For more than a year now, fears of a housing-led recession have been building in Australia. First, auction clearances fell in a hole, then house price declines, falling credit growth and building approvals, and finally, unemployment began to rise. A month ago, further falls seemed inevitable. Then Australian woke up on Sunday the 19th of May to the news that the Coalition had been returned to government. Bank stocks rallied, auction clearance rates picked up, and CoreLogic’s daily house prices indices began to flash green again. But can a surprise election result really turn the housing market? Or has the damage to the market and the economy already been done?
To find out, we asked six leading economists for their take on the current outlook for the Australian economy and housing market. Responses come from Jim Chronis, Ausbil Investment Management; Scott Haslem, Crestone Wealth Management; Simon Doyle, Schroders; Jay Sivapalan, Janus Henderson; Adam Bowe, PIMCO; and Chris Rands, Nikko Asset Management.
House prices to bottom – but don’t expect growth
Jim Chronis, Ausbil Investment Management
The prospect of lower rates, and with the Coalition government winning the Federal Election and taking negative gearing and capital gains changes off the table, the housing market has gained additional support. We think that while housing will remain weak for the remainder of 2019, that by 2020 the slowdown in housing will have halted.
Housing prices: Comparing other price declines
The chart above compares the slide in house prices from the most recent four examples, both 1981 and 1989 being recessions, and 2008 the Global Financial Crisis. The current fall in house prices, which began in 2017, is showing signs of slowing in a similar pattern to others. A complicating factor is the level of consumer indebtedness, which is at an all-time high, but we believe this will steadily improve. We do expect price declines to bottom soon, but we think housing growth with be negligible to modest in 2020.
APRA recently released a review of the serviceability assessment policy for banks. APRA has proposed changes to how Australian Authorised Deposit-taking Institutions (ADIs) should assess whether borrowers can afford their repayment obligations using a minimum interest rate of at least 7 percent. Instead, ADIs would be permitted to review and set their own minimum interest rate floor for use in serviceability assessments. This, in addition to lower interest rates and no changes to negative gearing policy are likely to help put a floor under the housing market.
The worst may be behind us
Australian growth slowed sharply during the second half of 2018, barely rising in Q3 and Q4. Recent data suggests a better Q1 2019 performance for the economy, but even then, the annual pace of growth is expected to drop below 2% for the next quarter or so. But a trilogy of recent developments does suggest the risk that the economy will slow further from here has reduced and some stabilisation, even improvement, in growth as we approach the end of the year is possible:
- A modest rise in unemployment (despite accelerating jobs growth) has led the RBA to signal a likely rate cut in early June (with the market expecting a follow-up cut in August), supporting household cash flows and the housing sector,
- The Coalition’s unexpected return to government is likely to support business and housing sentiment, and
- The regulator has signalled some easing of housing lending criteria.
Recent data does tentatively suggest the worst for the economy has passed, such as an improving trend for retail sales, some stabilisation in residential building approvals and an easing pace of decline in housing prices. Time will tell whether the recent rise in unemployment is just noise, or whether it signals a more sinister correction for the economy ahead. Of course, the outlook also remains vulnerable to further trade war escalation that leads to a sharp pullback in global growth or an unexpected correction in China’s domestic activity.
Australia’s golden run is vulnerable
The Australian economy is certainly not bullet proof. While it’s been 27 years since a recession, the economy’s as vulnerable now to this golden run ending as at any time in the intervening 27 years. We’re alert, but not alarmed, and on balance, expect the economy to stay weak, bouncing around in a sub-trend environment. Our base case is that it won’t get much better, but equally probably won’t get much worse.
There are several obvious downside risks to the economy. The first, that the housing downturn (both activity and prices) fails to stabilise, setting off a downward spiral of confidence, wealth effects and consumption. The second, that global trade (especially with China) collapses amid global trade and tariff tensions feeding back into commodity prices and export volumes. Clearly either a US or Chinese recession would be a disaster for Australia.
This said, there are positives. Easier monetary policy (which is coming) and a relaxation of lending standards will lower borrowing costs and improve the availability of credit. Likewise, fiscal policy is set to be eased, with the Coalition hoping to deliver on promised income tax cuts, providing an important boost to household disposable incomes, which have been under some pressure. In addition, there is a pipeline of non-residential construction projects (including a long list of infrastructure initiatives) that will at least partially offset the declines in housing activity.
Growth could surprise to the upside next year
Jay Sivapalan, Janus Henderson Investors
Whilst the pressure on falling house prices may have passed, the decline in housing construction activity is still ahead of us and well-telegraphed. This has implications for both direct construction employment as well as any spill over to broader consumption. Some of the drag from housing construction and consumption will be offset by positive contributions from public infrastructure investment, however, we still expect the overall growth environment to be a ‘muddle through’ scenario in 2019.
Having said this, 2020 economic growth could surprise to the upside. The clear majority government, lack of concerns around negative gearing policies, some likely monetary policy and fiscal policy stimulus and any new infrastructure building commitments could all positively stimulate the economy. Banking regulations are also being gradually eased which enable borrowers, refinancing activity and developers to access credit within prudent limits.
Overall, our expectation is that the worst (in terms of negative headlines, sentiment and house price adjustments) is behind us. Prices may continue to fall further, but the rate of change will likely be smaller. And the negative impact on consumption from deleveraging and sentiment should also wane from here on.
12 month rolling numbers of approvals (‘000s)
Risks still skewed to the downside
The election result could certainly provide a positive sentiment boost to certain sectors like the housing market now that tax rules around negative gearing and capital gains will remain unchanged. This sentiment boost is already visible in the relative performance of equity markets with the ASX 200 up 2.5% month to date despite the S&P 500 being down 4% over the same period. The election result, combined with APRA’s proposal to remove the 7% threshold that lenders are required to use when assessing household borrowing capacity, as well as potential interest rate cuts from the RBA, certainly remove some of the downside risks to the domestic outlook as we navigate the second half of 2019. As an example, during the Royal Commission banks moved away from standardized expenditure assessments when estimating a new customer’s borrowing capacity, which had a significant negative impact on the amount they were willing to lend per dollar of income. Our credit analysts estimate that this negative impact will now be approximately offset by the impact of:
- Potential RBA cuts,
- APRA removing the 7% threshold,
- Lower house prices, and
- Modest wage growth.
However, headwinds to the property sector remain, including the increased loan service burden from the ongoing transition of the bulge of interest-only loans written in 2015-2017 to principal-and-interest payments. So, until we get a more sustainable mix of policy and better balance of growth drivers, Australia’s economic outlook will remain fragile and reliant on over-levered households’ willingness to further lever up. And the global outlook remains highly uncertain as the recent deterioration in trade talks between the US and China illustrate. There is always the risk that there is no grand bargain in the near term between the US and China and instead we remain in a protracted period of volatile trade renegotiations. Small open economies with strong political ties to the US and strong trade ties to China like Australia are particularly vulnerable and may find themselves increasingly forced to choose sides, resulting in unintended consequences. So, while recent domestic developments should be supportive, the outlook remains challenging with downside risks more identifiable than upside risks.
Early signs positive, but still too early to call
The market has quite clearly become more positive on housing over the past few weeks and the early signs of improvement are positive. Auction clearance rates in the housing market moved higher last weekend, showing a trend of improving clearance rates since earlier this year. Given auction clearance rates lead house prices by a few months, any continued improvement could change the tone in housing market.
Housing prices and auction clearance rates
In addition, the equity market has read the changes as positive, with major bank stocks posting a considerable bounce over the past few weeks. Given the strong relationship between major bank prices and total investor mortgage approvals, this implies that we could see lending coming back for investors over the next few months. Considering negative gearing is now off the table and the RBA is set to cut rates, this fundamentally makes sense.
CBA stock price and investor mortgage approvals
Despite these improvements, we are not completely out of the woods yet. The RBA noted in their recent Statement of Monetary Policy that the “fall in housing prices has reduced the demand for credit, particularly from potential investors who are especially sensitive to expectations of capital losses”. While the early signs of improvement are positive, we still need to see lending flow back into the housing market to improve prices as they have historically followed this metric.
House prices and mortgage approvals
Additionally, given the median house price in Sydney (approximately $800,000) is about eight times income, some potential borrowers would still be caught up under APRA’s very high debt-to-income ratio of borrowing six times incomes. So, in the more expensive markets of Sydney and Melbourne, the rate cuts and serviceability changes may not entice as strong a reaction to borrowing as the period from 2014 to 2017.
Hence while the early signs are positive, we would like to see the mortgage lending stats begin to increase before we call the end of the declines.
Almost every reason given by those leading the cheer for house prices to go up again, be it negative gearing not being abolished, the RBA cutting rates, APRA lowering lending benchmarks, or the quiet reintroduction of interest only lending, involves throwing more debt into an already overindebted sector. Australian households are close to the top of any metric you care to name when it comes to indebtedness. The first chart, showing the real house price corrections from different periods, has been used by some to argue we're at or close to a bottom given we're in a similar ballpark. But it's instructive if you look behind the numbers: I don't know the data in 1981, but in 1989 household debt to disposable income was about 60% and house prices were trading at about 2.2 times disposable income; in 2008 the numbers were about 160% and 4.3x respectively, now it's 190% and 4.8x. In other words, house prices recovered from past corrections by using up borrowing capacity, but with mortgage debt having risen at 7% per annum over the past 10 years versus 2.5% for real wages, you really have to question how much spare capacity there is. I agree on the face of it those reasons can easily be interpreted as grounds for a recovery, but isn't that what Daniel Kahneman referred to as level one thinking?
How high can a dead cat bounce in a property bubble? Household borrowing has eased dramatically since the l981 housing down turn: deposit amounts have dropped from 1/3 of the property price to almost nothing, loan amounts have grown from 3X mortgage applicant's gross annual income to over 7X, average housing prices have grow from 4X average annual salaries to over 10X, and the average house has gone from a 1/4 acre block to a two bed flat. A Newtown terrace was valued below average at 3X average salaries and is now over 20X. Australia domestically funded it's mortgages but our current account is now over 1X GDP because our relatively high interest rates caused a flood of foreign deposits over the last 40 years with nowhere to go but housing. Immigration has been our strongest economic driver while manufacturing and economic independence industries like steel and refining have been crushed. The stock market hasn't reached its 2008 peak, in either price or earnings, wages are stagnant but property prices are up 50% in 5 years. We are in a property bubble. Our interest rates are now substantially lower than in the US, so RBA interest rate drops will see the currency lower and bank deposit rates higher or lending restricted. We sensibly want to cut immigration because we haven't built the infrastructure for any more new Australians, and, with the demise of our manufacturing economy and plenty of baristas and UBER drivers and fewer service jobs as a result of rationalization of retail, what will they do? The RBA now thinks housing prices are the economy and Government and RBA intervention are too late. As late as the 2008 super bonus that saw billions disasterously funneled into markets at the top. Scomo's victory is producing a bounce, but the challenge for the RBA is to deflate the bubble without popping it.
Patrick-your analysis & comments are always interesting---as is Livewire generally---EXCELLENT!!! Harry
Interesting Wire- and the same goes for the comments. I do wish Livewire would fix the lack of formatting options in the comments box, as I find the primitive formatting usually results in large blocks of text which are difficult to read.