- Australian home prices are falling, largely reflecting ongoing declines in the mining capitals and, more recently, Sydney and Melbourne.
- Private sector economists appear split as to whether the housing downturn will spill over into the broader Australian economy. Some think it will, while others think stronger labour market conditions will see households maintain their spending levels.
- For perspective, Capital Economics thinks “the longest and deepest [housing downturn] in Australia’s modern history … means that household housing wealth will decline by $800 billion over the next few years”.
- The RBA says it’s uncertain how consumption would respond to an extended period of low income growth and/or declining housing prices.
- Recent retail sales and consumer confidence data suggests the housing downturn may be starting to influence consumer behaviour.
No one seems to know whether the Sydney and Melbourne-led housing downturn will unravel Australia’s promising economic recovery, including policymakers at the Reserve Bank of Australia (RBA).
For some time, the bank has noted that “one continuing source of uncertainty is the outlook for household consumption”, in particular, “how consumption would respond if there were an extended period of low income growth, and/or declining housing prices”.
RBA Deputy Governor Guy Debelle touched upon the subject in a speech delivered earlier this month, admitting it was something the bank was 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 at Citibank’s investment conference in Sydney.
“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.”
It’s the $1.8 trillion question when it comes to the outlook for the Australian economy.
On one hand, economic growth was, at least based on recent data, incredibly strong in the first half of the year, helped in part by a strong rebound in spending at the shops in the June quarter. Unemployment also sits at six-year lows with employment still growing at a decent clip, albeit off the unprecedented levels seen throughout much of 2017.
Despite weak wage growth, the largest component of household income for most families, and savings levels falling to the lowest level since before the GFC, those positive factors should help to underpin household spending in the period ahead.
But what happens if ongoing and widening price falls in some property markets leads to a change in mindset from households? For most families, their home is the largest single asset they own, and with prices already falling and expected to do so for some time yet, there’s clearly a risk that some may choose to tighten the purse strings a little, an outcome that could potentially lead to weaker consumption and slower economic growth.
According to the Australian economics team at UBS, the likelihood of continued weakness in the housing market means the risk is rising, not falling, that a negative wealth effect will start to impact the real economy.
“We’re even more bearish on house prices,” said George Tharenou, Carlos Cacho and Jim Xu, members of the UBS Australian economics team.
“We previously expected around 5%, but now expect prices to drop peak-to-trough by 10% by 2020 to the lowest level since mid-2015, heavily skewed to Sydney and Melbourne with prices down 15%.”
Given that outlook, they warn persistent weakness in the housing market could lead to an increase in household savings, reversing the trend seen in recent years that allowed households to maintain their spending levels despite soft growth in household incomes.
It’s not just UBS that is concerned that such a scenario could eventuate.
Marcel Thieliant and Ben Udy, Economists at Capital Economics, share a similar view, suggesting recent trends are unlikely to be repeated in the future should home prices continue to fall.
“Households responded to rising house prices by lifting spending and we think they will eventually respond to falling prices with lower spending,” they say.
“Across the nation, the household saving rate has fallen as wealth has surged.
“Put another way, when house prices are rising rapidly households let their home do their saving for them, which means that households can spend a larger share of their income.
“This is the best evidence that there has been a positive wealth effect.”
With national home prices already down 4.6% in seasonally adjusted weighted terms from the cyclical peak in July last year, Capital Economics, like a majority of mainstream forecasters, believes the downturn will run for some time yet, meaning this downturn will likely end up being the largest in modern times.
“We now expect house prices to fall by 12% from their peak over the next three years,” Thieliant and Udy say.
“This would make the current downturn the longest and deepest in Australia’s modern history and means that household housing wealth will decline by $800 billion over the next few years.”
In their opinion, the decline in housing wealth will weigh on household spending, counteracting the recent improvement in labour market conditions.
“We don’t think the wealth effect is dead or that households will be able to shrug it off,” they said, in reference to the anticipated fall in home prices.
“Given that housing accounts for around 50% of household assets, a 12% drop would reduce household net wealth by around 6%. A 6% fall in net wealth is consistent with household consumption growth slowing by around 1.5 percentage points.”
And with household consumption accounting for around 55% of the Australian economy, Thieliant and Udy say that will inevitably weigh on GDP as a consequence.
“We estimate that the wealth effect will subtract 0.5 percentage points off annual consumption growth each year, or 0.3 percentage points from annual GDP growth per year.”
While that outcome wouldn’t risk Australia’s 27-year run without experiencing a technical recession, they say it will likely lead to slower GDP growth next year.
“This is part of the reason why we believe that GDP growth will slow from 3.2% in 2018 to 2.5% in 2020,” they say.
Based on the RBA’s latest forecasts offered in August, the bank sees GDP growth of 3.25% per annum both this year and next, higher than the level where unemployment and inflation is expected to remain stable.
Worryingly, on top of recent weak outcomes in Australian retail sales in July and August, there’s mounting evidence to suggest that UBS and Capital Economics may be right with respondents in the latest ANZ-Roy Morgan consumer confidence survey indicating that now is the worst time to buy a household item since May 2014.
If that is replicated in upcoming retail sales data, it will undoubtedly be a concern.
However, not everyone thinks the downturn in the housing market will derail the recent economic recovery.
Paul Bloxham, Chief Australia and new Zealand Economist at HSBC, is one who isn’t concerned about a housing-led spending and economic slowdown.
He says rather than changes in household wealth levels being the predominant driver of household spending, it’s changes in household income levels that play a far more significant role.
“Our central case sees continued solid jobs growth tightening the labour market further and driving a modest lift in wages growth. There are also already some tell-tale signs that wages growth is picking up, with firms reporting that it is getting harder to acquire skilled labour,” he says.
“These forces should support a pick-up in growth in household disposable income and underpin continued solid consumption growth.”
Unlike other forecasters, Bloxham says there was little evidence during the prior housing market upswing that it acted to support household spending levels.
“If changes in wealth were a major driver of consumption, then spending surely would have been much stronger in recent years,” he says.
“Over the past six years, household consumption growth has been steady and solid, although not as strong as it was prior to the Global Financial Crisis.”
As for the prospect that falling home prices could lead to increased household savings, he also points out that much of the decline in Australia’s aggregate household savings ratio over the past decade occurred in just two states — Western Australia and Queensland.
“This has been especially stark in Western Australia, where much of the initial boost to incomes from the mining investment and commodity price boom appears to have been saved rather than spent and, subsequently, when income growth slowed households reduced their saving rate to support consumption,” he says.
So who’s right and who’s wrong, or is the answer somewhere in between?
It’s easy to see why policymakers at the RBA, and others, aren’t really sure how households will respond. We are, after all, dealing with the personal views and confidence levels of millions of people. While history is helpful, it’s debatable whether Nostradamus himself would be able to answer this question with any certainty.
However, the real task will be to ensure an adverse economic situation doesn’t eventuate, regardless of what direction it may be.
That means incoming data on housing, spending and sentiment will watched extremely carefully for any early indications of trouble.
That process will continue later this week with the release of Australia’s retail sales report for September.