ANZ revise property forecasts and see 10 percent declines in Sydney and Melbourne
EXPERT OBSERVATION
Weakness in Australia’s housing market has persisted longer than we expected. We have revised our forecasts and now expect to see peak-to-trough price declines of around 10% in Sydney and Melbourne, with smaller declines elsewhere.
This doesn’t derail Australia’s economic outlook. The weaker housing market reflects a regulatory induced tightening in the supply of credit rather than tighter monetary policy. We think, as a result, that the impact on the economy will be a less pervasive. There are also offsets to the weaker housing market. For instance, we revised up our outlook for wages in the very near term, and larger-than-expected tax cuts are a positive development.
We think for 2018 GDP growth will stay around the 3% level reached in Q1. We expect similar growth in 2019, before a slowdown in government spending, investment and net exports sees growth drop to around 2.5% in 2020.
Growth in the order of 3% for this year and next is expected to push the unemployment rate down to 5% by the end of 2019. In turn this tighter labour market supports higher wage growth. The lift in wages helps the outlook for inflation, with core inflation lifting to 2.3% y/y by the end of 2020.
Falling unemployment and rising wages would allow the RBA to conclude that sufficient progress is being made toward the mid-point of the inflation target, which may prompt it to reduce monetary accommodation in 2019. Previously, we expected the RBA to tighten in May 2019. Our weaker house price outlook makes this timing challenging. While the RBA does not specifically target house prices, we think it will be reluctant to start tightening policy if house prices are still falling. Hence we have pushed the first hike to August to allow more time for stability to emerge, with another to follow in November and then for the cash rate to sit at 2% in 2020.
Obvious downside risks to our outlook come from: the threats to global trade, the possibility that house prices fall by more than we expect and/or that they have a more negative impact than we assume. An upside risk could be a much lower-than-assumed AUD, as the RBA lags the Fed further.
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HOUSE PRICES EXPECTED TO FALL FURTHER, WITH IMPLICATIONS FOR THE TIMING OF OUR RBA CALL
The housing market is weaker than we expected. Instead of prices stabilising in the first half of 2018 they have continued to decline. As a consequence we now expect to see peak- to-trough price declines of around 10% in Sydney and Melbourne, with smaller declines elsewhere (Figure 2). See our June Housing Chartpack for our revised outlook.
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A weaker housing outlook affects our outlook for household spending. We think there are offsets, like a slightly firmer outlook for wages and more generous tax cuts than we had factored into our last forecast update. Overall our projections for GDP, employment and inflation are broadly similar to the last update despite the weaker track for house prices.
This also reflects the fact that the source of house price weakness is a regulatory induced tightening in the supply of credit rather than one triggered by RBA rate hikes. We think this has a less pervasive impact on the economy than falling house prices brought about by higher interest rates would have. Not least because much of the impact of tighter credit supply is centred on Sydney and Melbourne rather than being country wide.
We do, however, think the housing market’s path will influence the RBA’s policy deliberations. We think that our expectations – a decline in unemployment toward 5%, a gradual acceleration in wages and a lift in core inflation above 2% – support the case for a higher cash rate at some point. But the weaker outlook for housing will also matter, in our view. While the RBA doesn’t focus on house prices specifically, we doubt it will be comfortable tightening if house prices are still falling as that would add to the downside risks for the economy at a time when the inflation outlook doesn’t require an aggressive approach. We think the RBA will want to be confident that the housing market is stable before it raises the cost of debt.
Our updated forecasts show house prices falling until the end of 2018 and then stabilising in the first half of 2019. It is possible that, by May, sufficient evidence of stability will be in place. A rate hike could take place then, as we previously expected.
We now think it more likely, though, that the RBA will wait a little longer before tightening, not only to ensure that the housing market has stabilised but also to ensure that the unemployment rate gets closer to 5%. As such, we have shifted the timing of the first rate hike to August 2019, with a second hike in November. This also gets us well past a possible May election. The lift in the cost of debt triggers a further modest weakening in the housing market. The RBA is then expected to keep the cash rate at 2% through 2020.
SOLID GDP GROWTH STILL EXPECTED OVER THE NEXT TWO YEARS
We have updated our GDP forecasts in the light of several factors, specifically our revised outlook for the housing market and the release of the Q1 GDP data. But also taking account of the policy measures announced in the May Commonwealth Budget, most notably the bigger tax cuts than we expected in our March forecast. The forecast horizon has also been extended out to 2020. We still expect solid growth this year and next, looking for around 3% in each year (Figure 3). We anticipate slower growth of 2.5% in 2020, as growth in public sector spending slows and the contribution from net exports turns negative.
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Our forecasts for the household sector are largely unchanged from our last update, despite weaker house prices. Consumption is likely to grow relatively modestly, given the constraints of low wage growth, high debt and now falling house prices. Slightly higher wages and bigger tax cuts than we expected provide offsets to the weakness in house prices. The outlook for housing investment is also likely to be subdued, with activity likely to eke out one more quarter of expansion, before gradually declining through H2 2018 and 2019 in response to lower approvals and higher interest rates in 2019. In 2020 we expect activity to stabilise, with a stable cash rate and ongoing solid population growth helping to support demand.
The outlook for private investment remains positive, and we continue to expect robust growth over the next few years. Surveys continue to suggest that firms are planning to expand capex and that capacity utilisation rates are high, with businesses reporting that they are bumping up against premises and plant limitations. We have, however, shaved our forecasts a little given heightened global uncertainty, particularly on the trade front, a modest downgrade to investment plans in the Capex Survey and recent weakness in non- residential building approvals. Overall though, the outlook remains good, and we expect business investment to be a key support to GDP growth over the next few years.
Another key support to growth will come from the public sector. The pipeline of infrastructure spending suggests that activity will continue to expand this year and next, although we see 2019 as the peak and expect activity to flatten out in 2020. Public consumption is set to continue to grow strongly with the ongoing roll-out of the National Disability Insurance Scheme (NDIS) supporting spending (Figure 4). Overall, public demand should continue to punch above its weight in terms of its contribution to GDP growth over the next few years.
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LNG is likely to be a key driver of the 0.6ppt contribution from net exports over the year to December 2018. We expect the 2019 contribution to be smaller and net exports to turn negative in 2020. Solid export growth and elevated commodity prices should help to support profit growth.
We continue to expect the unemployment rate to fall to 5.2% by the end of this year and then reach 5% by the end of 2019 (Figure 5). Ongoing solid growth should help to erode spare capacity through 2020, pushing the unemployment rate below the key 5% level.
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Wages growth is likely to remain subdued, although we have actually lifted our near term forecasts a touch. The recent improvement in the Wage Price Index (including bonuses) suggests that an increase in the difficulty of finding suitable labour is pushing businesses to lift pay to attract workers (Figure 6). This should eventually feed through into the headline measure. Moreover, the Fair Work Commission has just announced another larger-than- usual increase in the minimum wage of 3.5%, to start on 1 July. Given ongoing spare capacity in the labour market, however, the improvement in wage growth is expected to be gradual, with y/y growth in the Wage Price Index lifting to 2.4%, 2.6% and 2.9% by end- 2018, 2019 and 2020 respectively.
The slight improvement in wages seen to date has translated to a lift in household income growth. The 1.1% real annual growth is far off the low of -0.2% recorded in Q2 2017, however it remains well below consumption growth of 2.9%. Consequently, the household saving rate continues to fall. It is now only just above 2% – the lowest rate since the financial crisis.
We expect household income to lift in coming years, allowing spending growth to broadly maintain the pace of the past few years without the need for further declines in the saving rate (Figure 7). If we are wrong, and income growth fails to recover, the low level of the saving rate will limit households’ capacity to maintain the recent spending pace.
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While the outlook for household incomes and spending continues to be the key domestic downside risk to our forecasts, increasing global trade tensions have now raised the risks around the external sector. Clearly the evolution of trade discussions and geopolitical issues will have an important influence on Australia’s economy, given its large trade exposure. Any disappointment on this front has the potential to flow through to the business investment outlook, crimping a key driver of the current recovery.
NEAR-TERM INFLATION OUTLOOK A TOUCH HIGHER
We have nudged our near–term inflation forecasts higher, although we continue to expect only a very gradual acceleration in inflationary pressures. We now expect core inflation to hit 2% y/y in Q3 2018 – previously Q4 2018 – which partly reflects base effects from the solid 0.5% q/q result in Q1 2018.
Looking forward, our forecast for core inflation at the end of 2019 is unchanged, at 2.1% y/y, as wage growth accelerates only slowly and retail price deflation continues. Our profile for headline CPI is somewhat higher, largely reflecting our expectation that petrol prices will provide a significant boost over the remainder of this year. We now see headline CPI accelerating to 2.3% y/y by December 2018 (up from a previous forecast of 2.0% y/y). In annual average terms, we expect headline CPI to rise by 2.2% in both 2018 and 2019 (Figure 8, below).
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David Plank is head of Australian economics at ANZ.