The Reserve Bank of Australia (RBA) is in an economic pickle. When it meets on Tuesday it will consider a wide variety of economic indicators to arrive at a decision on interest rates. Most of these indicators make the course of action a fairly simple decision. Consumer sentiment is low, unemployment is steadily increasing, household expenditure as a ratio of income is yet to recover from the GFC and mining capital expenditure is in decline without an up-tick in non-mining capital expenditure. On top of all this, inflation has drifted to the lower end of its 2% - 3% range.

These indicators, but particularly subdued inflation and rising unemployment, provide strong impetus for the RBA to reduce interest rates further. This would all be academic and not all that interesting if it weren't for the completely at odds behaviour of the Australian property market, specifically Melbourne and Sydney. We can see these competing trends in the below graphs demonstrating a continued decline in CAPEX vs a growth trajectory in housing prices over a similar time period.


The RBA is now very concerned with the potential occurrence of a property market bubble. To address broadly subdued economic indicators, the RBA would typically soften monetary policy further. However any reduction in interest rates at this point would further fuel (through cheap money) an already rampant property market.

The RBA's use of monetary policy is the sledgehammer of economic management. Its role is to broadly effect the cost of capital which either discourages or encourages economic investment. It is government intervention, through more targeted industry reforms and policy, that can influence specific industry sectors.

The best path forward would be for federal and state government intervention to address the critical shortage of housing supply in key capital cities. This would then allow the RBA to continue to focus on its primary concern of economic stewardship.

To achieve an uplift in housing supply, government policy needs to encourage an uplift in housing density, supported by targeted infrastructure initiatives. This would ideally occur in addition to the broadening of a city's development footprint. This is a particular concern for Sydney given the strain on the already stretched existing infrastructure network. Melbourne is slightly better positioned with improved infrastructure and greater scope to spread its city footprint than Sydney, which is hemmed in by national parks and the ocean on all sides.

The RBA in previous meeting statements has already called for government intervention to assist in mitigating a property bubble and hopefully NSW's most recent election provides an impetus for Sydney to address its infrastructure concerns. Better infrastructure enhances a city's ability to support an increase in dwelling density, which in tern might help soften the trajectory in property market prices.

Whatever decision the RBA arrives at on Tuesday it is caught between trying to avoid an economic downturn and a property market bubble. Given how slow governments move on infrastructure development and policy reform, it is likely that the RBA will remain in an economic pickle for some time to come.