Australia's housing slowdown is another reason the RBA should leave interest rates on hold


Australia’s housing market is slowing, led by its largest city, Sydney.

Price growth is stalling and auction clearance rates are back at levels not seen in close to two years, coinciding with a noticeable lift in property listings and a slowdown in investor housing finance.

After years of strong price growth, particularly in Australia’s southeastern capitals, it looks like we’re in the early stages of regulator-driven national housing slowdown, led by Sydney.

Presuming the early indicators are right, the only question now is how severe the slowdown will be, and what will it do to the Australian economy in the years ahead?

To George Tharenou and Carlos Cacho, economists at UBS, while it’s unlikely to herald the start of a hard-landing for Australia’s once high-flying housing market, it will buffet economic growth, likely ensuring Australia will continue to lag the recovery in the broader global economy.

“In the last couple of years, the Australian economy has been supported by an improving global backdrop. This has led to a rebound in commodity prices, nominal GDP, and a rise in surveyed business conditions and employment growth to the strongest levels since the GFC,” the pair say.

“Nonetheless, the economy now faces a new domestic headwind from the end of a record housing boom.”

In particular, Tharenou and Cacho say that macroprudential tightening on investor and interest-only lending from Australia’s banking regulator, APRA, along with a sharp increase in new housing stock as a result of Australia’s residential construction boom, will see annual house price growth stall in the period ahead, creating renewed downside risks on the outlook for household spending.

“Our view of soft wages, combined with a fading household wealth effect, means that consumption stays subdued ahead, and probably even slows somewhat from 2.5% year-on-year now to 225% in 2018 and 2019,” they say.

“That would be a weaker scenario than most expect, especially the RBA.”

Source: UBS

Household consumption is the largest part of the Australian economy at a shade under 60% of GDP. There’s already some evidence that weaker housing market conditions are triggering a spending slowdown with retail sales volumes growing by a minuscule 0.1 percentage points during the September quarter.

Higher gas, electricity and petrol prices, along with out-of-cycle mortgage rate increases and the looming arrivals of Amazon in Australia, could also explain the softness in retail sales seen during the quarter.

Given the expectation that household consumption growth could slow even further, Tharenou and Cacho say this will likely lead to lower-than-expected GDP growth, offsetting any economic tailwinds from higher commodity prices and volumes, along with firmer non-mining business investment and public infrastructure spending.

They add that dwelling commencements could also fall by more than 25% from the peak of last year, further dragging on growth despite continued support from strong population growth.

“We continue to expect GDP to bounce solidly to 3% year-on-year in Q3, but only reflecting the base effect of a negative GDP contraction in the September quarter of 2016,” they say.

“But importantly, this 3% pace overstates underlying momentum, and will be close to the peak of growth.

“Indeed, we still see annual average GDP growth rising only moderately from 2.3% year-on-year in 2017 to 2.7% in 2018 in 2019.

“In contrast, the RBA’s GDP forecasts remain more bullish with acceleration to a booming 3.25% to 3.5% year-on-year in 2019, despite the RBA having to materially downgrade growth for each of the last 6 years.”

UBS says slower-than-expected growth will act to limit wage and inflationary pressures in the period ahead.

“The pick-up of wages is still likely to disappoint the hawks,” they say. “Indeed, we still expect only a relatively modest rise to around 2.5% year-on-year for wage rates [in Australia’s wage price index] in coming years.”

And, with wage pressures set to disappoint, inflationary pressures will remain close to non-existent.

“This moderation of consumption and slow wages limits the rise in CPI to only around 2% year-on-year in 2018 and 2019, more benign than most expect,” Tharenou and Cacho say.

As such, they don’t expect the RBA to be hiking interest rates anytime soon, particularly given the risks that it could further exacerbate the slowdown in the housing market.

“In our view, if the RBA hikes too much or too early, it runs the risk of turning a soft landing into a housing crash.”

“We expect the cash rate to remain on hold until the December quarter of 2018. We then expect the RBA to lag, but follow, the Fed, and hike twice in 2019 to 2.25%.”

While UBS say the RBA will likely tighten policy slowly as to mitigate the risks associate with the housing market, its call is actually more aggressive than that of the market who don’t have a full 25 basis point rate hike priced in until early 2019.

In a speech delivered on Monday, RBA Deputy Governor Guy Debelle said the bank was well aware that households would struggle if interest rates were to rise sharply given elevate levels of household debt, although he stressed that he saw no case where the RBA would be forced to take such policy action.

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