Australia frets as property blows hot at home, cold in China

Brendon Thorne | Bloomberg | Getty Images

Australian policy makers have two housing markets to worry about, and it's a toss up which carries the most risk.

One is too cold, the other too hot. One they can't do anything about as it is in China, the other is a home grown headache the authorities are just starting to wrestle with.

How they unfold will have lasting ramifications for Australia's economy and interest rates.

"There are two prices that matter for Australia right now, those for homes and those for commodities, said Paul Bloxham, chief economist for Australia at HSBC.

"Since the Chinese housing market is such a driver of demand for commodities, it matters just as much in the big picture as the domestic market," he added.

Read MoreChina property hard sell intensifies in bid to lift saggingsector

The property sector accounts for about 15 percent of China's economy and impact some 40 industries from furniture to steel, is of increasing concern to Beijing as it drags on growth.

The alarm is shared by Australia as over 35 percent of its exports go to China, giving it an annual trade surplus worth around A$50 billion with the Asian giant.

Such is its importance that the Reserve Bank of Australia (RBA) maintains one of only three international offices in Beijing and produces copious research on China's economy.

RBA Governor Glenn Stevens recently nominated falling Chinese house prices and their possible impact on the shadow banking sector there as one of his key concerns.

The bank devoted a chunk of its bi-annual report on China's financial system to highlight the risks, noting that around half of all new credit created in recent years had come from outside the regulated sector.

Read MoreChina home prices fall for fourth straight month

"Concerns about asset quality in China have been heightened by softening conditions in the residential property market," said the central bank in last week's report.

"While China has been able to manage a small number of defaults in trust funds and corporate bonds, a more widespread series of private-sector defaults - potentially associated with a sharp correction in property prices - could be more damaging."

Even if the financial fallout is contained, any weakness in home building would be a negative for Australia since the sector is a major user of steel, and thus iron ore - Australia's single biggest export earner.

China's steel consumption has already dropped this year for the first time since at least 2000, leading to a more than 40 percent plunge in prices of the steel making mineral.

Reconsidering rules on lending

So it was welcome news in Australia when reports emerged last week that Beijing was allowing banks and regional governments to relax their mortgage rules.

"We think China will be successful in stabilizing the economy, and that would be great news for Australia," said HSBC's Bloxham.

There is some irony, given that the RBA at the same time announced it was considering tightening lending standards to restrain speculative spirits in the domestic housing market.

Borrowing to invest in property is popular in Australia in part because it gets tax breaks and partly because returns on bonds and cash are so low right now.

Loans for investment were up 30 percent by value in July on a year earlier, four times the growth in loans for owner-occupiers. They also made up 40 percent of all mortgages in the month, the second highest share on record.

Much of this is for property in the inner cities of Sydney and Melbourne.

Read MoreIs this the China stimulus we've been waiting for?

Approvals for investor loans in New South Wales are now almost 90 percent higher than two years ago, while those in the state of Victoria are up by half.

The inner cities also happen to be magnets for Chinese buyers who have a fondness for multi rise apartments. Lawmakers are even running an inquiry into whether foreign money is pricing Australians out of the housing market.

All this demand has certainly driven an acceleration in home prices, with Sydney boasting an annual gain north of 16 percent in August. Values in Melbourne were up almost 12 percent, according to figures from property consultant RP Data.

This froth led the RBA to warn that the market was becoming "unbalanced" and to wonder whether bank lending standards were "conservative" enough for the current mix of record low rates, rapid price growth and already high levels of debt.

It even conceded that action might be needed to ration credit using macro-prudential tools, that would limit the build up of leverage and risk taking in the banking system as a whole rather than just at individual banks.

Read MoreRBA warns of risk of 'unbalanced' housing sector

That was a marked turnaround for the RBA which has long doubted the effectiveness of such tools and worried about unintended consequences.

They can include forcing banks to set aside more capital to cover certain types of lending, or put caps in loan-to-valuation and debt-to-income ratios.

In New Zealand, for example, curbs on loans worth a high proportion of the value of the property look to have forced buyers down market and inflated prices for cheaper housing.

Ultimately, New Zealand's central bank had to cool the market by raising interest rates a full percentage point.

The RBA, however, has scant scope to tighten given a long boom in mining investment is winding down while consumer sentiment remains fragile at best.

Read MoreNew Zealand to move from rock star to rock solid economy

If any prudential steps are taken they will likely be modest, perhaps pushing banks to adopt stricter standards on judging whether a borrower can deal with higher interest rates.

Moral suasion

In truth, the RBA prefers the bully pulpit to regulations.

The bank had some success with moral suasion in the early 2000's and again in 2010, warning Australians that prices could go down as well as up. Implied was the threat that the RBA would make it so by lifting interest rates.

It has also had the, largely unwitting, assistance of Australia's housing-obsessed media. Hardly a day passes without headlines screaming about a housing "bubble", which is always just about to burst to the ruination of all.

The RBA's every utterance on housing is front page news, magnifying the impact on the public mood.

Read MoreIs Australian housing facing a repeat of 2003?

There is some evidence that the RBA's rhetorical campaign might just be working with weekly surveys from RP Data showing home prices went flat in September after three strong months.

And a slowdown in housing would in turn lessen pressure for an increase in interest rates, says Peter Jolly, global head of research at National Australia Bank.

"Take away strong house price gains and there are plenty of reasons for the RBA to keep rates at 2.5 percent for a lot longer yet."