- Australian home prices have now been falling for over a year, creating renewed concern about negative spillover effects into other parts of the economy.
- In particular, fears over a spending slowdown from households are growing, seeing financial markets and an increasing number of economists speculate over potential RBA rate cuts.
- ANZ Bank says that it is “difficult to argue there will be no wealth effect” from the housing downturn. It sees household income growth as playing a crucial role in determining how bad things will get.
Australian home prices have now been falling for over a year, led by increasingly steep falls in Sydney and Melbourne, Australia’s largest and most expensive housing markets.
Many suspect the falls will continue for some time yet with the only real area of debate being just how large the peak-to-trough falls will be.
The downturn has already left its mark on residential construction, leading to large declines in building approvals and activity, especially for apartment building, along with a decline in employment across the sector.
The question that many are now grappling with is whether the downturn will lead to similar weakness in other non-housing areas of the economy. In particular, consumer spending, accounting for over 50% of GDP.
For the vast majority of Australian households, the family home is the largest store of wealth. And with prices falling in many parts of the country, including in the most populous areas, there is a growing sense of unease that it could see consumers starting to cave, creating downside risks for broader economic growth.
To this point there is no right or wrong answer — some believe the perceived reduction in household wealth will crimp household spending. Others, however, believe strong labour market conditions and legislated and potential further income tax cuts will be able to offset the negative wealth effect from housing, allowing households to maintain their spending levels in the period ahead.
To David Plank, Head of Australian Economics at ANZ Bank, it’s the income side of the equation, rather than the housing downturn, that will likely determine what the future holds.
“We think it difficult to argue there will be no wealth effect [from the housing downturn],” he said in note to clients.
“In our view, the fall in the household saving rate in recent years has been in part due to rising wealth. At the very least, we expect declining house prices to lead to a stabilisation in the saving rate, if not an up-tick.”
As seen in the chart below, changes in household wealth have often been influential on the level of disposable income saved by households.
In recent years, the proportion of disposable income saved has been falling, suggesting higher wealth levels, in an era of weak income growth, has encouraged households to save less in order to sustain their spending levels.
Now that wealth levels have been falling — not only due to declining home prices but recent weakness in Australia’s stock market — ANZ sees that trend stalling or reversing slightly, casting doubt over the outlook for the largest part of the economy.
For Plank, if households begin to hunker down by saving more, income levels will play a crucial role in determining whether that will lead to a slowdown in household spending.
“What a stabilisation in the saving rate means for household consumption will critically depend on what happens to household income,” he says.
“Tax cuts — which may be brought forward by the Government ahead of this year’s election due to the improved fiscal position — will provide a material boost to disposable income. We also expect wage growth to accelerate somewhat over 2019 and 2020, so long as employment growth remains robust.
“These factors will mean the household saving rate could stabilise without a dramatic slowing in household spending.”
Plank also notes that the current situation is somewhat unique, noting that rather than being driven by higher mortgage rates, the downturn in the housing market has largely been caused by the introduction of tighter lending standards.
“Past declines in house prices have been caused by higher interest rates. And higher interest rates would also be expected to slow household spending. The initial trigger for this housing downturn is different from those in the past, with it having been a tightening in the availability of credit rather than higher interest rates,” he says.
“This difference may mean a weaker relationship between house prices and consumption than in the past.”
Plank says tighter credit conditions may have also been responsible for the sharp drop in Australian new car sales late last year, creating uncertainty about the impact of sliding home prices on discretionary spending by households.
“We think it reflects the impact of tighter credit and is not necessarily evidence of a strong wealth effect,” he says.
While Plank suggests the uncertainty means the linkages between wealth levels and household spending may not be as strong as they were in the past, he admits that recent trends point to downside risks for household spending in the period ahead, including the potential for a larger-than-expected slowdown.
“We don’t think this will be the case given the nature of this cycle. But there is a lot going on in the current housing downturn that is unique, so we have to be open to the possibility that it might,” he says.
ANZ is currently forecasting that home prices in Sydney and Melbourne will fall 15% to 20% from their previous cyclical peak, a scenario it says will see the RBA hold off lifting official interest rates until the second half of 2020.
Financial markets currently hold a different view, putting the probability of the RBA cutting its cash rate by 25 basis points by November this year at around 50%. An increasing number of economists are also adopting this view, including Capital Economics who are now forecasting two rate cuts by the RBA by the middle of next year.
From a domestic perspective, updated data on home prices, employment, inflation and household spending in the coming months will likely determine whether even easier monetary policy settings from the RBA are justified.