The Reserve Bank says it still has scope to cut interest rates further, despite the corporate regulator warning there are signs of a dangerous property bubble in Sydney and Melbourne.
The Australian Securities and Investments Commission's (ASIC) chairman Greg Medcraft has become the first regulator to publicly use the term "bubble" in warning that borrowers could be burned when interest rates eventually rise or unemployment spikes.
"I think that the Sydney and the Melbourne markets are very hot. If you look at the average price to income ratio, it is very high," Mr Medcraft told The World Today.
"History has shown that often you don't know you're in a bubble until it's over, but you can look at history and look at historical averages and one can draw their own conclusions."
Mr Medcraft has compared a potential Sydney and Melbourne bubble to the lead-up to the housing slump in the United States, which played a key role in sparking the global financial crisis of 2008.
He observed that crisis first-hand as then chairman of the American Securitsation Forum.
Mr Medcraft said that US property investor expectations of constantly rising prices were burned when interest rates ultimately moved higher, especially borrowers on low "honeymoon" rates.
"Everyone thought prices would keep going up and obviously they didn't. We're a different economy with different mortgage structures,but you look around the world and history shows that that average ratio (prices to incomes) is something that is very important in residential housing," he said.
"We are not in a normal situation. Rates will not stay where they are and that's why the banks use a rate of 7 per cent to calculate their debt servicing."
Mr Medcraft said ASIC remained concerned about underwriting standards and is scrutinising interest-only loans from mortgage brokers to ensure high standards are maintained.
Mr Medcraft also warned of the potential for rising unemployment, after last week's federal budget forecast a peak of 6.5 per cent.
"That is the major driver of mortgage defaults," Mr Medcraft said.
RBA walks 'fine line' with rates strategy
The Reserve Bank's deputy governor Philip Lowe was also out this morning, in the first speech by a senior RBA official since the bank cut interest rates to a historic low of 2 per cent nearly a fortnight ago.
Analysts were critical at the time of the central bank's lack of guidance on what its next move may be.
Speaking at a Corporate Finance Forum event in Sydney this morning, Dr Lowe said that does not mean the RBA's easing bias - meaning that any move in rates is very likely to be down - has been abandoned.
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Audio: ASIC boss warns dangerous property bubble may be building in Sydney and Melbourne (The World Today)
He said the RBA was following long-standing practice rather than signalling that the easing cycle has come to an end.
"We still have scope to lower interest rates if we need to. That doesn't mean we're going to, but we have scope to do that. Nothing has changed in that dimension," he clarified.
"But the idea, when we announce a reduction in interest rates, that we continue to provide guidance, we haven't done that in the past."
Earlier in his speech, Dr Lowe acknowledged the risks posed by property prices while outlining reasons for this month's rate cut.
"It is unlikely to be in Australia's long-term interest to engineer a consumption boom by simply encouraging people to borrow large amounts against their future income," he said.
"It is especially so when debt levels are already high and prospects for future income growth are not as positive as they once were.
"So there is fairly fine line to tread here. The RBA's recent decisions have sought to strike a prudent balance, to help encourage consumption growth and thus ultimately business investment, but avoid the type of imbalances that could cause us serious problems later on."
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