Australia's huge housing market keeps central bank on edge – Free Malaysia Today

SYDNEY: Australia’s pivotal housing sector is turning into a double-edged sword for its central bank, which has repeatedly talked about a narrow path toward achieving a “soft landing” for the economy in its battle against inflation.
A key to that goal is how households, which hold nearly 2 trillion Australian dollars (US$1.35 trillion) of housing debt, respond to a succession of interest rate hikes – the latest coming last week. Most economists expect the nation will avoid a recession, but those hopes could be dashed if home prices plummet by more than the expected 20% from their peak earlier this year.
So far, the home price correction has been sharp but orderly, and loan arrears are near historical lows. If this continues to be the case, the Reserve Bank of Australia will have achieved a spending slowdown without engineering a recession in the AU$2.2 trillion economy – something no other central bank is even attempting.
But if consumer demand does not slow quickly, the RBA will be saddled with a long-term inflation problem, a battle that could prove extremely challenging.
“The risks have become more two-sided now, as housing has weakened and there are some early signs of moderation in household consumption. Increasingly, the Reserve Bank is acknowledging it gets a bit tricky,” said RBC Capital Markets chief economist Su-Lin Ong.
“It was all about inflation. It’s now less, given how much tightening has been done. I think rightly, they are more mindful of the impact on activity.”
The RBA last week lifted rates for an eighth consecutive month, taking its benchmark to 3.1%. Economists expect a pause to its tightening cycle early next year, with just one or two more quarter-point hikes to come.
Australia has not needed to push up rates to the same extent as some other central banks because roughly two-thirds of mortgages are on floating rates. Even when loans are on fixed rates, their duration is just two to three years, unlike markets such as the US, where the bulk of home loans are fixed for periods ranging from 15 to 30 years.
The RBA is also mindful of the impact of higher borrowing costs on a household sector burdened by some of the highest debt levels in the world. Australia’s household debt-to-income ratio stands at 211%, more than double the 101% in the US and far higher than the UK’s 148% and Japan’s 115%.
“The property sector is very important to the Australian economy and potentially more important than in other developed economies,” said Kristle Romero Cortes, an associate professor at the University of New South Wales Business School.
“We have a dual issue that not only do we see people living in their houses, we also see a lot of people investing in real estate.”
Australia’s AU$9.4 trillion housing stock is worth more than four times the size of its gross domestic product, and about 30% more than the combined market value of all companies listed on the Australian Securities Exchange, the country’s retirement savings pool and its total commercial real estate assets.
By comparison, the housing market in the US is worth around $43 trillion, roughly 1.6 times the size of the world’s biggest economy.
The dominance of variable rate mortgages and the speed of the hikes means Australian households have felt the impact of rate increases much faster than those in other countries. They are already having to allocate more of their income toward repayments and have also moderated spending, with the housing market enduring its sharpest downturn on record.
Prices have tumbled 7% from their April peak. A range of other indicators – including home lending, construction approvals, auction clearance rates and consumer confidence – are also pointing to a weakening market environment.
Data last week showed growth in Australia’s economy slowed to 0.6% in the September quarter, from 0.9% in the prior three months. A notable drag was an unexpectedly large slide in turnover in the property sector, which cut GDP growth by 0.2 percentage points.
Residential real estate accounts for about 5% of Australia’s GDP but has strong linkages to other parts of the economy, including household consumption and employment. It is also key to the fortunes of the country’s biggest banks.
Analysts believe financial stability in the housing market, therefore, features prominently on the RBAs radar as it balances combating inflation and safeguarding economic growth.
“This is a double-edged sword, and the RBA themselves have noted several times they’re walking a fine line. So too rapid an increase in rate rises could test mortgage serviceability,” said Eliza Owen, head of research at property analytics firm CoreLogic.
Another challenge will come when around US$300 billion worth of home loans that were secured at ultralow fixed rates during the pandemic come to maturity next year. These borrowers will face a “sticker shock” as their repayments spike due to effective interest rates jumping from below 2% to as high as 6.5%.
Any forced sales at the time could have a meaningful impact on a market where home prices are already pencilled in to fall a further 7% to 10% next year.
The RBA’s test will come in 2023 when economic growth is expected to slow down to 1.3% as a consequence of higher interest rates, as well as the downturn in the global economy.
“A combination of falling prices and households struggling with mortgage serviceability, that’s where you have a greater risk of the deterioration in housing market conditions,” Owen said.
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