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Author: Provision Wealth

Australia’s Achilles’ heel – high household debt and rising interest rates

Date: Jun 28th, 2022

…it’s not as bad as it looks, but it’s still an issue

Dr Shane Oliver Head of Investment Strategy and Chief Economist, AMP Capital

Introduction

If Australia has an Achilles’ heel it’s the high level of household debt that has accompanied surging home prices over the last 30 years. Of course, in the absence of a major trigger for debt servicing problems – either from a surge in unemployment or a surge in interest rates – it hasn’t so far caused a major problem for the economy. Fears that the pandemic would deliver a trigger in the form of higher unemployment were quickly headed off by JobKeeper and record low interest rates. But a potential trigger is now upon us again with rising interest rates.



At one extreme some see rising interest rates and high household debt as setting the scene for a perfect storm of a surge in mortgage stress, forced selling and a crash in property prices causing a big hit to the economy. At the other extreme some point out that the household sector is actually in good shape given a surge in wealth including a big rise in bank deposits so there is no need for concern. The truth is probably in between these two extremes. And much depends on how high interest rates go. This note looks at the main issues.

Australia – from the bottom to the top in debt

The next chart shows the level of household debt relative to annual household disposable income for major countries.

Household debt to income ratios

Source: OECD, ABS, RBA, AMP

While rising household debt has been a global phenomenon, debt levels in Australia have gone from the bottom of the pack to near the top. In 1990, there was on average $69 of household debt for every $100 of average household income after tax. Today, its $187 of debt for every $100 of after-tax income.

What’s driven the rise in debt?

The increase in debt reflects four things. First, increased competition amongst lenders following financial deregulation in the 1980s which made debt more available. Second, progressively lower interest rates since the late 1980s have made debt seem more affordable. Third, attitudes to debt have become more relaxed as memories of wars and severe economic downturns have faded so debt seems less risky at the same time that modern society encourages instant gratification as opposed to saving for what you want. So, each successive generation since the Baby Boomers have been progressively more relaxed about taking on debt. And finally, it’s become somewhat self-feeding in that rising debt has enabled home buyers to pay more for homes which in turn has necessitated rising debt levels to get into the property market.

The rise in household debt has gone hand in hand with higher home prices relative to incomes in Australia

Source: ABS, CoreLogic, AMP

It’s not quite as bad as it looks

There are several reasons why it’s not quite as bad as it looks:

  • First, the rise in debt partly reflected a rational adjustment to lower rates and greater credit availability since the 1980s.

  • Second, household debt has been trending up since credit was invented. It is unclear what a “safe” level is.

  • The rise in debt has been exceeded by a rise in wealth. Thanks to a surge in the value of houses and financial wealth, we are far richer. In particular, thanks to low rates & recovery from the pandemic total household wealth rose 32% over the two years to the March quarter with the value of dwellings up 40%, super up 30% and bank deposits up 26% (as income and government payments were saved during the pandemic). The value of average household wealth has gone from 5 times average after-tax household income in 1990 to 11.4 times in the March quarter.

Aust household wealth and debt relative to income

Source: ABS, RBA, AMP

So, while average household debt for each Australian has risen from $11,779 in 1990 to $107,318 now, average wealth per person has surged from $87,489 to $655,894.

Australian per capita household wealth and debt

Source: ABS, RBA, AMP

As a result, Australians’ household balance sheets, as measured by net wealth (assets less debt), are healthy. Net wealth relative to income has surged over the last 30 years and is high relative to comparable countries.

Aust household balance sheet in reasonable shape

Source: OECD, ABS, RBA, AMP

  • Fourthly, Australians are not having big problems servicing their loans with low non-performing loans. This may reflect record low mortgage rates until recently.

Household interest payments relative to disposable income

Source: RBA, AMP

  • Fifthly, the dollar value of debt is concentrated in higher income households who have a higher capacity to service it, particularly in relation to investment property loans.

  • Finally, lending standards did not deteriorate to the same degree in Australia as they did in the US prior to the GFC and were tightened from mid last decade with banks having to assess each new borrower’s ability to pay mortgage rates 2.5 percentage points above the borrowing rate up to October last year and 3 percentage points above since then.

But high debt has likely still increased the vulnerability of the household sector

While this analysis indicates that the rise in household debt in Australia is not as bad as it appears, its rise still leaves many households more vulnerable to rising interest rates (& higher unemployment) than in the past. After all, “it’s not what you own that might send you bust but what you owe.”

  • While the rise in wealth is good news it does not mean that there is no reason for concern. Debt has to be serviced out of income as opposed to out of wealth (as a colleague pointed out it’s not possible for a homeowner to sell off a bedroom to make higher interest payments). What’s more the surge in wealth, particularly for dwellings, flowed partly from low interest rates and is now coming under pressure as rates rise. We expect home prices to fall 10-15% which risks driving negative equity for recent low deposit home buyers.

  • The rise in debt means that moves in interest rates are now nearly three times as potent compared to 30 years ago. Just a rise in the cash rate to 2.5% will see a near doubling in debt interest payments as a share of household income (see last chart) and take them to where they were in 2013 (after which economic growth was relatively sluggish in Australia). A rise in the cash rate to around 4% (which is the money market’s expectation for next year) will push interest payments from around 5.2% of income to around 12%.

  • Coming at a time of falling real incomes due to cost-of-living pressures this implies a significant hit to household spending power.

  • While many households have built up cash buffers and are ahead on their mortgage payments and the household saving rate remains high, RBA analysis also indicates there is a significant group who would see a sharp rise in their mortgage payments if mortgage rates rose by 2% and most economists and the market expect more than this.

  • This group is likely to include those who bought into the property market more recently who have had less time to get ahead on their mortgages. While the dollar value of debt is concentrated amongst higher income households, its high amongst 30-40 year olds – ie, recent buyers with young families – and it’s this group who are most likely to be the marginal consumers who will likely have to cut their spending in response to rising interest rates and costs.

  • Rising unemployment should the economy fall into recession would add to debt servicing problems.

  • Poor consumer confidence and accelerating home price declines in Sydney and Melbourne (and other cities seeing a rapid slowing) far earlier in this rate hiking cycle than normal warn of the household sector’s increased vulnerability.

Concluding comment

This all sounds rather gloomy. The key though is that the RBA only needs to raise interest rates far enough to cool demand to take pressure off inflation and keep inflation expectations down. While the household sector in aggregate is stronger than a focus on household debt alone would suggest, the rise in household debt has made monetary policy more potent than it was in the past which in turn will limit how much the RBA will need to raise interest rates by. While the RBA is hiking more aggressively now to reinforce its commitment to the 2-3% inflation target, the greater sensitivity of the household sector to rising interest rates is likely to become evident fairly quickly which will mean the RBA won’t have to raise interest rates as far as the 4% or so cash rate that the money market is assuming. We continue to see the cash rate topping out at around 2.5% in the first half next year.

Source: AMP Capital June 2022

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

The plunge in shares & flow on to super

Date: Jun 20th, 2022

– key things for investors to keep in mind during times of market turmoil

Dr Shane Oliver Head of Investment Strategy and Chief Economist, AMP Capital

Introduction

Usually share markets are relatively calm and so don’t generate a lot of attention. But periodically they tumble and generate headlines like “billions wiped off share market” & “biggest share plunge since…” Sometimes it ends quickly and the market heads back up again and is forgotten about. But once every so often share markets keep falling for a while. Sometimes the falls are foreseeable (usually after a run of strong gains), but rarely are they forecastable (which requires a call as to timing and magnitude)…despite many claiming otherwise. In my career, I have seen many periodic share market tumbles.

And so it is again – with share markets starting the year on a sour note and despite a few bounces along the way having several legs down with another sharp fall over the last two weeks. From their all-time highs to their lows in the past week US shares have now fallen 24%, global shares have fallen 21% and Australian shares have fallen 16%. Always the drivers are slightly different. But as Mark Twain is said to have said “history doesn’t repeat but it rhymes”, and so it is with share market falls. This means that from the point of basic investment principles, it’s hard to say anything new. Which is why this note may sound familiar with “key things for investors to keep in mind”, but at times like this they are worth reiterating.

What’s driving the plunge in share markets

The key drivers of the fall in shares remain:

  • Shares had very strong gains from their March 2020 lows and speculative froth had become evident in tech stocks, meme stocks and crypto, and this left them vulnerable.

  • High and still rising inflation flowing from pandemic distortions made worse by the war in Ukraine and Chinese lockdowns. US inflation rose further in May to 8.6%, its over 8% in Europe and looks to be on its way to 7% or so in Australia (not helped by our own electricity crisis & floods).

  • The ongoing upside surprises on inflation have seen central banks become more aggressively focussed on pulling it back down and so stepping up the pace of rate hikes with: the US hiking by 0.75% last week; Canada, NZ & the UK all continuing to raise interest rates; the ECB moving towards rate hikes from July; and the RBA hiking rates by 0.5%.

  • The increasing aggressiveness of central banks in the face of higher inflation is in turn raising the risk of triggering a recession, which could depress company profits.

  • Rising bond yields in response to rising inflation and central bank tightening is adding to the pressure on share markets by making them look relatively less attractive which is driving lower price to earnings multiples.

  • The ongoing war in Ukraine along with tensions with China are adding to the risks.

  • As always, the most speculative “assets” are getting hit the hardest including the pandemic winners of tech stocks (with Nasdaq having fallen 34%) and crypto currencies (with Bitcoin down 70% from its high last year). Crypto currencies surged with semi religious fervour around the claimed marvels of blockchain, decentralised finance, NFTs, freedom from government, an inflation hedge, etc, only to become a speculative bandwagon fuelled by easy money and low interest rates. Trying to disentangle its true fundamental value from the speculative mania became next to impossible. And now the easy money and low rates are reversing, pulling the rug out from under the mania and driving mishaps along the way (eg, Terra, Celsius Network and Babel Finance). Fortunately, the exposure of major banks and mainstream investors to crypto is still relatively low so this is unlikely to be another GFC moment.

Reflecting the sharp falls in share markets and in fixed interest investments (which suffer a capital loss as bond yields rise) balanced growth superannuation funds are down by 5% or so for this financial year to date and are on track for their first financial year loss since 2019-20 (due to the pandemic) & their worst financial year loss since the GFC. See the next chart.

Balanced/growth superannuation fund returns

Source: Morningstar, AMP

Key things for investors to bear in mind

Sharp market falls are stressful for investors as no one likes to see their investments (including their super) fall in value. But there are some key things investors should keep in mind:

First, while they unfold differently, periodic share market corrections and occasional bear markets (which are usually defined as falls greater than 20%) are a normal part of investing in shares. For example, the last decade regularly saw major pullbacks. See the next chart.

Share market pullbacks are normal

Source: Bloomberg, AMP

And, as can be seen in the next chart rolling 12 month returns from shares have regularly gone through negative periods.

Australian share returns over over rolling 12 mth & 20 yr periods

Source: ASX, Bloomberg, AMP

But while the falls can be painful, they are healthy as they help limit excessive risk taking. Related to this, shares climb a wall of worry over many years with numerous events dragging them down periodically (next chart), but with the long-term trend ultimately up & providing higher returns than other more stable assets. As can be seen in the previous chart, the rolling 20-year return from Australian shares has been relatively stable and solid. Which is why super funds have a relatively high exposure to shares along with other growth assets. Bouts of volatility are the price we pay for the higher longer-term returns from shares. As can be seen in the first chart in this note while this financial year has been rough for super funds longer term returns have been solid & so recent weakness has to be seen in perspective.

Australian shares have climbed a wall of worry

Source: ASX, AMP

Second, historically, the main driver of whether we see a correction (a fall of say 5% to 15%) or even a mild bear market (with say a 20% or so decline that turns around relatively quickly like we saw in 2015-2016 in Australia – which may be called a “gummy bear market”) as opposed to a major (“grizzly”) bear market (like that seen in the mid-1970s or the global financial crisis when shares fell by around 55%) is whether we see a recession or not – notably in the US, as the US share market tends to lead most major global markets. We remain of the view that a global recession can be avoided – if inflation starts to slow later this year or early next (as supply improves) taking pressure off central banks and in Australia as growth initially cools faster than expected (as the plunge in consumer confidence suggest that it will) putting a cap on how much the RBA needs to hike interest rates allowing it to avoid triggering a recession. But with inflation still surprising on the upside and central banks hiking rates aggressively the risks have increased to the point that its now a very close call. Either way it’s still too early to say that shares have bottomed.

Of course, short-term forecasting is fraught with difficulty and should not be the basis for a long-term investment strategy, so it’s better to stick to long term investment principles.

Third, selling shares or switching to a more conservative superannuation investment strategy whenever shares fall sharply just turns a paper loss into a real loss with no hope of recovering. Even if you get out and miss a further fall, the risk is that you won’t feel confident to get back in until long after the market has fully recovered. The best way to guard against deciding to sell on the basis of emotion after falls in markets is to adopt a well thought out, long-term strategy and stick to it.

Fourth, when shares fall, they’re cheaper and offer higher long-term return prospects. So, the key is to look for opportunities’ pullbacks provide. It’s impossible to time the bottom but one way to do it is to “average in” over time. Fortunately, the Australian superannuation system does just that by regularly putting money into shares for workers (via their super) effectively taking advantage of the fact they are cheaper.

Fifth, while share prices have fallen dividends have not and so the dividend yield has increased. Australian shares are offering a very attractive dividend yield compared to bank deposits despite rising deposit rates. Companies don’t like to cut their dividends, so the income flow you are receiving from a well-diversified portfolio of shares is likely to remain attractive.

Aust shares still offer an attractive yield versus bank deposits

Source: RBA, Bloomberg, AMP

Sixth, shares and other related assets often bottom at the point of maximum bearishness, ie, just when you and everyone else feel most negative towards them. So, the trick is to buck the crowd. “Be fearful when others are greedy. Be greedy when others are fearful,” as Warren Buffett has said.

Finally, turn down the noise. At times of uncertainty like now, the flow of negative news reaches fever pitch. Talk of billions wiped off share markets and of “crashes” help sell copy and generate clicks. But less newsy are the billions that market rebounds and the rising long-term trend in share prices add to the share market. Moreover, they provide no perspective and only add to the sense of panic. All of this makes it harder to stick to an appropriate long-term strategy – which is particularly important when it comes to super as it has to be seen as a long term investment, except for many of those near to retirement. So best to turn down the noise and watch the new Elvis biopic!

Source: AMP Capital June 2022

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

The RBA hikes rates again with more to go

Date: Jun 08th, 2022

– but falling confidence and home prices will limit RBA tightening

Dr Shane Oliver Head of Investment Strategy and Chief Economist, AMP Capital

Key points

  • The RBA has hiked the cash rate again – by 0.5% taking it to 0.85% and continues to signal more rate hikes ahead.

  • We expect the cash rate to rise to 1.5-2% by year-end and to peak at 2-2.5% by mid next year.

  • Greater sensitivity to higher interest rates will cap how much the RBA ultimately needs to hike by well below market expectations for a cash rate of 4% or more.

  • Falling home prices and very weak consumer confidence indicate RBA monetary tightening is already getting traction earlier than in past rate hiking cycles.

Introduction

The RBA has increased its official cash rate by another 0.5% taking it to 0.85% for the second rate hike in this cycle. This was above market expectations. Our expectation was for a 0.4% hike with the risk that it would be 0.5%.

In justifying the move the RBA noted that: the economy is resilient; the labour market is strong with the unemployment rate falling to just 3.9%; the Bank’s business liaison continues to point to higher wages growth; and inflation is expected to increase even more than it expected a month ago with notably higher prices for electricity, gas and petrol.

The RBA’s move is consistent with the stepped up pace of tightening from central banks in New Zealand and Canada and likely soon in the US as they all try to get ahead of the surge in inflation and to contain inflation expectations. This and the low starting point explains why the 0.5% rate hike is the biggest in 22 years.

The RBA’s commentary remained hawkish reiterating that it will “do what is necessary” to return inflation to target and that this will likely require “further steps in the process of normalising monetary conditions” which in short means that more interest rate hikes are likely on the way.

Australian interest rates on the rise

Source: RBA, Bloomberg, AMP

Banks are likely to pass the RBA’s rate hike on in full to their variable rate customers and deposit rates will rise further. Fixed mortgage rates have already moved up in line with rising bond yields in anticipation of higher cash rates – more than doubling from record lows around 2% early last year.

While the rate hike adds to the cost of living the RBA has little choice but to “normalise” interest rates

Supply constraints – reflecting the impact of the pandemic, the war in Ukraine and the floods – are the main factor behind the rise in inflation and RBA rate hikes won’t boost supply. But the RBA has little choice but to continue the process of tightening monetary policy.

  • First, strong Australian demand is also a factor with for example retail sales still running around 15% above their long-term trend. As is the very tight labour market.

Australian retail sales

Source: ABS, AMP

  • Second, having a still near zero cash rate when unemployment is 3.85% and inflation is 5% and still rising makes no sense. So the RBA is right to be “normalising monetary conditions”.

  •  Third, inflation pressures are still building with surging electricity and gas prices, petrol back above $2 a litre, rents starting to rise rapidly and supermarkets warning of more price rises and increasing wage demands. Its looking likely that inflation will now rise to 7% or so in the second half (compared to RBA expectations for a peak around 6%).

  • Fourth, the experience from the 1960s and 1970s tells us the longer high inflation persists the more inflation expectations will rise and get built into price and wage setting making it even harder to get inflation back down again without a recession. By raising rates the RBA is signalling its commitment to get inflation back down to the 2-3% target. Not doing so would call that commitment into question which would see inflation expectations rise.

  • Finally, the global backdrop now of bigger government, a long period of ultra-easy monetary policy and big budget deficits, the reversal in globalisation and the demographic decline in the proportion of workers relative to consumers, all point to a transition from the falling and low inflation world of the last 30-40 years to structurally higher inflation. This means that central banks like the RBA have to be more hawkish than has been the case for some time.

Money market expectations for a cash rate of 4% plus are too hawkish.

All of the above considerations point to more rate hikes ahead. But trying to get a handle on where they peak is always a bit of a guessing game. A build up in excess household saving of around $250bn through the pandemic – which is evident in a 25% rise in bank deposits since late 2019 and many households being well ahead on their mortgage payments – imparts a degree of resilience for households which some have argued means that the RBA may have to be a lot more aggressive taking the cash rate to 3.5% or more. This along with the hawkish nature of the RBA’s post meeting statement this month appears to underpin futures market expectations for the cash rate to rise above 3% by year end and then 4.5% by mid next year and to then stay above 4% for the subsequent two years.

However, its likely that the cash rate won’t have to go that high before the RBA achieves its aim of cooling demand enough to take pressure off inflation and keep inflation expectations down.

  • First, while the household debt situation is not as perilous as some would have it – with household wealth up more than household debt and many households well ahead on their payments – many will experience a significant amount of pain from higher rates. For example, RBA analysis indicates that about 25% of variable rate borrowers would see a 30% or more rise in mortgage payments from a 2% rise in rates. A new borrower in NSW where average new loans are around $800,000 would see monthly payments jump by more than $1000 if the cash rate rose to 2.5% compared to what they were paying back in March. This is a huge hit to the household budget.

  •  Second, the RBA just wants to slow things down to take pressure off inflation and give time for supply to catch up. It does not want to crash the economy and is not on autopilot. So it will be watching indicators of spending and things like house prices very closely.

  •  Third, it looks like the RBA is already getting traction. Consumer confidence has fallen sharply and is well below where it’s been at the start of past RBA rate hiking cycles. See the next chart.

Consumer confidence

Source: Westpac/MI, AMP

National average home prices have already started to fall, whereas at the start of previous RBA rate hiking cycles they were rising solidly and did not start falling until sometime after the start of rate hikes. See the next chart

Capital city home prices

Source: Core Logic, AMP

The earlier than normal hit to confidence and home prices likely reflects a combination of things: a greater sensitivity to interest rate movements now reflecting higher levels of household debt (and high levels of debt required to get into the property market for new borrowers); the fact that the tightening cycle started before the rise in the cash rate this time around with the removal of the 0.1% bond yield target last year which helped drive a sharp rise in fixed mortgage rates and pulled the rug out from under the housing boom before the RBA started to move the cash rate; and cost of living pressures that have seen an unprecedented plunge in real wages and hence spending power in the context of the last 20 years.

Australian wages

Source: ABS, AMP

But regardless of the precise drivers, the bottom line is that RBA monetary tightening appears to be getting traction earlier than would normally occur in an interest rate tightening cycle. While the RBA does not target house prices, falling home prices (where we expect a 10 to 15% top to bottom fall) will weigh on consumer spending (via negative wealth effects as we saw in 2017-18). All of which will start to take pressure off inflation and limit the amount by which the RBA ultimately will need to raise the cash rate by. So we expect that while the RBA will raise the cash rate to 1.5% to 2% by year end, the peak in the cash rate will come at around 2% to 2.5% by mid next year. This is well below money market expectations for a rise above 4%.

Given that the latest RBA hike was roughly in line with our expectations we have made no changes to our cash rate forecasts. We continue to see average home prices falling 10-15% over the next 18 months but this may now occur earlier and faster than previously expected.

Source: AMP Capital June 2022 

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

National property prices fall for the first time since the pandemic

Date: Jun 01st, 2022

– expect a 10-15% top to bottom fall

Dr Shane Oliver Head of Investment Strategy and Chief Economist, AMP Capital

Key points

  • Australian home prices fell 0.1% in May, their first decline since the pandemic.

  • The main drivers behind the downturn are: poor affordability with prices up nearly 29% over 21 months; rising mortgage rates; a rotation in spending away from housing; and a decline in home buyer confidence.

  • We continue to expect a 10-15% fall in home prices.

  • While the RBA is set to continue raising interest rates, the negative wealth effect from falling home prices will limit how much it ends up raising rates by as it does not want to crash house prices and the economy.

First fall in home prices since the pandemic

After a massive 28.6% gain from their pandemic low – which was the biggest gain over 21 months since 2003 – national average home prices fell for the first time in May since September 2020 based on CoreLogic data. While national average dwelling prices fell 0.1%, they were led by falls of 1% in Sydney and 0.7% in Melbourne. Sydney prices have now fallen for four months in a row and Melbourne prices for three months. Momentum in monthly home price growth has been steadily slowing since it peaked at 2.8% in March last year.

Australian dwelling price growth

 

May % change

12 mths to May, % chg

Sydney

-1.0

10.3

Melbourne

-0.7

5.8

Brisbane

0.8

27.8

Adelaide

1.8

26.1

Perth

0.6

5.6

Hobart

0.3

17.3

Darwin

0.5

6.4

Canberra

-0.1

18.7

Capital city average

-0.3

11.7

Cap city houses avg

-0.4

13.4

Cap city units avg

-0.2

6.6

Regional average

0.5

22.1

National average

-0.1

14.1

Source: CoreLogic, AMP

The property cycle turns

Residential property prices boomed last year on the back of record low mortgage rates, government incentives, recovery from the lockdowns of 2020, a lack of supply, coronavirus driving a switch in consumer spending from services (like holidays) to “goods” including housing and FOMO (or a fear of missing out). However, it’s now turned down decisively.

Average capital city home prices

Source: Source: CoreLogic, AMP

Declining auction clearance rates also point to a slowdown – although so far clearances are lagging the falls in prices.

Sydney auction clearance rate and home price growth


 

Source: Source: Domain, CoreLogic, AMP

The seven drivers of the property downturn

The drivers of the downturn are a combination of:

  • deteriorating affordability with the 29% surge in prices since the pandemic comparing to wages growth around 2.3% pa;

  • a more than doubling in fixed mortgage rates from around 2% to around 5%;

  • the start of RBA monetary tightening which is pushing up variable mortgage rates;

  • a rise in new listings in Sydney and Melbourne;

  • a rotation in spending from goods back to services;

  • high inflation making it harder to save for deposits; and

  • a decline in consumer and home buyer confidence.

The deterioration in affordability has priced many out of the market. But the main driver of the downturn is the upswing in interest rates. This started last year with rising fixed mortgage rates (on the back of rising long term bond yields). Being able to borrow at a fixed rate of 2% or less was a key driver of the boom in prices with fixed rate lending accounting for 40-50% of new lending about a year ago, compared to a norm of around 15%. But with fixed mortgage rates roughly doubling over the last 12 months combined with an increase in the interest rate serviceability buffer from 2.5% to 3% this has substantially reduced the amount new home buyers can borrow and hence their capacity to pay. As a result, the share of fixed rate home lending has fallen back to around 15% but variable rates are now rising too as the RBA continues to raise the cash rate. The net effect is a sharp dampening in home buyer demand.

Australian interest rates on the rise

Source: RBA, AMP

The slowing trend since March last year has been led by Sydney and Melbourne, reflecting their more expensive housing and greater vulnerability to higher interest rates at a time when interstate migration was still helping to boost demand in cities like Brisbane and regional property remained in hot demand, kicked off by the pandemic. However, other cities and regional areas are now also seeing a loss of momentum.

The slowdown in monthly price growth is seeing annual price growth roll over too. Simple mean reversion after a period of well above average growth warns of a further slowdown ahead.

Annual home price growth is now slowing rapidly too

Source: CoreLogic, AMP

Expect average property prices to fall 10 to 15%

National average property prices have likely now peaked and we continue to expect a peak to trough fall of around 10% to 15% reflecting the combination of: poor affordability; rising fixed mortgage rates; monetary tightening from the RBA pushing up variable rates by around 2% out to mid next year; higher listings in Sydney and Melbourne; a rotation in consumer spending back towards services; high inflation which is making it harder to save for a deposit; and a collapse in home buyer confidence.

Likely reflecting increased sensitivity to higher interest rates property prices have also started falling a bit faster than we initially anticipated. So, after 22% growth in national average home prices last year, home prices this year are now expected to fall 2% (revised down from flat) and we expect around a 10% decline in average prices in 2023 (unchanged). Top to bottom, the fall in prices is still likely to be around 10-15%. Seen in the context of the huge 29% plus surge in prices since their 2020 low this will just take average prices back to the levels of around March last year, so a big rise in negative equity is unlikely. However, those who purchased in the last 18 month on low deposits are at risk of negative equity.

Sydney, Melbourne and Canberra are likely to be hardest hit, Brisbane and Adelaide may hold up for a few months longer and Perth and Darwin may hold up better as Perth is only just above its 2014 high and Darwin is still below. Regional prices may also continue to benefit. Units may not fall as much as they did not go up as much. However, most areas of the property market will be impacted as rising rates impact buyer demand

What are the risks?

The main upside risk to our forecast for a 10-15% fall in prices would be a rapid surge in immigration, although this is likely to show up initially in higher rents and then higher prices with a lag. The new round of 60,000 low deposit home loan guarantees, and 10,000 places in the Government’s “Help to Buy” scheme, will provide some support to property prices but are unlikely to be enough to prevent the unfolding downswing.

The more significant risks are probably to the downside and relate to the risks around the first interest rate hikes in over 11 years coming when household debt to income and house price to income ratios are way higher than they were when the last rate hiking cycle started in 2009. RBA analysis suggests most households are well ahead on their mortgage payments and have built up significant buffers and if banks have been appropriately applying APRA interest rate serviceability tests, then borrowers in recent years should be able to withstand a 2.5% (or 3%, since October) rise in their mortgage rate. So while there will be an increase in mortgage stress we do not expect to see an avalanche of forced selling crashing prices, but rather see weaker demand as being the main driver of lower prices. Given the unknowns around how new borrowers will cope with higher rates this is probably the biggest risk though.

Falling home prices will limit how much the RBA hikes

The offset to this risk though is that the RBA does not operate in isolation and will be closely watching for the impact of rising interest rates. Falling home prices will do part of the RBA’s job for it – via negative wealth effects on consumer spending (ie home prices fall, we feel poorer, we slow down spending and this takes pressure off inflation). So if house prices start to fall rapidly with significant evidence of rising mortgage stress then the RBA will be able to ease up on the interest rate brake. The fact that prices are already starting to fall tells us that rate hikes are already getting traction suggesting that it may not have to raise rates as much as would otherwise be the case, with the peak in the cash rate being, say, 2% rather than the 3% plus that the money market is predicting.

Concluding comment

At present the property downswing starting to unfold looks like just another cyclical downswing but note that the 25-year bull market in capital city property prices may fade in the years ahead as: the 30 year declining trend in inflation and hence mortgage rates which has enabled new buyers to progressively borrow more and more, and hence pay more and more for property is now likely over; and the work from home phenomenon and associated shift to regions may continue to take some pressure off capital city prices.

Source: AMP Capital June 2022

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

 

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