Westpac with the note:
We have revised our outlook for Australian dwelling prices.
Back in February we boldly predicted a 20% increase over 2021 and 2022. A stronger than expected surge over the first half of 2021 is now expected to see prices up 18% in the first year alone. Lockdowns will see some loss of momentum in the third quarter, particularly in the Sydney market, but an eventual easing in restrictions should see activity rebound swiftly and price growth lift again into year end.
Evidence of an 18% lift in prices nationally – including a 22% gain in Sydney – and a 7% increase in housing credit will set the scene for prudential policy tightening in the first half of 2022.
Price growth is expected to slow to 5% in 2022 with most of the increase occurring in the first half. Prices are then expected to decline 5% in 2023 as stretched affordability in most markets combines with the RBA’s first rate hike cycle since 2009.
The upswing that emerged at the start of this year has continued to run ahead of expectations with markets carrying strong momentum into the second half. Prices nationally rose 12.2% over the first six months, an extraordinary 25.6% pace in annualised terms.
Coronavirus disruptions are likely to take some heat out of markets in coming months. While prices have posted a solid gain in July, momentum already appears to have slowed somewhat with repeated ‘mini–lockdowns’ across several states and the more prolonged closure in NSW starting to impact activity.
The number of auctions has halved in Sydney and Melbourne, although it remains well above pre–COVID levels. That reflects both the strength of markets heading into disruptions and a degree of adaptation to virus restrictions.
Price growth may stall altogether, particularly in Sydney where restrictions look set to last for some time yet. However, any slowing is very likely to be transitory with easing restrictions and a national economic rebound driving a subsequent re– acceleration. At this stage that pick–up looks likely to be in the December quarter. Rising vaccinations rates and a more sustained reopening of the economy will be important catalysts through this period.
Moving into 2022, market dynamics and policy changes are expected to become more prominent drivers – specifically: deteriorating affordability is likely to weigh on owner occupier demand, and a tightening in macro–prudential policy settings will restrain the supply of credit.
As we set out in our previous forecast note (see here), we expect affordability constraints to become more binding once the cumulative gain in prices starts to near 20%, particularly in markets that had already seen big price increases through the previous cycle (Sydney, Melbourne and Hobart).
Deteriorating affordability is already weighing heavily on buyer sentiment – the ‘time to buy a dwelling’ index in the Westpac Melbourne Institute Consumer Sentiment Survey is down 25% from its peak last November. There are also tentative signs that finance to owner occupiers has peaked. Notably, new lending to first home buyers is now down 5% from its peak in January.
Price increases are already impacting affordability (see Figure 1) and our projected increases through the remainder of 2021 and the first half of 2022 will see a further squeeze.
However, we are not aware of any previous instances in which stretched affordability alone has driven a market correction.
Instead, corrections have always been due to either a combination of stretched affordability and policy tightening (interest rate increases or macro–prudential tightening) – or some shock to the economy. Occasionally they have been triggered by a combination (e.g. during the GFC).
With the economy looking well–placed once near term COVID disruptions ease, policy developments will be key to housing prospects in 2022. And macro–prudential policy will be the area to watch.
While past macro–prudential tightening episodes have targeted investors, there may be a different approach in this cycle. New lending to investors is growing quite rapidly (+30%qtr) but is still at a relatively low level, accounting for around 25% of the total value of new finance approvals compared to 45% in 2015.
We expect housing credit growth to exceed 7% by the first half of 2022 triggering a likely policy intervention. The precise response will depend on the composition of lending over the next year. If there is a rise in particular loan types viewed as riskier (e.g. high LVR, high debt to income, or interest only loans), these may be capped (as in 2017).
If gains are driven by a more general lift in credit growth, the regulator may instead place a limit on aggregate lending for investors (as in 2015). The regulator may also use ‘micro– prudential’ guidelines for individual loan assessments, for example mandating a larger ‘buffer rate’ to be applied in loan serviceability assessments, differential rates for investors and owner occupiers or perhaps gearing limits.
Reining in the housing market is clearly not the policy priority right now, particularly given the prospect of COVID disruptions taking some of the heat out of some markets in coming months.
However, we expect it to come back on to the agenda quite quickly once the current lockdowns have passed and the economy is picking up again.
On balance, while we still see an eventual macro–prudential tightening as highly likely, the timing is expected to be delayed until around March–June 2022. Measures are expected to be successful and to weigh more heavily on markets where affordability is stretched. Price growth is expected to stall in Sydney and Melbourne through the second half of 2022 but maintain some positive momentum in most other markets where affordability is still attractive.
A slowing in the housing market in 2022 is not expected to discourage the RBA from lifting the cash rate in the March quarter of 2023. Those decisions will result from the Bank achieving its full employment and inflation objectives through the second half of 2022.
The combination of rising rates; stretched affordability; and macro–prudential policies is likely to see prices easing off their highs by an average of around 5% in 2023 with all markets expected to see modest declines.
Summary
Our core forecast back in February that dwelling prices nationally will increase by 20% through 2021 and 2022 has proven to be overly cautious. We now see a total gain over the two years of 23% with 18% coming in 2021.
However, we have not changed our general view on the dynamics of the housing market over the 2021–2023 period.
It will be marked by surging prices through to the first half of 2022; followed by a flattening in the second half in response to macro prudential tightening; with prices entering a mild correction in 2023 as the RBA begins its rate hike cycle.
Several factors limit the risk of a harder landing for the market.
Firstly, we do not expect regulators to take a heavy–handed approach to macro prudential tightening.
Secondly, unlike in 2017–19, we do not expect to see additional damage from other developments – fears about potential changes to housing–related tax policy and the Banking Royal Commission both exacerbated the market correction in 2018–19.
Finally, we expect that the rate hike cycle will be quite benign with a peak cash rate of 1.25% being reached in the second half of 2024. We estimate that anything above 1.25% would push the household debt servicing ratio to levels that see significant stress on household finances. With inflation likely to remain well contained it will not be necessary to over tighten financial conditions.
