The Reserve Bank of Australia has poured cold water on fears that falling property prices will cause households to tighten their belts and spend less.
The RBA is instead eyeing developments in the labour market for signals that confidence in the housing sector remains strong.
Addressing the Housing Industry Association March Industry Outlook Breakfast in Sydney on Tuesday (26 March), Reserve Bank assistant governor Luci Ellis said there has been talk about the possibility that ‘wealth effects’ from declining housing prices might be weighing on spending.
“It’s important to remember, though, that people’s reaction to a fall in prices is likely to depend partly on how far prices had increased previously,” she said.
Ms Ellis pointed to some recent work by her colleagues at the RBA, which suggests that the link is a bit subtler than simply that increases in wealth boost spending directly.
“It isn’t so much that people wake up one morning, realise their home is worth more, and decide to go out shopping. Rather, if their home is worth more, they can borrow more against it, which matters for some people’s decision to buy a car. And because rising housing prices usually occur in the context of high rates of transactions in the market, spending on home furnishings tends to rise and fall with housing prices.
“So when housing prices decline, turnover also declines. This means there are fewer people moving house and realising their old couch doesn’t fit or they need new furnishings in the extra bedroom.”
Whatever other forces might be affecting housing market developments, Ms Ellis said that, fundamentally, demand for housing rests on the household sector's confidence and capacity to take on the financial commitments involved in the purchase or rental of a home.
“Without enough income, and so without a strong labour market, that confidence and capacity would be in doubt. This is not the only reason we are watching labour market developments closely. But the nexus between labour markets, households and housing are crucial to our assessment of the broader outlook.”
However, AMP Capital chief economist Shane Oliver believes falling property prices will have a greater impact on household spending than the RBA suggests.
“I’m probably in the more negative camp on the wealth effect and I think the evidence is there. RBA governor Philip Lowe gave a speech two weeks ago where he said that a 10 per cent decline in net housing wealth would reduce consumer spending by 0.75 per cent in the short term and 1.5 per cent in the longer term.
“A 10 per cent fall in net housing wealth would be equivalent to a 7 per cent fall in actual house prices, given a degree of gearing. Net housing wealth is about 75 per cent of total housing wealth, so if you’ve got a 10 per cent fall in total housing wealth, it implies a bigger impact of around 2 per cent in consumer spending.”
As Ms Ellis noted, the strength of the labour market is a key indicator of the health of the housing market. Mr Oliver predicts the unemployment rate will increase from 4.9 per cent to 5.5 per cent by the end of the year.
As the US election cycle draws to its close, investors must avoid getting distracted by the bluster around the result. ...