In the past few weeks two major personalities – doomsday US commentator Harry Dent, who is spruiking a book, The Great Crash Ahead, and the telegenic star of Channel Nine’s The Apprentice show and founder of listed wealth manager Yellow Brick Road Mark Bouris – have gone head-to-head with their conflicting views of the world in high-profile presentations in Sydney and Brisbane. 
The Dent-Bouris clash has coalesced around several predictably sensational forecasts from the US economist, including, of course, that Australian house prices will fall by 50% (which has led Dent to beseech Aussie families to sell their homes), that the global economy is set for a big crash, and that you should get out of risk asset classes and squirrel your money away in cash. Interestingly, while the protagonists disagree on much, they also find some common ground. 
I was lucky enough to get access to Bouris’s presentation, and thought it was worthwhile reviewing in detail today. 
The founder of Australia’s largest non-bank lender begins by assaulting the presumption that the world is set on an irreversible course towards recession simply because the US and Europe are in trouble. 
More specifically, Bouris argues that there is too much financial market and media focus on the G7 economies, pointing out that they have accounted for less than 34% of global growth over the last decade. 
The “developing world”, on the other hand, has been responsible for generating nearly half of all global GDP over this period.
Bouris tells us that this disconnect is projected to widen: according to the IMF, emerging and developing economies will account for more than 60% of global economic growth over the next five years (see his first two charts below). Click to enlarge
 
<a href="/images/stories/oct191.gif" title="Click to enlarge" rel="shadowbox"><img src="/images/stories/oct191thumb.gif"></a>
<a href="/images/stories/oct192.gif" title="Click to enlarge" rel="shadowbox"><img src="/images/stories/oct192thumb.gif"></a>
His critical insight here is that Australia is one of the few developed nations that is industrially leveraged to the much more propitious emerging world: 65% of all our exports go to developing countries, with 75% sent to Asia alone. 
With this in mind, Bouris contends that notwithstanding the ineluctable vagaries of the business cycle, the urbanisation and industrialisation processes taking place in China and India – which collectively absorb one-third of all Australian exports – will inevitably continue. 
Here he draws on his bete noir, the RBA (more on that later), quoting the latter’s estimates that 300 to 400 million Chinese will migrate out of country dwellings into urban cities over the next two decades. Another fascinating statistic he digs out in this context is that whereas there are 170 Chinese cities with more than one million residents, Europe, by comparison, has only 35. 
In a dose of good fortune for the lucky country, it just so happens that the modernisation underway in “Chindia” is dependent on three things that we produce in abundance: steel (iron ore); energy (coal and LNG); and protein (agriculture). On the latter variable, Chinese protein consumption per head has exploded, as it typically does when per capita incomes rise. 
Bouris explains that this is directly impacting Australia’s economy via an unprecedented, and mostly assured, wave of private investment. He presents data showing that the domestic capex that has already commenced, but is not yet complete, is currently worth about $105 billion, or 8% of 2011 GDP. If you then include the more speculative “planned” investment for 2011-12, total expected capex spending rises to a stunning $160 billion, or 12% of 2011-12 GDP using past “realisation ratios” (i.e., the share of planned capex that actually gets expended). The two charts below graphically outline this thesis. Click to enlarge
<a href="/images/stories/oct193.gif" title="Click to enlarge" rel="shadowbox"><img src="/images/stories/oct193thumb.gif"></a>
<a href="/images/stories/oct194.gif" title="Click to enlarge" rel="shadowbox"><img src="/images/stories/oct194thumb.gif"></a>
The message from the Wizard Home Loans founder is perhaps best paraphrased as: Yes, the North Atlantic economies will likely experience challenging economic times. But, the G7 is emphatically not the “global” economy; in fact, it will contribute less than 29% of global output in the next five years. So while difficult days could lie in wait, the world will not end, as our friend Dent insinuates. 
The key take-away is that Australia is well-positioned to navigate any future turbulence given that most of our major commercial linkages are with those parts of the globe that represent the new world. 
At this stage, Bouris temporarily digresses to critique the RBA. He thinks interest rates are being held too high by the RBA’s obsessive inflation focus, which, it must be said, is scorn that has attracted added weight in recent months. After initially reporting two scorchingly high headline and core inflation prints, the ABS has unusually revised down the underlying numbers to much more benign levels. Recent changes to the ABS’s weighting methodology also cast a more favourable light on the current inflation pulse. It would appear that the RBA is reluctantly moving towards this Boursisian view of the world, with its media proxies canvassing a once-off Melbourne Cup Day cut in the last couple of days. 
While Bouris disagrees with Dent on the outlook for the Australian economy, he is more sympathetic to his portfolio construction preferences. In particular, he agrees with Dent that the emergence of people in the “baby boomer” demographic, which were in the “accumulation” phase of their life-cycles during the 1980s, 1990s and 2000s, drove demand for higher-returning (and higher-risk) investments like shares and real estate. 
This effect was redoubled, Bouris notes, by the introduction of superannuation in 1992, which directed the vast bulk of household savings into volatile shares. As the baby boomers transition into retirement and start to “de-accumulate”, the demand for higher-growth assets will dissipate, which is a negative for equity returns. The main beneficiaries of this demographic dynamic will be those asset-classes that offer certainty and security; namely, cash and fixed-income. 
At this juncture, however, the back-slapping ends. Whereas Dent maintains a very pessimistic position on shares and real estate care of his prediction that the “great crash” is coming, Bouris’s views are founded on a more nuanced evaluation of risk. 
Using 30 years worth of data, he shows that the total returns to 10-year Australian government bonds have outperformed both global equities and ASX-listed property trusts (LPTs). On a risk-adjusted basis, government bonds and cash (i.e., bank bills) leave Aussie shares, global shares and LPTs for dead (refer to the Sharpe Ratios, which divide the investment returns – less the risk-free rate – by the volatility, in the table below).
 
<img src="/images/stories/oct195.gif">
The story here is simply that cash and fixed-income have an important – not exclusive – role to play in properly diversified investment portfolios. 
 
<hr class="system-pagebreak">
 
Bouris backs this up with much more sophisticated “portfolio optimisation” analysis across the major asset-classes over the last three decades (see next chart). He explains that if one were to “target” an expected nominal return of, say, 10% per annum (or inflation plus 4% to 5%), most of your money should have been invested in cash and fixed-income, with only a relatively small 10% to 20% weight to Aussie shares. Click to enlarge
 
<a href="/images/stories/oct196.gif" title="Click to enlarge" rel="shadowbox"><img src="/images/stories/oct196thumb.gif"></a>
Interestingly, in these optimisations global shares and LPTs don’t attract any capital at all because of their ultra-high correlations (or “beta”) with domestic shares, which means that allocating across all three assets just parlays up your risk with no performance benefits (since global shares and LPTs yield inferior returns). 
Regular readers will know that I have made similar comments in this column over the years, and Bouris echoes my censure of Australian pension fund portfolios harnessing the latest OECD data. The OECD’s analysis demonstrates that Australian super funds have among the highest exposures to risky equities of any pension system in the world, which has propagated comparatively poor returns. 
The final clash in the Bouris-Dent conflict takes place over the familiarly emotive territory of Australian house prices. In remarks on David Koch’s Sunrise program, Dent begged viewers to sell their homes before the 50% crash in prices arrived at their doorsteps. Dent’s argument appeared based solely on the claim that Australian dwelling values were “9.5 times family incomes”, and should, in his view, be about “half” this level. 
As with many spruikers in search of a headline, Dent’s claim is incorrect. And Bouris was more than happy to set him straight. He starts by noting that while Australian interest rates are among the highest in the OECD, Australia’s mortgage default rates are a fraction of most peers. In particular, the latest RBA data finds that only 0.8% of the circa 4 to 5 million households with a mortgage are behind on their repayments. This is around one-tenth and one-quarter of US and UK ratios, respectively. 
He then contrasts the long-term rise in the cost of Australian housing with house prices in a nation that has endured a sharp correction: the United Kingdom. During the GFC, UK house prices fell by 14% peak-to-trough, while the unemployment rate has soared to over 9%. 
Despite the partial collapse of the UK banking system, extreme credit rationing and default rates multiples Australian levels, Bouris’s analysis shows that long-term house price growth in the two countries has been indistinguishable. It was, in fact, UK house prices that substantially overshot their Australian siblings in the five years before the GFC hit. And it has only been the recent crash that has brought them back in line Australian prices indexed since 1993. 
Bouris extends this insight to a range of other countries again using RBA data. This confirms that the run-up in Aussie house prices in the period 2003 to 2007 was actually substantially less than that experienced in the US, UK, Spain, Ireland and France (see first chart below). Indeed, if there was any “bubble”, it would appear to be found in Australian commercial real estate (refer to the left-hand-side panel in this same chart), which has produced much stronger price appreciation than equivalent assets overseas. Click to enlarge
 
<a href="/images/stories/oct197.gif" title="Click to enlarge" rel="shadowbox"><img src="/images/stories/oct197thumb.gif"></a>
<a href="/images/stories/oct197.gif" title="Click to enlarge" rel="shadowbox"></a>As the final chapter in the housing debate, Bouris directly attacks Dent’s proposition that Australian house prices are 9.5 times family incomes. He presents a chart released by the RBA in the latest Financial Stability Review (see below),  which shows that their estimate of the correct house price-to-income ratio is, in fact, around four or five times (or, ironically, half Dent’s claims). With this information in hand, Bouris opines that “Australian house prices are not going to fall 50%, and your home should remain a solid, tax-effective store of wealth over the long-term.”
<a href="/images/stories/oct198.gif" title="Click to enlarge" rel="shadowbox"><img src="/images/stories/oct198thumb.gif"></a>
As you can tell, I find the Yellow Brick Road chairman’s view of the world more persuasive than Dent’s. Bouris left his listeners with a final thought, which I think is worth quoting in full: 
“I believe we do indeed live in the ‘lucky country’, but the RBA cannot afford to roll the dice with our destinies in the name of pursuing some statistical abstraction. We are incredibly fortunate to be endowed with rich natural resources, and to be highly leveraged to that part of the world that is growing rapidly – the developing countries – rather than the old world that is stagnating. Having said that, it makes sense to prudently diversify your wealth to protect against adverse outcomes, and, subject to your risk preferences, you should have part of your portfolio invested in safer income-generating assets like cash and fixed-income.”
 
Harry Dent and Mark Bouris appeared at three-day Brisbane conference “Secure the Future”.
Christopher Joye is a leading financial economist. The above article is not investment advice.
</body></html>

Mark Bouris tackles Harry Dent's bearish claims: Christopher Joye

Roseville is poised for a wave of new apartment development following the NSW Government's rezoning of land around Roseville Station under its Transport Oriented Development program.

The new planning controls have unlocked significant development potential within walking distance of the station, with a number of sites expected to be amalgamated and redeveloped in the coming years as developers seek to take advantage of the increased density allowances.

One of the more restrained developments in the precinct, and set among the first to be delivered having commenced well before the recent changes, is Hyecorp's Juliet. The boutique apartment project is already well under construction and remains on track to welcome residents by the end of the year, offering a markedly different proposition to many of the larger-scale developments now likely to emerge across the suburb.

[smartcode_project:default project_id=7395 project_image_fid=278194]

<a href="https://www.apartments.com.au/new-apartments/juliet-roseville-64-pacific-highway-roseville-nsw-2069">Juliet</a> will comprise just&nbsp;34 one-, two-, and three-bedroom apartments opposite Roseville Station. For Hyecorp, which has delivered projects across Sydney's Lower North Shore for more than three decades, Roseville presented a rare opportunity to address a growing gap in the market.

"<a href="https://www.apartments.com.au/developments/roseville-nsw-2069">Roseville</a> has long been one of the North Shore's most tightly held and desirable suburbs, offering a unique combination of village charm, established greenery, excellent transport connections, and proximity to some of Sydney's best schools and lifestyle amenities," Hyecorp said.

"We recognised a growing demand from local homeowners seeking to downsize without leaving the community they have built their lives around. The location presented a rare opportunity to create homes that cater specifically to that buyer profile."

[smartcode_project:default project_id=7395 project_image_fid=278196]

The six-level development has been designed by <a href="https://www.apartments.com.au/architects/pbd-architects">PBD Architects</a> as a collection of residences that feel more like homes than apartments. The brief centred generous floorplans, abundant natural light, quality finishes, and strong connections to outdoor space.

PBD Architects drew inspiration from Roseville's established garden suburb character, creating a building that sits comfortably within its surroundings rather than dominating them. The architecture incorporates natural materials, soft forms, layered landscaping, expansive balconies, and generous setbacks to strengthen the connection between residents and the suburb's leafy environment.

"The focus was on designing spacious, house-like residences for discerning owner-occupiers and downsizers who wanted to remain on the North Shore without compromising on comfort, privacy, or design," PBD said.&nbsp;

"Every apartment was to feel considered, timeless, and highly functional."

[smartcode_project:default project_id=7395 project_image_fid=278195]

Inside, residences feature engineered timber flooring, stone kitchen benchtops and splashbacks, integrated Fisher &amp; Paykel appliances, ducted air conditioning, and large outdoor entertaining areas designed to take advantage of district and treetop views.

Residents will also have access to a rooftop barbecue and lounge area, alongside practical amenities including parcel lockers, EV charging capability, bicycle storage, a dog wash bay, and a basement car wash facility.

The majority of purchasers so far have been local owner-occupiers from Roseville, Lindfield, Chatswood, Killara, and the broader Upper North Shore, many of whom are transitioning from larger family homes.

"Buyers are looking for spacious, house-like apartments that allow them to downsize without feeling like they are sacrificing comfort or functionality," Hyecorp noted.

"They value large kitchens, generous living areas, ample storage, quality finishes, secure parking, lift access, and low-maintenance living."

[smartcode_project:default project_id=7395 project_image_fid=278204]

Juliet sits directly opposite Roseville Train Station and within walking distance of Roseville Village, while Chatswood's retail and dining precinct is only minutes away. The development is also surrounded by some of Sydney's most established schools, including Roseville College, Ravenswood, Pymble Ladies' College, and Knox Grammar, as well as nearby parklands and golf courses.

Juliet is currently more than 75 per cent sold ahead of its anticipated completion in late 2026.

[smartcode_project_cta:default project_id=7395]

Joel Robinson

Juliet to sit quietly amid Roseville apartment boom

Sherpa Property Group has unveiled the third instalment of its Flourish series, securing full approval for the two-tower, $500 million Flourish Soleira development in Palm Beach.

<a href="https://www.apartments.com.au/new-apartments/flourish-soleira-1150-1154-gold-coast-highway-palm-beach-qld-4221">Flourish Soleira</a> will rise from a prominent site in the commercial heart of Palm Beach, the long-time home of Cash Converters and a range of local retailers.

The project will introduce a new retail and dining precinct at ground level, beneath 286 apartments.

[smartcode_project:default project_id=150017 project_image_fid=370959]

“We’re very committed to not only providing affordable residential offerings that are much needed in Palm Beach, but also delivering a vibrant new commercial heart that complements the extraordinary growth of the southern Gold Coast,” Sherpa Property Group founder Christie Leet said.

The development will sit under Sherpa's Flourish brand, which is aimed at providing a pathway into the beachside suburb for locals, first-home buyers and downsizers. In a move designed to assist first-home buyers entering the market, Sherpa has reserved all one and two-bedroom, one-bathroom apartments exclusively for eligible first-home buyers.

[smartcode_project:default project_id=150017 project_image_fid=370964]

“Our vision through Flourish is to create a vibrant retail and lifestyle focal point within the Palm Beach centre zone, delivering thriving communities underpinned by lifestyle-rich locations,” Leet said.

“So far, Flourish has been an incredible success, and we hope to carry this momentum as we progress the next two Flourish projects in Palm Beach.”

[smartcode_project:default project_id=150017 project_image_fid=371430]

Located across 1150-1164 Gold Coast Highway and 3 Sixth Avenue, the development will comprise two towers. The northern tower will deliver 154 apartments, while the southern tower will add a further 132 residences, helping address ongoing demand for new apartments in the tightly held coastal suburb.

Flourish Soleira will also feature the most extensive rooftop amenity offering ever delivered in Palm Beach.

The two towers will be connected by a skybridge, with residents gaining access to a rooftop recreation deck featuring a full-width swimming pool, hot and cold plunge pools, wellness spaces, a gymnasium, private dining facilities, massage treatment rooms, barbecue areas, a basketball court, golf simulator, indoor and outdoor dining spaces, sun lounges and extensive landscaping.

LPS Group is expected to start construction later this year.

Sherpa is already well advanced on construction of its debut Flourish project, Flourish Amargo, located just around the corner from Soleira. Meanwhile, Flourish Oasis, positioned opposite Amargo, recently commenced construction and has nearly sold out its collection of 47 apartments.

[smartcode_project_cta:default project_id=150017]

Sherpa unveils $500m mixed-use Palm Beach precinct, Flourish Soleira

Are mortgage holders set to get a reprieve from the RBA in 2026?

Big Four bank NAB believes so. They are now expecting the next move from the RBA to be a cut, rather than a hike, which they had pencilled in for August. They are unsure of the timing of the cut however, they note in their latest&nbsp;NAB Economics RBA Watch.

NAB Chief Economist, Dr Sally Auld, said recent data suggests the economy has lost momentum and the outlook for rates has shifted, noting that the broader economic backdrop has changed since earlier in the year.

“The next move in the cash rate is likely to be down, but the timing is uncertain," Dr Auld said.

"In February, growth was above trend, the economy was operating above capacity and there was uncertainty over the restrictiveness of rates. None of these conditions exist today,” she outlined.

Dr Auld said recent data pointed to softer momentum across the economy while acknowledging that at the same time, uncertainty remains a key feature of the outlook.

“Both Q1 GDP data and the NAB business survey suggest momentum in the economy has slowed, meaning that growth has likely peaked for the cycle. That said, we are cognisant there is still considerable uncertainty around the outlook, both with respect to activity and inflation.”

Dr Auld said inflation risks and labour market outcomes would be important to watch.

“On the prices side, we are still forecasting above target core inflation through to mid-2027. Margins will compress and weaker labour market outcomes are a risk.”

She said tighter financial conditions are expected to weigh on housing and activity.

“Tighter financial conditions will be reflected in a slowing in house price growth and housing credit growth. In summary, we have greater conviction that the next move in rates is down, but less conviction on the timing.”

Mortgage relief? NAB forecasts RBA rate cut, not hike, after softer economic conditions

A local downsizer has splashed $6.5 million on a penthouse in Perifa's Alex &amp; Willow development in Crows Nest. 
&nbsp; 
The purchaser sold their long-held family home in the area before embarking on a six-month search for the right apartment. After inspecting a range of options across the Lower North Shore, the buyer returned to <a href="https://www.apartments.com.au/new-apartments/alex-willow-crows-nest-82-90-alexander-street-crows-nest-nsw-2065">Alex &amp; Willow</a>. 
&nbsp; 
The buyer profile reflects the project’s broader purchaser mix. <a>Alex &amp; Willow</a> has attracted predominantly local downsizers looking to transition from larger homes without compromising on space or quality, alongside a smaller cohort of upsizers and investors drawn to the project’s location and design credentials. 
&nbsp; 
The milestone sale comes as the project, developed by&nbsp;<a href="https://www.apartments.com.au/developers/perifa">Perifa</a>&nbsp;and delivered by <a href="https://www.apartments.com.au/builders/versatile-made-construction">Versatile Construction</a>, both part of Versatile Group, reaches 60 per cent sold.

[smartcode_project:default project_id=6680 project_image_fid=371325] 
&nbsp; 
Eddie Mansour, Managing Partner of <a href="https://www.apartments.com.au/project-marketer/ray-white-projects">Ray White Projects</a>, said the result demonstrates not only a headline price but also depth of demand. 
&nbsp; 
“This is an exceptional outcome and a clear reflection of sustained buyer demand for premium, well-located downsizer product,” Mansour said.

“We’re seeing a consistent pattern of local homeowners selling family residences and reinvesting into high-quality apartments that allow them to remain within their community. Alex &amp; Willow has resonated strongly with this group because it offers genuine scale, thoughtful design and immediate proximity to the village.” 
&nbsp; 
The sale reflects a broader and consistent trend of local downsizers actively seeking high-quality, low-maintenance residences close to established village centres. Agents report that demand for this product type has remained resilient, particularly where developments offer a rare combination of scale, design quality and walkable amenity. 
&nbsp;&nbsp; 
Fabrizio Perilli, Managing Director of Perifa and Versatile Group, said the sale marks a defining moment for the project. 
&nbsp; 
“The penthouse sale is a strong endorsement of the quality we have delivered, alongside our partners, and the clear demand from local downsizers for premium, boutique residences in this location,” Perilli said.&nbsp; 
&nbsp; 
“Most importantly, we’re proud to see the Alex &amp; Willow community beginning to take shape. As we move closer to completion, we’re looking forward to welcoming residents and seeing the project come to life.”&nbsp;

[smartcode_project:default project_id=6680 project_image_fid=338516] 
&nbsp; 
Designed by <a href="https://www.apartments.com.au/architects/nettletontribe">Nettleton Tribe</a> with interiors by <a href="https://www.apartments.com.au/interior-designers/richards-stanisich">Richards Stanisich</a>, Alex &amp; Willow is a boutique collection of generously sized two- and three-bedroom residences in the heart of Crows Nest village.&nbsp;

Completion is slated for early 2027.

[smartcode_project_cta:default project_id=6680]

Alex & Willow, Crows Nest penthouse sells off the plan for $6.5 million

Fresh from launching the first stage of its Wollongong precinct, <a href="https://www.apartments.com.au/new-apartments/keira-place-wollongong-120-122-smith-street-wollongong-nsw-2500">Keira Place</a>, builder-developer Urban Property Group has unveiled plans for the next phase of the masterplanned community.

Now on public exhibition through the NSW Government's Housing Delivery Authority pathway is a State Significant Development Application for a further 657 homes on the prominent gateway site opposite Beaton Park.

The proposal comprises three buildings, including two build-to-sell towers rising 25 and 30 storeys, delivering 391 apartments, alongside a 12-storey co-living building with 266 residences, making it one of the largest co-living proposals currently planned in regional New South Wales.

Of the apartments proposed in the build-to-sell towers, the majority, 310, are two-bedroom dwellings. The balance comprises 44 one-bedroom apartments and 37 three-bedroom residences. Apartment sizes range from around 50 sqm for one-bedroom homes to approximately 90 sqm for three-bedroom apartments.

<img alt="Smith St" data-entity-type="file" data-entity-uuid="19347059-1612-41a0-9c74-b86a657237f8" src="https://s3.ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/inline-images/Screenshot%202026-06-10%20at%2010.02.18%E2%80%AFAM.png?VersionId=sWXnaCcA.cIC6N8YT1dg5pJ2e1V3Z6z7" />

The submission says the proposal has evolved significantly from its original Housing Delivery Authority application following extensive consultation with the State Design Review Panel and Wollongong City Council.

The final scheme has been designed to align with the emerging vision for the Flinders Street Precinct, an area identified by Council as a future high-density mixed-use neighbourhood capable of accommodating substantial housing growth close to transport, employment and community infrastructure.

According to the design report prepared by COX Architecture, the development aims to "deliver a built outcome consistent with the future character of the Wollongong CBD while responding to the site's unique constraints and opportunities."

"Our vision for the next phase of the site evolution in Wollongong is grounded in three design pillars that guide the design response: place, natural environment and celebration," COX said.

"Inspired by its surroundings and grounded in the stories of place on Wodi Wodi Country, the design proposal acknowledges the established character of its setting while creating a unique and timeless identity that sits harmoniously within it.

"The design proposal responds to its specific site conditions, acknowledging the vegetation, climate, wind conditions and solar access of the site."

The architecture responds directly to the site's position between Wollongong's urban core and its natural landscape setting.

COX identified views towards Mount Keira and the Illawarra Escarpment as defining features of the site, while the upper levels of the towers will also capture expansive views across the city and out to the Pacific Ocean.

The design team has positioned the tallest buildings closer to the rail corridor, where overshadowing impacts can be better managed while establishing a landmark built form on the northern approach into the city.

<img alt="Smith St" data-entity-type="file" data-entity-uuid="79580d5b-500c-4ebf-9629-797146a4a694" src="https://s3.ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/inline-images/Screenshot%202026-06-10%20at%209.51.59%E2%80%AFAM.png?VersionId=WbTB1EKSG.KDfsfz0F3wp1QVa2oCMGR5" />

Urban Property Group secured the 11,000 sqm Smith Street site in 2022 and has since progressed plans for the broader Keira Place precinct.

Construction recently commenced on the first stage of Keira Place, which will deliver 150 apartments across two residential buildings, including 27 affordable housing apartments and 18 specialist disability accommodation dwellings, alongside activated ground-floor retail and commercial space.

Urban Co-CEO Patrick Elias said the commencement of construction marked a significant milestone for Wollongong and reflected the developer's long-term commitment to regional cities.

"Today's groundbreaking is about turning approvals into homes and moving quickly to deliver much-needed housing in Wollongong's city centre," Elias said.

"Keira Place will provide a diverse mix of homes close to jobs, transport and services, while setting a high benchmark for quality, durability and consumer protection."

Read more:&nbsp;<a href="https://www.apartments.com.au/news/nsw/groundbreaking-marks-start-of-construction-at-keira-place-in-wollongong-cbd">Groundbreaking marks start of construction at Keira Place in Wollongong CBD</a>

&nbsp;

&nbsp;

&nbsp;

Christopher Joye

Editor's Picks

Have something to contribute?

Developments

New apartments

New townhouses

News