24 October 2018

Housing prices ain’t everything

Cooling property prices might be a hot topic at barbeques but they do not override Australia’s overall economic performance, argues HSBC Australia’s Chief Economist, Paul Bloxham.

Don’t confuse BBQ chatter with economic logic

For Australians, talking about the housing market is somewhat akin to a national sport. The various twists and turns in housing prices get significant attention in the local media, the pub and at weekend barbecues across the country.

Of course, much of this is justified. For most Australian's, their house is their single biggest purchase and largest asset.‎ Like other 'sports', there are also winners and losers in the housing market, which gives any discussion extra entertainment value. However, Australia's national housing obsession also creates challenges, particularly as it can give the impression that the housing market is the whole economy, which it is not.

This problem is particularly acute at the moment because, despite a cooling housing market, the broader economy is performing well.

On two of the broadest metrics, the economy appears to be in its best shape in six years. The latest GDP numbers show growth running at a six-year high of 3.4% in the second quarter, while the unemployment rate is at a six-year low of 5.0%. The jobs outlook also looks bright, with job vacancies at a record high. At the same time, national housing prices have fallen by 4% over the past year.

As we have pointed out on these pages, much of the local upswing can be explained by the positive momentum in global growth, which has underpinned rising commodity prices and positive business conditions.

The lift in commodity prices is boosting national incomes and, amongst other effects, is filtering through to an improved budget position. The budget deficit is the narrowest it has been in a decade‎. The better budget position has seen the rating's agency, S&P, recently remove Australia from 'negative watch' for its triple-A sovereign rating, a rating it also holds with the other agencies.

A focus on the housing market distracts observers from these other stories.

Admittedly, part of the focus on housing from some observers stems from their concerns that although the cooling housing market has not yet weighed on growth, it may start to do so soon.

One argument is that falling housing prices could have a negative wealth effect on consumer spending. ‎However, there is scant evidence of this happening yet, even though housing prices have fallen for over a year in Sydney and are now down 6%, and have also fallen in Melbourne.‎

In fact, a key driver of the strong GDP growth over the past year was above average growth in household consumption, which rose by 3.0% in the second quarter. The recent retail figures have also shown steady and solid growth and consumer sentiment was still above its average in October, despite the cooling housing market.

Another concern is that rising loan mortgage servicing costs could weigh on consumers. One issue here is the effect of the recent lift in standard variable mortgage rates by the banks in response to higher funding costs, which was partly driven by rising US rates. Another issue is mortgage resets that are occurring as interest-only loans shift to principal-and-interest loans.

However, neither of these effects has been large thus far.

The increase in mortgage rates has only been small. While a number of local banks have lifted their standard variable mortgage rates by 10-15bps, this has been partly offset by increased discounting, meaning that effective mortgage rates have risen by less.

On the principal and interest loan shift, the stock of interest-only loans has already fallen from around 40% to 30% of mortgages over the past year, and this has not noticeably weighed on consumer spending or seen a large rise in loan arrears. More resets are yet to come, but the macroeconomic effect has been insignificant thus far.

Indeed, another testament to the excessive local focus on housing is that much of the recent discussion about the effect of higher US rates has been about the implications for local mortgage rates, while the bigger effect is likely to be that the higher US rates are pushing the Australian dollar lower, which supports local growth.

This is a particularly positive story at the moment because the fall in the local currency is happening while commodity prices are rising, which boosts the local currency value of exports and lifts national incomes.

Standard models suggest that the 5% fall in the Australian dollar trade-weighted index ‎this year to date is likely to be equivalent to the effect on growth of a 25bp cut in the RBA's cash rate, outweighing the impact of the recent increase in standard variable mortgage rates.

In short, although the housing market is important and will probably still dominate your weekend barbecue conversations, keep in mind that housing is not the whole economy. The macro-economy developments in the jobs market, the recent rise in commodity prices and the lower Australian dollar are at least as if not more important for the macroeconomic outlook.