Why Australia's housing market slowdown won't wreak havoc on the economy

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Australia’s housing market is cooling after years of strong, predominantly debt-fuelled price growth.

Prices in Sydney — the nation’s largest and most expensive housing market — have fallen in each of the past two months, according to data released by CoreLogic, coinciding with a noticeable decline in auction clearance rates over the same period.

And while not to the same degree as Sydney, at least not yet, Melbourne’s housing market is also starting to cool. Price growth in the city slowed to its lowest level since mid-2016 in the three months to October, with clearance rates also sliding to the lowest level in over a year.

The combination of affordability constraints and increased stock availability, particularly in Sydney, along with measures introduced by Australia’s banking regulator, APRA, to curb investor and interest-only housing finance growth, meant the rollicking price gains in recent years have now come to an end.

At a time when the economy is not all that strong, particularly the all-important household sector, it has caused some angst about what the slowdown in Sydney and Melbourne may mean to the broader Australian economy, particularly given signs that other smaller markets are now also starting to slow.

What does it mean for the outlook for residential construction and household spending, the largest part of the Australian economy at around 60%? And, if these start to weaken as a result of the price slowdown, what will that mean for economic growth, the outlook for labour market conditions, inflationary pressures and official interest rates?

We’ve already seen weakness in recent Australian retail sales reports, casting a worrying picture on the health of household finances given high levels of indebtedness, weak wage growth and higher electricity, gas and petrol costs since the start of the September quarter.

Coupled with a slowdown in residential building approvals, a lead indicator on the outlook for residential construction, it’s clear why some commentators have adopted the view that Australian economic growth will likely disappoint in 2018, keeping pressure on the Reserve Bank of Australia (RBA) to maintain or even lower interest rates despite ongoing concerns about potential financial instability.

However, while some remain concerned about what the futures holds, Paul Bloxham, Chief Australia and New Zealand Economist at HSBC, is not, pointing out that there’s likely to be some offsetting factors that will keep economic growth humming along nicely in 2018.

“Thankfully, the fall in dwelling investment is arriving just as the mining investment drag is coming to its end and, importantly, the drag from mining was much bigger,” he says.

“The mining investment decline is set to go from a maximum drag of around 1.5 percentage points (ppts) of GDP in mid-2016, to no drag at all by mid-2018.

“By comparison, the dwelling investment contribution to growth, which was a maximum of around 0.5ppts of GDP in mid-2016, is forecast to be a drag of around 0.25ppts by 2019.

“The collective effect from these two sectors is that a net drag on GDP of around 1ppt in mid-2016 is set to be almost no drag at all in 2018 and 2019.”

Source: HSBC

The point Bloxham is making is that the Australian economy is a series of moving parts, and while residential dwelling investment will likely detract from GDP next year, that will be largely offset by an end to the unwind in the mining infrastructure boom.

As for the threat posed to household consumption by continued weakness in the housing market, Bloxham says that its effect is unlikely to be as bad as some other commentators make out.

“The argument is that households will be less inclined to spend as the cooling of the housing boom means they are no longer seeing wealth gains. However, in our view, there has been little evidence of a positive wealth effect in recent years, so we see a large negative wealth effect as unlikely,” he says.

Bloxham dismisses the suggestion that the recent decline in Australia’s household savings ratio is a sign that higher house prices helped to encourage households to spend more in recent years.

“Although the national household saving rate has fallen in recent years, the state-level numbers show that the saving rate has not fallen in the states which have had housing prices boom [such as New South Wales and Victoria],” he says.

“If the rise in wealth had driven households to consume more, surely it would have happened in the states where wealth has been rising? Instead, household saving rates have only fallen in the mining states, after rising during the mining boom.”

“The moves in household saving rates therefore appear to reflect the impact of the resources cycle on incomes, not a wealth effect.”

Source: HSBC

Rather than housing wealth dictating household spending patterns in recent years, Bloxham says changes in Australian household income growth has been far more influential, noting that weakness in household consumption has been due to the slow growth in household incomes reflecting weak jobs and wages growth at the end of the mining boom.

However, while there’s still a large degree of uncertainty as to what degree wage pressures — the largest part of household income — will lift should labour market conditions continue to improve, Bloxham remains optimistic on the outlook for worker wages.

“The cyclical factors are now supportive of a pick-up in wages growth,” he says.

“Commodity prices have lifted, corporate profitability has improved, business conditions are at high levels and, critically, the labour market is tightening up.

“Our central case is that the cyclical factors, particularly the tightening of the labour market, will see a pick-up in wages growth in 2018, which will complete Australia’s ‘great rebalancing act’.”

And with wage pressures set to build in his opinion, Bloxham says Australian economic growth in 2018 will be both faster and broader than in recent years.

“We expect growth to be more broad-based across industries and regions than it has been in at least a decade,” he says, pointing out that increased government infrastructure investment, along with booming tourism and education exports, will also act to buttress growth.

Bloxham, echoing recent uncertainty from the Reserve Bank of Australia (RBA), says the biggest risk to his view will be if structural factors in the labour market such as technology, offshoring, decreased unionisation and an increasing casualisation of the workforce limit wage pressures longer than he expects.

“The clear risk is that this process takes longer than we have factored in, as the structural factors continue to offset the impact of the positive cyclical forces,” he says.

“The outlook for wages growth remains the main focus of the story.”

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