The heavy reliance on housing to rebalance the economy after the mining boom has created financial stability and macroeconomic risks, an investment bank has flagged.
These risks could be more challenging to manage than during the unwind of the mining boom, according to Citi.
In its recent analysis entitled Australia Economics & Multi-Asset View, Citi said that the economy now faces a “second rebalancing challenge” as the housing boom begins a protracted unwinding.
“Drivers of the housing boom are being replaced by tighter lending standards, higher lending rates, reduced foreign investment and increased supply relative to demand,” the bank explained.
As commodity prices and mining investment have normalised, Citi pointed out that housing has been a “key element” of the rebalancing of the economy.
“This has been Australia’s largest housing construction upswing and house prices in Sydney and Melbourne smashed previous valuations. Despite only representing about 5 per cent of GDP, housing activity contributed just over half of the growth in private sector demand in the past three years.
“Surging house prices in Sydney and Melbourne have been a prime contributor to the 30 per cent increase in household wealth in the past three years.”
This reliance on housing has “created its own risks”, says the bank. There are signs of oversupply in some apartment markets on the east coast, placing downward pressure on rents and prices in these segments, while house price valuations are “stretched” in Sydney and Melbourne with household debt continuing to rise to new record levels.
Given these factors, Citi said it expects that a “partial correction is likely” for house prices, and there are some “signs of cooling” in Sydney and Melbourne markets in particular.
Indeed, April figures from CoreLogic showed that dwelling values increased by just 0.1 per cent across the combined capital cities during the month. CoreLogic and Citi both noted however that seasonal factors, such as Easter and school holidays, may have contributed to April’s results.
Ultimately, Citi concluded that some correction would seem likely as supply continues to catch up to demand.
“Our model of house prices includes measures of underlying demand and supply for housing, with the dwelling stock growing faster than population, and the model also includes household debt. It suggests that the run up in house prices was facilitated by rising household debt.
“If APRA succeeds in limiting further rises in household debt and ultimately, we see some mild deleveraging, there could be a partial correction in house prices during the course of the next two years. This would be the case even if population growth remained strong.
Recently UBS Investment Bank also maintained its forecast that housing activity is likely to correct when it ‘called the top’ of the housing market at the end of April.
APRA measures to have ‘meaningful impact’
Citi says the prudential regulator’s measures announced in March, including limiting new interest-only lending to 30 per cent of total new mortgage lending, will have a “much more meaningful impact on mortgages” than the earlier 10 per cent speed limit on investor credit.
“With customers needing to change their monthly repayments, rather than simply their loan classification, [our bank analysts] expect the limit in new interest-only mortgages will slow overall system loan growth to 4 per cent by FY19.
“The RBA estimates that rates for investors on interest-only mortgages have risen by around 40bp since November last year and our bank analysts are expecting further interest-only mortgage repricing (up to 50bps) to assist in slowing demand for credit.”
Further, Citi said that while the RBA has previously argued that the effectiveness of macroprudential measures has limitations, on this occasion the measures adopted by APRA have seen the banks raise lending rates, especially to investors who have been “an outsized contributor to this housing cycle”.
“Our analysts report that tighter financial conditions have seen a marked lengthening of settlement times and lower pre-sales,” Citi said.