The largest part of the Australian economy could be about to weaken

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  • The RBA is banking on household spending to help support economic growth, lower unemployment and boost inflationary pressures, potentially allowing it to lift official interest rates.
  • However, it admits there’s great uncertainty about the outlook for household spending, especially given recent weakness in the housing market.
  • In the past, annual changes in home prices in New South Wales and Victoria – the states where home prices have fallen the fastest in 2018 – have often led changes in consumption patterns.

The Reserve Bank of Australia (RBA) is banking on household spending to help support economic growth, lower unemployment and boost inflationary pressures, eventually allowing it to lift official interest rates for the first time since late 2010 if all goes to plan.

However, while the bank expects continued employment growth and a modest pick-up in wages growth to keep household consumption — the largest past of the economy at just under 60% — growing around 3% per annum, it acknowledges there is a great deal of uncertainty as to whether that optimistic view will play out.

“The outlook for household consumption growth continues to represent a significant uncertainty for the forecasts,” the RBA said in its quarterly statement on monetary policy.

“This derives from uncertainty about the outlook for household income growth as well as uncertainty about how households may respond to significant housing price declines.”

Like so many others, the RBA is not exactly sure how households will respond to the current downturn in the housing market, predicted by some to be the largest in modern times.

Some, such as Westpac and Capital Economics, suggest the hit to household balance sheets will weigh on household spending, resulting in economic growth cooling next year following a strong period in the first half of 2018.

Others such as HSBC say that if booming property prices didn’t boost household spending in the past, it’s anything but certain that it will lead to a slowdown in spending on the way down.

Based on recent consumer confidence data released by ANZ Bank, it certainly doesn’t appear that weakness in the housing market is having much of an impact — at least not yet — with sentiment towards current family finances lifting towards the highest level since before the GFC last week.

That hardly suggests Australian households are about to save more and spend less in period ahead, suggesting HSBC’s view may well be right.

However, if the charts below from Macquarie Bank are anything to go by, there is a risk that falling home prices in Australia’s most populous states — New South Wales and Victoria — could create risks to household spending levels in the period ahead, a scenario that will make it incredibly difficult for the RBA to achieve its economic forecasts in the coming years.

The first shows year-ended growth in household consumption in Victoria, overlaid against annual movements in home prices in the state. The latter has been advanced by six months by Macquarie, and suggests that where home prices move, spending levels tend to follow.


The second shows the relationship between consumption growth and home prices in New South Wales, not only the most populous state in Australia but also home to the fastest falling property prices this year.


Based on historic patterns, it suggests the housing downturn may start to weigh on consumption levels in the coming quarters, especially as nearly 60% of Australia’s population is located in these states.

If prior trends are maintained it will take a Herculean-like performance from Australia’s other states and territories to prevent a broader spending slowdown across the country.

Such a scenario is unlikely.

Given movements in home prices often lead changes in consumption patterns, it also reinforces just how important continued strength in labour market conditions will be in the period ahead to help offset the risks posed by the housing downturn.

Right now, the RBA believes the labour market will be able to offset those risks. However, if it too was to weaken, then it will only intensify the risk of a slowdown in the Australian economy.

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