Alarm bells started ringing around the nation last week amid predictions of a national inflation figure above the Reserve Bank’s upper target of 3 per cent.
Alarm bells started ringing around the nation last week amid predictions of a national inflation figure above the Reserve Bank’s upper target of 3 per cent.
While the figure ended up being just inside the 2 per cent to 3 per cent annual consumer price index band targeted by the RBA, Perth was singled out for its 4.1 per cent in the 12 months to September, the highest of any capital city.
But whether or not this spells danger for the state’s economy depends on the extent to which Western Australia’s booming housing market breeds inflation of its own.
A closer look at the CPI figures reveals that, if housing prices are taken out of the picture for Perth, the city’s underlying inflation figure was significantly reduced.
In the September quarter housing costs accounted for nearly half of the increase in Perth’s CPI figure of 1.5 per cent. Removing this element of the CPI would have meant a rise in the index of just 1.9 per cent in the year.
The housing group within the basket of goods covered by the CPI includes rents, utility costs and other rates and charges, but the rise was largely attributable to a spike in new house purchase prices, which rose 15.6 per cent during the year, according to the Australian Bureau of Statistics.
The RBA’s relative success in controlling inflation in recent years has been widely viewed as the Australian end of the phenomenon, which has recently crippled the economies of Brazil and Argentina.
In March, the RBA increased the cash rate by a quarter of 1 per cent on fears of the impact of the housing bubble in eastern Australia, which has now substantially subsided.
But while the effect of higher oil prices on the Australian economy has been broadly discussed in the public realm, booming house prices in WA have received less attention. Last year in the midst of the eastern states’ housing boom, the RBA published considerable research into understanding the effect the bubble would have on the nation’s economy, although WA’s comparative size means the state’s property market is unlikely to have a large bearing on the bank’s decision.
The extent to which the state’s housing boom contributes to underlying inflation is considered by economists to hinge on the proportion of additional spending that takes place from greater property asset wealth. In short, how much more are property investors likely to spend at department stores if they feel they are sitting on a good investment?
ANZ research estimates that housing wealth gains directly contributed two percentage points of household consumption growth of 6.2 per cent in the year to March 2004.
But this might not be a trigger for higher interest rates, as the RBA has expressed concern about Australian credit growth steadily rising in the past four years, despite falling marginally in the latter half of this year. This makes any abrupt hike in interest rates likely to result in considerably larger interest payments for borrowers, potentially bringing the economy to a screeching halt.
And with the large proportion of debt that has been taken out for investment properties, renters have, by and large, been almost as amenable to higher prices.
Perth’s median rental prices have risen 13 per cent in the past 12 months, which would most likely be enough to offset most interest rate payments on the median established house price in Perth last year of $250,000, as estimated by the Real Estate Institute of WA.
Should the inflationary effect of the housing boom be flowing through to other areas of the economy, there are two major costs to the economy to consider.
Firstly, it creates financial uncer-tainty as budgeting becomes harder.
And since producers come before consumers in the inflation chain, this uncertainty has already occurred. Numerous projects around the state have already been put on hold this year as rising costs eat into margins, making development less economical.
It also makes exports less competitive, although this is a smaller effect, since other factors are more likely to come into play. One of these is the value of the Australian dollar, which fell one cent against the US dollar as the high CPI data was released last week, making exports more competitive.
Chamber of Commerce and Industry WA acting chief economist John Nicolaou said the overall strength of the WA economy, and the capacity constraints that had emerged, had essentially been behind the rise in Perth’s inflation rate over the past four quarters, with house price inflation the major contributor to the CPI.
