Australia’s housing sector has been one of the key areas held back as the economy contracted to make way for the mining expansion. The key driver of this, in our view, was the above neutral interest rates the RBA kept in place through 2011, as well as the fairly hawkish rhetoric they espoused through this time.
As a result, building approvals have been at very low levels. Approvals for housing construction reached their lowest level in over a decade. With mortgage rates now having decreased to below average, there are some tentative signs that the housing construction cycle has troughed.
The historical relationship between the housing construction cycle and mortgage rates implies that we should expect housing construction to pick up solidly from here (Chart 18). We have in mind that housing construction will continue contribute to GDP growth in Q4 2012 and will make a solid contribution to growth in 2013.
There are also signs that housing prices are beginning to rise, with prices up by 2.2% in the past seven months, after having fallen by 7% in the previous 18 months. With around 90% of Australian mortgages at variable rates, the below average RBA cash rate has already had a substantial impact on household income flows and this typically supports the housing market.
Mortgage rates are now around 100bp below average, which typically sees housing prices start to rise. We expect housing prices to lift modestly in 2013, with single-digit rates of growth likely. This is a forecast we first articulated in July 2012.
We estimate capital city house prices rise by around 6% a year in 2013 and 2014. Given the declines in housing prices in 2011 and early 2012, some catch-up in housing prices over the next couple of years would not be unreasonable, given continued solid household income growth. Indeed, housing prices would need to rise by around 9% in each of the next two years if we are to maintain the average pace of house price growth that has been apparent since the end of Australia’s 2002-03 house price boom.
That is, for housing price growth to average 4% over the five years to end-2014 – which is its recent average pace and broadly in line with household income growth – housing prices would need to rise by 9% a year for the next two years, given the price falls in 2011-12.
Housing loan approvals have already started to pick up in response to below average mortgage rates, though the recovery is, so far, more mild than during previous upswings. We expect below average mortgages rates and rising housing prices to start to see a further pick-up in new housing credit in 2013.
A shortage of housing in Australia is another reason to expect a further pick-up in housing construction and is expected to continue to be a key support for housing prices.
Given the low rates of housing construction, most estimates suggest Australia still has a housing undersupply relative to the rates of population growth. This is reflected in low rental vacancy rates. Rents are also rising in the major capital cities, which is another sign that there is undersupply relative to demand.
The retail sector has been weak in recent years. Demand for goods has been subdued in part because household wealth has declined. To rebuild lost wealth, households have been saving more out of their income and have been spending less on goods.
What is interesting, however, is that while retail spending has been weak, overall household consumption spending is growing at about its average pace. Households have been spending more on services, online purchases and on international travel than previously. With solid income growth, households have had solid overall consumption growth and still maintained elevated rates of household saving.
The retail sector has also been put under pressure by the high AUD. It has encouraged increased international travel by domestic residents, and thus more spending abroad. The high AUD has also seen greater online purchases from offshore providers. In addition, the high AUD has put downward pressure on imported goods prices, eroding local retailer profit margins.
But there are a number of reasons retailers should be optimistic about the future.
First, Australian households have done a fair bit of deleveraging already, having done most of the heavy lifting of their saving rate 3-5 years ago. The household saving rate rose by 9.4 percentage points between 2007 and 2009. It has only risen by 1.2 percentage points in the past three years. Most households are also now well ahead on their mortgage repayments.
Second, the RBA has lowered rates by 175bp and is looking to provide support for the retail sector as they seek to rebalance Australian GDP growth when the mining investment contribution to growth fades later next year.
Third, lower rates are already driving some recovery in housing prices and the residential construction cycle. As more houses are built, more furnishing and durables will be purchased to fill them.
Fourth, the depressing effect of the AUD on growth in retail sales and on retail margins should start to wane, as the currency has now been steady at above USD parity for over two years. There has already been a significant slowdown in growth of international travel by Australian residents (which implies that the drag on growth is less than it has been previously). With lower growth in international departures there is likely to be less of a pick-up in spending abroad by Australian residents. There has also been strong growth in international arrivals from China over the past couple of years, with this trend set to continue. The depressing effect of the previous AUD appreciation on imported goods prices is starting to wear off which should see local retailers better able to maintain margins (discussed below).
There are some early signs that suggest demand for retail goods and services is improving. Consumer sentiment has improved recently, which is perhaps a precursor to improvement in the retail sector.
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