China property: Why policy easing impact may be different now

January 15, 2020 08:30
Over the past two years, the typically more speculative first-tier home market has displayed smaller price gains than the lower tier Chinese cities. Photo: Reuters

China loan prime rate (LPR) is down 16 basis points (bps) compared to half a year ago. Authorities have also cut the reserve requirement ratio (RRR) for commercial lenders, and there could be more such moves. Now we come to the question: Can the easier policy again provide a boost to the property sector?

While lower rates help, real estate boom-bust cycle also tends to follow the direction of the overall economy. Also, we should bear in mind that policy easing often reflects economic weakness. Given the two counteracting forces, how would the property market react? Let’s take a look at historical data.

In the accompanying chart, we get a picture of the interest rate and housing price (HP) movements. The former is policy rate, which is one-year LPR since 2015 and is one-year benchmark lending rate before that. As for the latter, it shows newly built home prices in China's 1st, 2nd and 3rd tier cities compiled by the Bloomberg Intelligence based on data from 70 cities. All data (both LPR and HP) are expressed in year-on-year percentage change or growth rate.

Since rate cut is expected to boost housing price growth, the two should be inversely correlated.

Hence one of the vertical axes (here the blue one) is inverted, with zero levels matched to show rate cut corresponding to housing price inflation and vice versa.

From the chart, it can be seen that policy effect lags about four quarters behind the action. That means, the rate cut (blue line up) does lead to housing price inflation a year after (red line up). However, there are three noteworthy observations recently.

First, the housing price changes of first tier cities’ have been getting more volatile over time in reacting to rate cuts, in comparison with those of second- and third-tier cities.

While home prices of first-tier cities are supported by policies and speculative capital, second and third tiers are comparatively more fundamentals driven. The abnormally high volatility of the first-tier home market compared to the other two implies an abnormally high extent of speculation.

Second, in the past three episodes of rate cut, the year-on-year reduction was up to the magnitude of 150 to 200 bps. Now it is of just one-tenth order. With the ammunition of 435 bps (the existing LPR level), one might argue that there is still plenty of room to boost. But whether the government would want to do so is one thing; and a much weaker economy which might hinder the stimulative effect is another. This brings to the last noteworthy point.

Over the past two years, the typically more speculative first-tier home market has displayed smaller gains than the lower tier cities. The last time this appeared was during 2008, when first-tier cities deleveraged most.

While historical pattern suggests home prices would tick up in the coming quarters, the upside this time may be less. There is even the possibility that this time could be different, where policy easing may fail to lift the property market.

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A chart suggests that policy effect lags about four quarters behind the action, when it comes to housing price changes. Credit: Bloomberg Intelligence

The author is Adjunct Professor in the Department of Economics and Finance, City University of Hong Kong and previously the chief economist of a bank. (facebook.com/kachung.law.988, [email protected])