Good news or not for the Australian housing market?

 

Matthew Peter, Chief Economist

We begin the New Year with very strong data on two closely related sectors of the Australian economy: the housing market and the consumer. This week’s data showed that dwelling approvals jumped by 11.7% in November, against an expected fall of 1.3%, and retail sales increased a very solid 1.2% (also in November) cf expectations of a rise of just 0.4%.

Of course, monthly data are notoriously volatile and we should be careful in our interpretation of a single monthly outturn. Nonetheless, how the broader sweep of housing market and consumption data unfolds will be key in determining the prospects of the Australian economy.

In this week’s Brief, we concentrate on the housing market, where the November data showed that 21,055 buildings were approved over the month. Of this increase, over half of the approvals were for the development of apartments, potentially adding to the already strong pipeline of supply to this segment of the residential property market.

From the point of view of economic activity, the strong approvals outturn is a positive in that it should lead to additional jobs in the construction industry and, hence, stronger growth for the economy more generally. However, from the point of view of housing-market fundamentals, ongoing additions to supply, particularly of apartments, are likely to exacerbate excess supply conditions.

Currently, Australia’s population is growing at an annual rate of around 1.5%, which translates to around 31K people per month. According to 2016 Census data, there are around 2.6 people per household, so that the underlying demand for houses is currently running at around 12K per month (i.e., 12 = 31/2.6).

The November data of 21K new dwelling approvals is almost double the rate of increase in underlying demand. While the November outcome is elevated, dwelling approvals have been averaging in excess of 18K per month since 2013; more than 6K per month more than underlying increase in demand.

A strong rate of increase in housing construction over the period from 2013 to 2015/16 was required to reduce a shortage of dwellings that was built up during the mining boom and the very strong population growth that preceded the GFC. However, signs are now emerging that not only has the excess demand gap been closed, but conditions of excess supply are emerging in the apartment segment in the capital cities of Australia’s eastern seaboard.

With the housing market cooling, strong additions to supply risk driving an even larger supply/demand imbalance than currently exists. However, QIC’s view is that the Australian housing market will avoid a hard landing. Even though the pace of dwelling approvals has been elevated for some time now, the trend is clearly in decline, with annual approvals falling steadily; from 240K in 2015 to 230K in 2016 to an estimated 220K in 2017, notwithstanding the surge in November.

We expect this trend decline in dwelling approvals to continue in the face of falling house prices and ongoing restrictions on bank lending by APRA. We anticipate a slowing in approvals to 190,000 in 2018 and 180,000 in 2019.

However, the decline in construction that such a fall in approvals implies will not be sufficient to return the market to equilibrium and our view is that house prices will need to fall by around 5% to realign demand and supply. We would characterise such a correction in the housing market as a soft-landing and to not be a cause of the Australian economy failing to establish trend growth over 2018.

A hard-landing in the housing market should be avoided for two main reasons. First, recovering population growth is providing support to underlying demand for housing. Second, the rebound in employment growth, lower unemployment rate and ongoing low interest rates should support households’ ability to service their mortgage, limiting the number of defaults.

While a recovery in business investment, a pick-up in the global economy and increased public infrastructure spending should ensure an ongoing gradual economic recovery in Australia, the slowdown in the housing market, which will also constrain consumer spending, means that the Reserve Bank of Australia must maintain the cash rate at its current historically low level of 1.5% until late into the September quarter.

 

Table 1: Financial market movements, 4 - 11 January 2018

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,767.6

1.6%

US

2.54%

8.4 bps

US Dollar Index (DXY)

91.85

0.0%

Nikkei 225

23,710.4

0.9%

Japan

0.07%

1.5 bps

USD-JPY

111.26

-1.3%

FTSE 100

7,762.9

0.9%

UK

1.31%

7.5 bps

GBP-USD

1.354

-0.1%

DAX

13,202.9

0.3%

Germany

0.58%

14.7 bps

EUR-USD

1.203

-0.3%

S&P/ASX 200

6,067.6

-0.2%

Australia

2.74%

5.7 bps

AUD-USD

0.789

0.4%

Source: Bloomberg

 

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