- New research from UBS suggests movements in Australian home prices tend to lead changes in employment and household spending, with the lag time usually six months or more.
- Given home prices are continuing to fall in many parts of the country, UBS expects this will soon lead to a slowdown in household spending.
- Household consumption accounts for about 55% of the entire Australian economy.
Australia’s economy grew at an annualised pace of more than 4% in the first half of 2018, helped in part by firm spending by households, the largest part of the economy.
Policymakers at the Reserve Bank of Australia (RBA) believe those trends will continue in the coming years, forecasting that household consumption will continue to grow at around 3% per annum on the back of firmer conditions in the jobs market, helping to keep the broader economy expanding at over 3% this year and next.
However, like many forecasters, the RBA is not sure whether that will eventuate given uncertainty over what impact, if any, falling home prices in many parts of the country will have on consumer behaviour.
Some believe the housing downturn in the housing market won’t have much impact on consumer spending at all, pointing out that consumption is likely to be supported by faster wage growth and more Australians finding work, helping to boost household income levels should current trends continue.
Others, however, think weaker property prices will have a significant impact on the broader economy, potentially weighing on employment growth, residential construction and, as a consequence, household spending and the broader Australian economy.
Safe to say, the UBS Australian economics team sits in the latter camp, suggesting falling home prices will likely weigh on household spending if history is any guide.
“Ongoing credit tightening will see house prices fall 10% or more if regulators or the RBA don’t ease,” says George Tharenou, Carlos Cacho and Jim Xu, economist at UBS.
“Hence, we expect consumption to moderate from the strong 3% plus annualised pace in recent quarters to 2.3% in 2019.
“House prices and consumption are clearly correlated, with a typical lag of six months plus to consumption and jobs.”
So while home prices have now been falling for well over a year, according to data released by CoreLogic, UBS believes it will take time for the impact of a reduced wealth effect on household balance sheets to show up in lagging economic indicators such as employment and household spending.
Like separate research released by the bank showing changes in home prices tend to lead annual employment growth, the chart below suggests movements in national property prices are also influential on annual household consumption growth.
Given that housing is the largest store of wealth for many Australian families, and with construction the third-largest employer in Australia behind healthcare and retail, it’s not all that surprising that changes in home prices are influential on employment and household incomes, hence the ability for households to spend.
That’s not just seen from a national perspective, but also at an individual state level too.
Here’s a chart from UBS showing the relationship between real, inflation adjusted annual growth in household consumption in New South Wales and movements in home prices in the state.
The story is similar in Victoria, as seen in the next chart below.
These are the states where property prices have fallen the fastest this year, something Tharenou, Cacho and Xu say will likely act to slow household spending in the period ahead, a significant headwind to the broader economy given just under 60% of all Australians live in these two states.
“During the house price boom years since 2013/14 — which were clearly concentrated in Sydney and Melbourne — real consumption growth was much stronger in New South Wales and Victoria which both were well above the rest of Australia at only 2%,” they say.
“Given that house prices historically lead consumption growth by 6+ months, this suggests that the relatively recent slump of house prices, particularly in Sydney and Melbourne, are likely slow overall consumption growth ahead.”
Australian household consumption accounts for around 55% of the entire Australian economy. If spending were to slow in New South Wales and Victoria as UBS suggests, it would take a monumental spending boost from Australia’s remaining states and territories to keep household spending humming along at 3% per annum as the RBA expects.
Whether that’s realistic is highly debatable, particularly given the headwinds it will create for the broader economy.
Adding to downside risks for spending, UBS says there’s also evidence that booming home prices in prior years encouraged wealthy households to boost their spending levels on aggregate, fueled by declining levels of household savings during a period of soft household incomes growth.
“The relationship between the saving ratio and wealth-to-income is very tight for high wealth households in the top 40%,” UBS says, pointing to the chart below.
“We estimate a 10% fall in home prices, which causes a 10% plus fall in wealth, would be consistent with the saving ratio of high wealth households spiking by around 5 percentage points.
“This could cut 2 percentage points off total nominal consumption… [and] is broadly in-line with our outlook for real growth in annual consumption to slow from 3% plus now to 2.3% in 2019 and 2.1% in 2020.”
Like UBS, economists at Capital Economics believe the impact of falling home prices will lead to a slowdown in household consumption in the years ahead, seeing the Australian economy slow from the levels seen earlier this year.
“We don’t think the wealth effect is dead or that households will be able to shrug it off,” said Marcel Thieliant and Ben Udy, Economists at Capital Economics.
“Given that housing accounts for around 50% of household assets, a 12% drop in national home prices would reduce household net wealth by around 6%. A 6% fall in net wealth is consistent with household consumption growth slowing by around 1.5 percentage points.”
Hinting that downside risks for household spending may be growing, retail sales growth slowed sharply in the September quarter, increasing by just 0.2% in real, inflation adjusted-terms, well below the 1% pace seen in the three months to June.
The slowdown mirrored a noticeable decline in private new motor vehicle sales over the same period, and came despite continued strength in employment growth over the same period, seeing Australia’s unemployment rate fall to a six-year low of 5%.
Given that mix, there’s likely to be plenty of interest on broader household spending growth when Australia’s Q3 GDP report is released in early December.
As yet, we don’t know whether the weakening in retail sales and new car sales was mirrored by a similar deceleration in spending on services, a substantially larger part of household spending at just over 70%.
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