The downturn in Sydney and Melbourne home prices may not even be halfway through

(Photo by Steve Christo/Corbis via Getty Images)Aerial view of construction work and housing in Western Sydney.
  • Sydney and Melbourne are Australia’s largest and most expensive housing markets, and prices in both cities have now been falling for well over a year.
  • So far, the downturn in Sydney’s median price has been 11% and 7% in Melbourne. Prices are still falling quite rapidly in January, according to CoreLogic’s daily data.
  • AMP Capital believes recent declines in Sydney could double, and quadruple in Melbourne, before the downturn comes to an end.
  • It says that will weigh on Australian economic growth, placing downward pressure on wages and inflation and upward pressure on unemployment. Such a scenario would leave the domestic economy very vulnerable to a potential external shock.
  • AMP says the RBA will be forced to cut the cash rate twice this year, leaving it at 1%. It also expects modest tax relief for households in the federal budget.

Sydney and Melbourne home prices have been falling for over a year with median values down 11% and 7% respectively from their cyclical peaks.

And they’re still falling in January, according to CoreLogic’s daily data, with Sydney and Melbourne prices down 1% and 1.3% respectively. And there’s still eight more days to go.

To AMP Capital’s Chief Economist Shane Oliver, already among the most bearish mainstream Australian house price forecasters, there’s plenty more downside to come in the coming years.

He says the declines in Sydney are probably not even at their halfway point yet, while those in Melbourne could quadruple from what’s already been seen.

“For Sydney and Melbourne our base case has been that prices would have a top to bottom fall of around 20% out to 2020,” Oliver says, referring to his prior forecasts.

“However, the further plunge in auction clearance rates and acceleration in price falls late last year suggest a deeper fall possibly of around 25%, although it’s impossible to be precise.

“This suggests around another 15% fall in Sydney and more in Melbourne.”

While Oliver acknowledges such a decline in would be regarded by many as a property crash, he says the size of the decline needs to be put into perspective relative to how much prices rose in the subsequent cyclical upswing.

“A 25% plunge in Sydney and Melbourne may seem like a crash but given the extent of the prior gains it’s arguably not,” he says.

“A 25% top to bottom drop would take prices back to where they were in late 2014/early 2015.”

AMP Capital

Oliver says there’s no one single factor that has caused the latest downturn in Australia’s largest and most expensive housing markets, nominating tighter lending standards, a record supply of new apartments, a potential change in government, and with it changes to the tax treatment of housing, reduced foreign demand, a growing expectation that prices will keep falling and an absence of RBA rate cuts as reasons for why prices are now falling.

However, on the latter factor, RBA rate cuts, a factor that has seen property price declines slow, then reverse, during cycles in the past, Oliver says the RBA will have to cut prices again in the year ahead, but not because of home prices.

He says the economy will need easier policy in order to prevent a pronounced economic downturn.

“The housing downturn will affect the broader economy via slowing dwelling construction, negative wealth effects on consumer spending and if rising defaults drive a further slowing in bank lending. The first two will detract 1 to 1.5 percentage points from economic growth,” he says.

“Growth in infrastructure spending and business investment should help keep the economy growing but its likely to be constrained to around 2.7% which in turn will keep wages and inflation low.”

Oliver’s view that wage growth and inflation will remain low, thwarting any possibility of RBA rate hikes, is because trend economic growth in Australia is widely regarded as being around 2.75% per annum.

Trend growth is the level where unemployment and inflationary pressures are stable. As things currently stand, unemployment is still above the level where wages growth is expected to accelerate while inflation remains entrenched below the RBA’s 2-3% medium-term target.

Without some form of policy support — be it fiscal or monetary, or both — that will leave Australia’s economy vulnerable to any shocks from abroad in the period ahead.

As such, Oliver expects both the RBA and government to take action to boost the economy’s resilience this year.

“Constrained growth due to the housing downturn resulting in lower for longer inflation will likely drive the RBA to cut interest rates this year, with two cuts taking the cash rate to 1% by year end,” he says.

“Our base case is that this will occur in August and November, giving the RBA chance to assess the election and tax cuts, but soft data could see it come earlier.”

From the fiscal side of the equation, Oliver says government support, while there, will likely be modest given the risks a large stimulus program could could cause to the budget position in the future.

“Tax cuts from July are unlikely to be big enough to head off the need for rate cuts,” he says.

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