Absa expects interest rates to start rising from mid-2006
News > news - 14 Jul 2005
Absa is projecting a gradual increasing trend in interest rates between mid-2006 and late 2007 as a result of Reserve Bank attempts to keep inflation in check.

The bank’s view, contained in its Property Trends forecast released today, is based on the negative impacts on the economy from the recent upward trend in international oil prices and the weakening rand exchange rate, both of which Absa expects to curtail prospects for further rate cuts this year.

However, it warns that if an oil price shock does occur together with a sharply weaker exchange rate, inflation pressures will increase significantly, leading to the risk of markedly higher interest rates.

In the event of such developments, Absa says the housing market may experience a significant downward correction in terms of activity and price levels, taking into account current conditions in the market.

In the same review, Absa also scrutinises whether the local residential property market is emulating international property trends and the possibility of a bubble occurring.

The bank says according to recent international media reports, the global housing boom of the past number of years is currently regarded as the biggest financial bubble in history. Taking into account the record size of house price gains over this period as well as the number of countries involved, this boom is unrivalled.

Two factors, Absa notes, are mentioned as the main reasons for this housing boom: historically low interest rates, resulting from low inflation, and the strong performance of property because of under performing asset classes such as equities. As a result, new homebuyers took out bigger loans, while existing homeowners increased their mortgage loans to turn capital appreciation into cash for consumption purposes.

In many countries property market indicators such as the level of real house prices and the ratio of house prices to rentals and income levels, have reached record highs. As housing is normally financed via debt, which is unlikely to be the case when buying
shares, the IMF has found that the adverse effect on economic output of a housing market crash is twice as large as that of a stock market crash.

With global inflation currently relatively low, the economic effect can be more severe if prices fall not only in real terms, but also in nominal terms. Furthermore, in many countries property prices were driven to higher levels by investors. A massive sell-off by investors when the cycle turns can lead to a sharp downward correction in prices. In Australia, house prices have already dropped in reaction to higher interest rates, resulting in much lower levels of investor activity.

Against the international backdrop, Absa asks what are the trends in South Africa?

Are we likely to follow global developments and will the local property market also become totally overheated with an inevitable bursting of a bubble?

Over the past five years, the South African residential property market experienced strong price growth of about 20 percent per annum in nominal terms and 13,6 percent per annum in real terms. During this period the market was driven by a wide range of factors after many years of mediocre growth from the mid-1980s up to the late 1990s. Property prices have probably been catching up with other asset prices since then.

As a result, an important indicator such as the ratio of house prices to the level of remuneration has increased significantly since 2000, but has towards the end of 2004 not yet reached the peak of early 1984. An increase in this indicator implies that house prices are increasing at a faster rate than remuneration.

The monthly measured rate of year-on-year growth in house prices began to taper off in mid-2004. In the fourth quarter of 2004, nominal growth averaged 34,2 percent, mildly lower than in the third quarter. In the first and second quarters of 2005, nominal house price growth was respectively 29,2 percent and 24,8 percent.

The monthly Absa House Price Index for June 2005 showed its eighth successive month of declining year-on-year growth, measuring 23,3 percent, down from a peak of 35,5 percent reached in October 2004.

This declining trend in house price growth since late last year the bank says can most probably be ascribed to fact that housing has in general become less affordable, taking into account the abovementioned trend in the ratio of house prices to remuneration.

Although it must be taken into account that the local property market situation has deteriorated over the past few years, the abovementioned housing market related indicators, together with various supporting factors do not suggest that the South African residential property market is generally experiencing bubble conditions yet.

However, it is quite conceivable that certain types of housing in certain areas of the country are experiencing bubble conditions, which may result in the prices of those properties declining when the cycle turns.

In some areas, the buy-to-let market, i.e. the investment market, has been instrumental in driving house prices higher. Any saturation of and a massive sell-off in this market could therefore, Absa concludes, lead to either stagnating or weaker prices.
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