The Reserve Bank says home prices are likely to grow slowly, if at all, now that the low-inflation driven boom of the late 1990s and early 2000s has ended.

The RBA says the move to inflation targeting in the early 1990s , and resulting lower consumer price rises, meant home buyers could borrow roughly twice as much as before.

This bank's head of financial stability, Luci Ellis, says this ability to borrow more explains a lot of the massive rise in home prices, both in absolute terms and relative to income, over the late 1990s to early 2000s.

However, she says this transition to a low inflation environment now appears to have run its course.

"It also takes time for this additional borrowing capacity to bid up housing prices. But the transition does end after a while, and it is our assessment that it has now ended," she said in a speech to the Citibank Property Conference yesterday.

Dr Ellis says the household debt to income ratio has been fairly steady since 2005 and the ratio of average home prices to incomes levelled off around a year before that.

She also notes that household saving has been around 10 per cent of income since the global financial crisis.

"But given it has actually been quite stable for the past five years, it seems reasonable to suppose that where we are is at, or close to, a 'new normal'," Dr Ellis said.

The Reserve Bank's chief watcher of Australia's financial system's health says that means households, banks and businesses in the property sector should brace for much slower and patchier house price growth than they were used to in the period before the GFC.

"Trend housing price growth will be slower in future than in the previous 30 years," Dr Ellis forecast.

"We don't have a strong view about whether the ratio of prices to income should be mildly rising, falling or constant from here. We do not have a target for this variable. But we think it is very unlikely to return to its 1970s levels, or to rise rapidly once again.

"Nor would we want to see another boom like the one a decade ago."

The Reserve Bank warns that this slower housing market will lead to more periods when house prices are falling, meaning purchasers and financial institutions need to be wary of respectively borrowing and loaning too much of the purchase price, as they might find the outstanding loan becomes bigger than the value of the home - a situation known as negative equity.

This slower property market is also likely to have implications for bank profits.

"If trend growth in housing prices will be slower in the future than in the past, trend housing credit growth will necessarily be slower too. This has obvious implications for the rate of growth of bank balance sheets and profits," Dr Ellis observed.

However, she warns banks against lowering lending standards to try and boost loan growth and profits, particularly in light of the risk of periods where home prices fall.

Instead Dr Ellis concludes that bank shareholders need to get used to lower returns.

Empty cities

In the second major theme of her speech, Dr Ellis observed that demographic forces combined with the financial forces she described earlier would probably drive more Australians into medium and high density housing.

The trend towards higher density housing was partly being driven by the high cost of homes, which Dr Ellis said cannot be blamed on a lack of land release on the urban fringes.

"If constraints on land supply were the most important factor explaining high housing prices, we would see prices rising fastest where those constraints were most binding - the greenfield sites on city fringes. But that is not what we see," she argued.

Neither state government levies on developers or the cost of vacant land on urban fringes are the major culprits for high home prices either according to Luci Ellis.

"Rather, it turns out that construction costs are the largest contributor to the total costs of production, and they seem quite high compared with the total cost of a newly built home in some other developed countries," she added.

Dr Ellis also argues that a lack of medium and higher density housing closer to city centres is a much more significant reason for Australia's relatively high home prices.

"Part of the reason why land seems in such short supply is that we each consume so much of it. Australian cities are the least dense, in terms of population per square kilometre, than the cities of any other sizeable country, developed or emerging," she concluded.

"Even with slower population growth, the price of our low-density life has become unaffordable for some. It therefore seems likely that our cities will become denser over time."

However, Dr Ellis says there are impediments to an adequate supply of apartments and medium-density dwellings which may cause problems as developers continue adapting to the trend for higher density housing.

"It takes longer to build a block of apartments on a brownfield site than the same number of dwellings as detached houses at the fringe," she observed.

"Dwelling investment has already become less cyclical in the past 10 years than it was in the previous 20 years. It might well be that construction lags - and concerns about supply - will become even more acute."

However, despite the many challenges and slower growth for Australian housing, Dr Ellis is not too worried about the possibility of a property price crash.

"We are pretty sure that the boom we saw in the early 2000s managed to end with a fizzle, not a bust. So we don't expect a sharp reversal from a starting point described by the situation we face now," she predicted.

"But we certainly can't rule out the possibility of a major housing downturn in the longer-term future."