Price growth to stay positive with Australian housing prices in 2018: ANZ

Price growth to stay positive with Australian housing prices in 2018: ANZ
Price growth to stay positive with Australian housing prices in 2018: ANZ

Currently, auction clearance rates, which have a history of accurately leading dwelling prices, suggest that the downturn in house price inflation may ease In coming months.

Auction clearance rates and the credit impulse, while providing leading information about house prices, are only useful over a matter of months. To accurately forecast housing prices over a longer-term, we need a different approach.

We have built a model of Australian housing prices to inform our view of the market.

The model’s forecasts are consistent with our expectation that national housing price growth will continue to slow in 2018 (Figure 1), though only moderately and without falling into negative territory.

According to the model, housing price growth will trough at around 1% y/y in the second quarter of 2018, growing around 2% y/y for the year as a whole. However, this slowdown is unlikely to persist as the model forecasts that growth will accelerate to around 4% y/y in 2019. 

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Price growth to stay positive with Australian housing prices in 2018: ANZ

The second half of 2017 saw an easing in housing price growth, compared to the first half of the year in which Sydney and Melbourne had pushed national growth rates into double digits. Tighter macroprudential regulations were the primary cause of that slowdown, further dampened by soft wage growth.

With the intense scrutiny that movements in Australian house prices receive, we decided to spend the summer building a new model to inform our forecasts1. This provides an additional method of producing projections.

In 2018, we expect continued deceleration in price growth. Our model is forecasting national dwelling prices to grow 1.9% in 2018, compared to 4.2% for 2017, but then to accelerate to 4.1% in 2019. Significantly, we do not foresee a nationwide decline in dwelling prices in the next two years, although individual cities may see annual falls. 

There are a couple of leading indicators that provide information about likely changes in house prices. The auction clearance rate is a simple and historically accurate tool for forecasting movements in housing prices in the near term (Figure 2). Interestingly, it has stabilised in recent months (once you seasonally adjust the data), suggesting the worst of the recent slowdown may be over. 

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Price growth to stay positive with Australian housing prices in 2018: ANZ

Another tool we have had some success with is the housing credit impulse. This looks at the change in the growth rate of credit as a signal for the change in house prices (Figure 3). 

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Price growth to stay positive with Australian housing prices in 2018: ANZ

These tools work because they effectively summarise the key demand and supply factors in the housing market. The problem is that they only provide short-term signals about the change in house prices a matter of three to four months in both cases.

To forecast house prices beyond the near term, we need to consider the likely drivers of supply and demand and anticipate their impact on house prices.

 

We chose an error correction model (ECM), the advantage of which is that it is simple and it captures the main dynamics of housing price movements then makes the link between prices and economic conditions explicit.

There are two steps to estimating the model. 

First we determined the fundamental price that which would prevail over the long term, without influence from the economic cycle. Population growth emerged as the best predictor there. To measure supply, we looked at other variables but found them to be practically and statistically insignificant.

Next, we used an equation with three elements to predict shorter-term changes in dwelling prices. These were:

  1. The error correction term the difference between actual dwelling prices and the fundamental value estimated in the first step because prices tend to revert to their fundamental value over time.

  2. The lagged growth rate of dwelling prices to account for the momentum that typifies housing price movements.

  3. Changes in dwelling investment, gross total incomes and the average mortgage rate to capture the effect of economic conditions, ie demand and supply.

Together, these variables are sufficient to capture the main economic drivers of dwelling prices, without over-complicating the model.

We tested the model’s accuracy by producing two-year forecasts on a rolling basis from 1995 to 2017 and comparing them to actual prices (Figure 4). 

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Price growth to stay positive with Australian housing prices in 2018: ANZ

Our model outperformed benchmarks, such as an AR(1) model and the four quarter moving average of prices.

IN THE MEDIUM TERM, PRICES WILL KEEP RISING JUST

Using our forecasts for the relevant input variables over the next two years, the model predicts that housing price growth will continue to slow in the near term, bottoming out at 0.8% y/y in the second quarter of 2018 and gradually picking up thereafter.

We found changes in the lending rate to be the largest drag on prices in 2018, particularly in the second half of the year. Underlying this is our expectation that the RBA will hike its policy rate twice in 2018, pushing up mortgage rates.

GDP growth will, we expect, accelerate to around 3%, and the unemployment rate will edge lower, which would prompt the RBA to take the real cash rate out of negative territory. However, this forecast assumes an uptick in wage growth, so the Q4 wage price index data (out 21 February) will be critical for our view. 

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Price growth to stay positive with Australian housing prices in 2018: ANZ

Construction activity will be a drag on prices in the first half of 2018 according to the model. This reflects the lagged effect that 2017’s elevated levels of construction activity are likely to have on prices. Roughly 200,000 dwellings are now under construction, which is enough oncoming supply to dampen price growth.

Income growth will, we anticipate, have a small positive impact on prices in 2018. As with our interest rate forecast, our confidence in this and in the trajectory of income growth will firm up following the next WPI print.

BEYOND THE MEDIUM TERM

Looking further ahead, the model predicts that housing price growth will improve in 2019. For 2019, the forecast is for prices to grow 4.1% y/y. We are not expecting any moves from the RBA in 2019, so the drag on price growth from 2018’s hikes is likely to be short lived. Also, we expect a mild slowdown in dwelling investment in 2018, which will be positive for prices in 2019. 

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Price growth to stay positive with Australian housing prices in 2018: ANZ

Overall, the model supports our view that while nation-wide growth in housing prices will slow in 2018, prices will not fall.

The main risk to this forecast is from interest rate movements.

If wage growth disappoints again, it is unlikely the RBA will have enough confidence in the economy to hike rates. In which case, we would expect dwelling prices to rise by more than the model predicts, because of the reduced interest rate drag. 

 

 

 

 

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Anz Property Forecast

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