Summary March 2019:
- The RBA again kept the cash rate unchanged at 1.5%;
- The RBA is still forecasting a decent economic outlook, but acknowledges the risks;
- Developments in housing market are one of those risks;
- But housing developments can be largely explained by that most basic economic concept – supply and demand.
“A ship in the harbour is safe, but that is not what ships are built for,” William GT. Shedd.
"Where you stand depends on where you sit", is a quote that can aptly be applied to risk. For example, the above quote is from the ‘you have to be in it to win it’ school, where taking some risk is seen to be a good thing. By contrast, a read of any RBA Statement will lead you to the view that risks are something that is bad. Budding entrepreneurs clearly sit in very different chairs from the RBA.
The least surprising news from the latest RBA Board meeting is that the cash rate was again kept unchanged. But interest rates have been now been unchanged for so long that no longer counts as news. Over the past month the RBA has given speeches, released its quarterly monetary policy statement and appeared before Parliament. So its statement released following the March Board decision also was not a surprise. In summary the RBA thinks that the global economy is doing Ok, with unemployment rates in many countries at very low levels. Domestically, there is plenty of infrastructure work to be done and business capex budgets are being boosted (notably for miners). Industries such as tourism and education are doing well. Jobs growth is rising, the unemployment rate falling. The RBA has become more positive on the wages outlook.
But then there are those risks. Europe is slowing. China is an even bigger concern, not the least because of the size of its economy. The Chinese Government is aware of the risks and is again putting its shoulder hard to the economic wheel. Recent history suggests that they will succeed in keeping the economy on an even keel. But there is always a first time for failure. Domestically, sustained economic growth will require a bigger consumer presence. And that will require bigger pay packets.
The weaker global outlook has seen markets shift from thinking the next move in cash rates by global central banks will be up, to the next move will be down. The RBA is seeing the economic glass as half-full, keeping its 2019 GDP forecast unchanged (at about 3%). But they are aware that the glass has become a little bit emptier over the past 6-months. And there is a risk that it could become emptier still. The RBA keeps on top of thousands pieces of data so changes in no one individual number will by itself lead to action. But clear signs that the unemployment rate is heading higher would have a bigger weighting in any discussions for a rate cut. By contrast, confidence that inflation is shifting up will be necessary before a rate hike can be seriously discussed.
Analysts are broadly evenly divided between the glass half-full and half-empty camps (although the half-empty camp is currently receiving more inquiries). Financial markets are not for dilly-dallying and and at the time of writing have fully inked a rate cut by mid next year. Most can agree that the cash rate is unlikely to be changed before end-June. Thereafter interest rate views are driven by views on which data slipstream the economy will find itself in.
The risk that has received the most attention over recent months has been developments in the housing market (although housing always gets plenty of attention). Recently, Corelogic reported that house prices fell over the year to February in Sydney, Melbourne, Brisbane, Perth and Darwin, and grew modestly in the other capital cities. Hobart was the standout exception.
Over the past decade annualised price growth (according to the ABS) has been strong in Sydney, Melbourne and Canberra, and more modest in the other capital cities. By contrast, over a twenty year period annualised growth was a strong 6-9% for each capital city. This suggests that in the 10-15 years prior to the GFC there was a common factor driving house prices across all cities (declining interest rates, rising household debt). In the decade since the GFC regional-specific factors have played a greater role.
From a longer-run standpoint falling house prices is not an unusual event. In Sydney annual house price declines (in both nominal and real terms) were quite common before the Second World War. Changes in the structure of the economy mean that similar levels of volatility are now unlikely (the exchange rate is now flexible, agriculture/mining is a smaller part of the economy). But annual real house prices growth (the change in house prices after taking account of inflation) in Sydney has been negative five times since 2000.
Capital City House Price Growth (annual % change)
Proportion of CPI Items
Housing and the economy
In aggregate housing comprises a bit over half of consumer’s wealth (for most consumers it is an even higher proportion). The RBA has noted that the link between short-term movements in house prices and consumer spending is weak. As an example, when house price growth was very strong (2012-15) consumer spending was soft. But in a previous period when house price growth was strong (the early 2000’s) consumer spending was also robust with some households even borrowing against the value of their home (at that time the household saving ratio was negative).
In the second half of last year consumption was (surprisingly) weak. Retailers reported a notable decline in business conditions. Household goods was the weakest retail segment (particularly in NSW and WA), a sector that can be expected to be impacted by a softening housing market. The RBA have also found that car purchases can also be influenced by changes in house prices.
But the biggest driver of consumer spending is the outlook for disposable income growth. More dollars usually means more consumer spending. Looming tax cuts for low and middle income earners will be a plus. Jobs growth looks good for at least the next 3-6 months. Wages growth is also starting to rise. Thereafter it will be how the economy evolves.
Annual Growth In Hours Worked
(3 Month Average)
Retailers View of Business Conditions
(2 Quater Average)
Job Vacancies As Proportion of Labour Force
Construction of multi-unit dwellings has been a key driver of economic growth over the past 2-3 years, and helped the economy transition away from the mining boom. In late 2016 construction of units was a bit under 2% of GDP, the highest ratio on record. The supply of units is peaking, and building approvals data indicates that a sizeable decline in unit construction is on the way. The fall in construction of detached housing is likely to be less marked given the number of standalone houses built in recent years has been less marked than for units. It is possible that there might even be a rise in alteration and addition spending given the greater availability of builders.
(4 Quarter Sum, % GDP)
Number of Unit Approvals
(Rolling 3 Month Sum)
The outlook for residential construction is likely to be tough for the next couple of years. But other areas of construction are in better shape. There is plenty of work still in the pipeline for non-residential construction, partly reflecting the shortage of office space in Sydney and Melbourne. The possibility of new mines is again being explored. And the large amount of infrastructure work should underpin means there is ample work for those doing engineering construction.
Industry Views on New Orders
(3 Months Average)
House price drivers over recent years
In 2014-16 there were concerns that foreign buying was driving up house prices. At that time the Chinese Government was also worried about the size and pace of capital outflows and tightened regulation to reduce buying of foreign real estate. The federal and some state governments also increased taxes on offshore real estate purchases. The combined result subsequently led to a sharp fall in offshore purchases of Australian real estate.
Domestic investors were attracted back into the property market by strong price growth. Such was the demand for loans from investors’ that APRA introduced limits to investor credit growth. The growth of investor borrowing started slowing from the start of 2017, coinciding with the peak of house price growth. Lending to owner occupiers continued to rise through 2016 and 2017 but started to decline through last year. Tighter lending standards has copped a fair bit of the blame. It is possible that existing home owners may not have wanted to sell into a declining market (even if that meant buying a cheaper home). One bit of good news is that other buyers exiting the market has made room for the re-emergence of first-home buyers (attracted by improved affordability).
But the divergence of house price performance between capital cities suggests factors other than regulation are at play. Sydney and Melbourne have experienced strong population growth (and therefore a big jump in demand for housing). For a period that increase in demand was not met by higher supply. The result was that house prices rose. But over the past year a large amount of supply has come onto the market leading to lower prices (there has also been a rise in rental vacancies rates in Sydney, less so in Melbourne because of stronger population growth).
Foreign Investment Review Board Residential Approvals
Proportion Home Loans Made to First-Home Buyers
(6 Month Average)
The other factor that made house prices vulnerable to a fall was valuation. For example, in 2017 the value of residential land in NSW reached record highs both relative to both the size of the NSW economy and the value of rural land.
Value of Residential Relative to Rural Land In NSW
Value of NSW Residential Land (% GSP)
In the near term many analysts think that further declines in house prices in Sydney and Melbourne are possible. Population growth is still strong. But the supply of housing will be even stronger. The outlook for household disposable income growth is modest. It is possible that house prices might get a boost if there is a cut in interest rates. But a significant rise in the unemployment rate would be a negative. A longer-term concern would be if there was a significant slowing of population growth.
The housing market will always punch above its weight in getting attention. But it is one risk amongst the broader developments in the national and international economy. Ships may not have been built to stay in harbours. But even for the most experienced of captains the sailing has become a little less easy in recent months.
We live in interesting times!
Peter Munckton - Chief Economist