'Risks are on the downside': Why Australia's housing downturn could see the RBA cut rates again

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  • AMP Capital says Sydney and Melbourne home prices could fall more than the 20% level it currently anticipates.
  • Given the risk of a deeper downturn, it says the next move in the RBA cash rate may not be higher after all.
  • Like other forecasters, it remains concerned about the potential for the housing downturn to spillover into weaker household spending.
  • Australia will receive updated data on household consumption and retail sales later this week.

AMP Capital Chief Economist Shane Oliver is one of the more pessimistic forecasters when it comes to the outlook for Sydney and Melbourne home prices.

Following the release of CoreLogic’s Home Value Index earlier this week, revealing that Sydney and Melbourne home prices fell by 1.4% and 1% respectively from October, Oliver says the risks to his forecasts are now to the downside.

He says there are a number of factors working in tandem to push prices lower in these cities, describing it as the “perfect storm”.

“The decline in property prices is being driven by a perfect storm of tighter credit conditions, poor affordability, rising unit supply, reduced foreign demand, the switch from interest only to principle and interest mortgages for a significant number of borrowers, fears that negative gearing and capital gains tax concessions will be made less favourable if there is a change of government, falling price growth expectations and FOMO (fear of missing out) risking turning into FONGO (fear of not getting out) for investors,” Oliver says.

“These drags are most evident in Sydney and Melbourne because they saw the strongest gains into last year and had become more speculative with a greater involvement by investors.”

As seen in this simple-yet-effective chart from Oliver, the recent downturn in CoreLogic’s national price measure only really reflects the movements in Sydney and Melbourne, the two markets where prices boomed in recent years.

In average weighted terms, Australia’s smaller capital city markets — which didn’t participate in the prior price boom — are now failing to participate in the current price downturn.

AMP Capital

Oliver expects those trends in his chart will continue in the period ahead, suggesting that downside risks are emerging to valuations in Sydney and Melbourne, but not in the other capitals.

“The decline in Sydney and Melbourne property prices likely has much further to go as these considerations continue to impact particularly as Comprehensive Credit Reporting kicks in making it even harder to get multiple mortgages and if changes to negative gearing and capital gains tax become reality after a change of government at the coming Federal election,” he says.

“In these cities we expect to see a top to bottom fall in prices of around 20% spread out to 2020.

“However… the risks are on the downside.”

In contrast, he says the valuations in Australia’s mining capitals — Perth and Darwin — are close to cyclical nadir, while those in the remaining capitals are likely to edge higher.

“Having not had the same speculative boom over the last five or six years other capital cities are likely to perform better,” Oliver says.

“Perth and Darwin are likely close to the bottom as the mining investment slump comes to an end while Adelaide, Brisbane, Canberra and Hobart are likely to see moderate growth.”

Despite the mixed outlook for prices across the country, given the threat posed by an even deeper downturn in Sydney and Melbourne — home to around 55% of Australia’s total housing wealth — Oliver says the risk of a rate cut from the Reserve Bank of Australia (RBA) cannot be entirely ruled out.

“With prices continuing to slide there is a high and rising risk that the next move in official interest rates will be a cut rather than a hike, but at this point the RBA is a long way from contemplating a rate cut as it would need to see evidence that the slump in home prices and the drag on consumer spending is seriously threatening to push inflation even lower, so it’s probably a second half 2019 story at the earliest,” he says.

Similar to the views expressed by the likes of Capital Economics and UBS, Oliver says “ongoing home price falls in Sydney and Melbourne will depress consumer spending as the wealth effect goes in reverse and so homeowners will be less inclined to allow their savings rate to decline”.

That is, in an era of weak household income growth and falling home prices, it could lead to households becoming more risk averse, potentially leading to money being diverted into savings rather than spending, reversing the trend that’s been in place since the end of the GFC.

Around 40% of Australia’s population live in Sydney and Melbourne, and household spending accounts for over 50% of Australian economic growth.

Should only a relatively small proportion of households in these cities react by spending less and saving more, that carries the potential to slow the broader economy, creating the potential for an increase in unemployment and softer wage and inflationary pressures, increasing the risk that the next move in the RBA cash rate may not be higher after all.

While the RBA continues to suggest the next move in official interest rates is likely to be higher, putting faith in stronger labour market conditions to keep household consumption growing at around 3% per annum over the next couple of years, it acknowledges there’s plenty of uncertainty about the possible influence that falling home prices could have on the economy.

“There continues to be uncertainty about how quickly the unemployment rate will decline and how quickly that will feed into wage pressures and inflation,” the bank said in its quarterly statement on monetary policy released in November.

“Uncertainty about wages growth also translates into uncertainty about the outlook for household disposable income, which has a direct bearing on consumption growth, as does the evolution of housing prices through household wealth.”

Given heightened uncertainty, RBA Deputy Governor Guy Debelle said the potential for the housing downturn to spillover into weaker household spending is something the bank is watching closely.

“It’s something that we’re paying pretty close attention to. How much of a drag it may constitute… is just not clear,” Debelle said in a speech delivered in October.

“It’s not entirely clear how much of a boost the rising house prices provided to the economy on the way up, which also means it’s not entirely clear how much of a drag it may provide or may constitute on the way down.

“I’m not saying that because I think it’s one way or the other, it’s just that it’s really an uncertainty.”

While uncertainty remains heightened at present, it may not remain that way for long.

Later this week, the ABS will release data on household consumption growth in the September quarter along with retail sales figures for October, providing updated information that may determine what impact, if any, weakness in Sydney and Melbourne property prices is having on consumer behaviour.

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