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August 17, 2016

Australia came one step closer to losing its triple-A sovereign credit rating when Standard & Poor’s moved its outlook from ‘stable’ to ‘negative’ at the start of July. A downgrade from AAA to AA would be the country’s first downgrade from S&P since 1989.

Traditionally measures of a country’s creditworthiness, sovereign credit ratings are also a benchmark of how stable and resilient to shocks an economy is, with coveted AAA ratings providing a strong pull for international property investors.

Rated AAA by major credit agencies, S&P and Moody’s, Australia’s rating has withstood the GFC, demonstrating the economy’s resilience to global volatility – a desirable trait in today’s environment.

A downgrade would undoubtedly impact business Down Under but how would the country’s property markets cope? David Rees, Head of Research, JLL Australia, explains why investors shouldn’t worry just yet.

“Commercial yield-to-bond spreads have continued to widen despite six rating changes – between 1986 and 2016, commercial property yields have continued to widen relative to the ten-year inflation-indexed bond rate which is the risk-free rate,” he explains.

“If credit ratings were a factor in office yields, we might expect to see yields widen in response to ratings downgrades and vice versa but the long-term trend actually seems to suggest the opposite, showing that there are broader factors at work. For example, currently real bond yields in Australia are near all-time lows – as they are in most global markets.”

At the margin, in the quarters either side of a rating change, the short term effect has been minor.

“Only after Australia was downgraded in 1989 from AA+ to AA did the prime office yield spread to the real bond rate change substantially, narrowing by 65 basis points (-43%) from 4Q89 to 1Q90.

However at the same time the Reserve Bank cut its policy rate by 160 basis points.”

In the residential market, mortgage rates have moved independently of sovereign ratings between 1996 – 2016, based on the spread between the official interest rate and the average variable home loan rate offered by Australian banks.

“For a period around the turn of the millennium, it was standard practice for Australian banks to closely match their mortgage loan rate to the official cash rate,” says Dr. Rees

“This relationship persisted despite two rating upgrades, and over a period when the cash rate varied between 4.25 percent and 7.50 percent.”

Since the Global Financial Crisis in 2007, Australia’s domestic banks have widened the spread, reflecting increased competition for deposits in the local market as they seek to reduce their dependence on offshore sources of finance.

“This further illustrates the insignificant role that rating changes have on the Australian residential property market,” he says.

“Using history as our guide, we can anticipate that property markets will shrug off a possible downgrade to Australia’s AAA rating.”

David Rees
Head of Research, JLL Australia

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