Any 2018 property market hard landing requires a shock from abroad and sharp rise in unemployment: HSBC's Paul Bloxham
After five years of strong house price gains in Sydney and Melbourne, the market is cooling, particularly in Sydney (Chart 14).
In both cities, housing price growth has run at double-digit annual rates over the past five years. However, in the past six months, Sydney house prices have declined 3% and Melbourne price growth has slowed to a 5% annual rate. The rest of the country has had low single-digit house price growth over the whole period.
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The slowdown in Sydney and Melbourne has been driven by a number of factors.
First, housing supply has ramped up, as an apartment building boom has delivered new dwellings to market.
Second, prudential settings have been tightened, which has also included an increase in lending rates for investors.
Third, foreign demand has pulled back, reflecting restrictions on Chinese capital outflows, constraints on lending to foreign buyers by domestic banks and increased local taxes on foreign buyers.
We expect these factors to continue to weigh on housing price growth in the coming quarters and forecast national housing price growth to slow from the near double-digit rates of recent years to 3-6% in 2018 (Table 16).
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We expect housing construction to remain at a high level over the next 6-9 months – given a large pipeline of apartment construction that is already underway – and expect it to be a drag on GDP growth from H2 2018 and in 2019 (Chart 15).
However, we do not expect a sharp decline in housing prices and expect only a modest decline in construction activity, as both are likely to be supported by strong population growth and low interest rates. Although we see the RBA beginning to lift its policy rate in 2018, we expect only a slow pace of cash rate tightening and some relaxation of current tight prudential settings as the housing market cools.
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A hard landing is possible, but we believe this would require a negative shock from abroad and a sharp rise in the unemployment rate. In short, we do not see a significant local housing imbalance and view Australia as having had a housing boom rather than a bubble (for more on this see Downunder Digest: Australian housing: Cooling not crashing, 12 December 2017).
Household debt concerns may be overdone
A key concern that has been flagged by the RBA, amongst other observers, is that household debt levels have risen in recent years (Chart 17).
This concern has a number of dimensions.
First, if new household debt has been misallocated, then falling housing prices or a rising unemployment rate could threaten financial stability.
While this could be a concern, we see the recent household debt as having been reasonably well allocated, given tightened prudential settings. We also expect the unemployment rate to fall, rather than rise in the coming quarters.
Second, slower growth in credit, as the housing boom cools, could crimp consumer spending. However, we see little evidence that the ramp up in household debt in recent years has supported much consumer spending. Unlike the housing price and debt boom of the early 2000s, households have been injecting equity into their houses in recent years, rather than withdrawing it (see Downunder Digest: Australia’s shifting consumer, 27 June 2017).
In addition, although the national household savings rate has fallen, which could be a sign of a wealth effect, it has not fallen in the states that have had housing booms – New South Wales and Victoria (Chart 18). Instead saving rates have fallen in the mining states, which is likely to reflect the end of the mining boom weighing on incomes, rather than a positive wealth effect.
Finally, it is also worth keeping in mind that although household debt has risen, driven by a rise in new borrowing, on average, existing mortgage holders have been paying down their mortgages faster than required and thereby building up a buffer against negative income shocks.
One way to measure this buffer is to look at how much funding households have in their mortgage offset accounts.
As Chart 17 shows, when these account balances are netted out, the climb in household debt has been much shallower.
In our view, the key to the outlook for consumption growth is the forecast for household incomes. Strong jobs growth is already supporting a pick-up in household income growth and our central case suggests the tightening labour market will also see wages growth lift in 2018, further supporting household income growth and consumer spending.
There are already signs that consumer sentiment is lifting (Chart 19).
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We see the RBA lifting its cash rate in 2018
Given the expected pick-up in growth, tightening labour market and expected rise in wages growth this year, we expect the RBA to begin to normalise its cash rate setting in 2018.
The cash rate has been at its record low of 1.50% since August 2016 and the RBA has stated that it estimates Australia’s neutral rate to be around 3.5%, suggesting that monetary policy is currently very stimulatory. As the policy rate setting is well below neutral, we see the RBA as likely to want to start lifting its cash rate as soon as it is confident that wages growth is past its trough.
Keep in mind that wages growth is usually a lagging indicator of the economy.
Our central case is that the RBA will lift its cash rate in Q2 2018 although the risk is that it takes a little longer for the central bank to be convinced that wages growth is past its trough and underlying inflation is headed back to target.