US sub-prime events, inflation, & housing supply 
– what does the Reserve Bank think?                                                                         

We set out below extracts from the RBA November Board minutes in support of our view that:

• The Australian housing market will not materially suffer as a result of the US sub‑prime issue
• Inflation will not spiral out of control, and therefore any interest rate rises will be temporary
• There is undersupply of housing which will lead to continued capital gains

1. US sub-prime events

B&A View – Australian banks not materially affected by US sub‑prime events

RBA quote: “In Australia, the performance of the financial sector, in particular the banks, stood in sharp contrast to that in the United States. Australian banks had reported strong growth in earnings in the half-year to September. No write-downs in asset values related to US sub-prime loans and structured debt were reported, as exposure to these instruments was negligible.”

B&A View – Sound Australian borrowers not materially affected

RBA quote:  “But the tightening of credit conditions in Australia had not been as pronounced as elsewhere and, in any event, local conditions had improved in recent weeks. Although interest costs in wholesale markets were still a little higher than a few months earlier, sound borrowers were still able to obtain finance readily.”

B&A View – Australia largely insulated from any economic slowdown in the US

RBA Quote:  “Members took note that parts of the world economy had become weaker in recent months and forecasts for the United States and other major industrial economies had been lowered, partly reflecting the likely effects of the tightening of capital market conditions since August. However, world growth was still expected to be above average in 2008, due to the growing importance of China and other emerging economies. Ongoing rapid growth in China, in particular, was stimulating the Australian economy, with the higher levels of commodity prices and the terms of trade lifting domestic incomes and underpinning strong growth in spending.”

2. Inflation

B&A View – Inflation will not spiral out of control

RBA Quote:  “The staff forecast for underlying inflation, in the absence of any monetary policy tightening, was for it to rise to around 3¼ per cent in the next couple of quarters, after which it would gradually ease to just above 3 per cent by the end of 2008 and into 2009.” … “The Board decided that the cash rate should be increased by 25 basis points to 6.75 per cent”

3. Excess demand for housing

B&A View – There is considerable excess demand for housing, particularly in Sydney