Rates’ stress compounded via labour market downturn: Westpac

Westpac Bank senior economist, Matthew Hassan, confirmed Australia’s housing markets are “in the grips of a material correction” with a long duration coming.

He said while there are some “tentative signs” that the pace of price and turnover declines may be moderating, Australia is unlikely to see a stabilisation any time soon.

“Markets are basically hostage to the policy tightening cycle and the associated economic cycle,” Mr Hassan explained.

Outlining that Australia’s housing market correction is now into its seventh month, Mr Hassan highlighted that November CoreLogic figures [were] set to show another monthly decline, with major capital city prices down over 7.5 per cent from their April peak and turnover 30 per cent below the post–delta reopening surge a year ago.

There have been some positive signs of stabilisation in recent months, however, he pointed out.

“The monthly pace of price falls has moderated, turnover has steadied, and auction clearance rates have lifted — but these shifts should all be read with caution,” he said.

“Prices are still firmly locked into a weakening path, and low volumes, still-elevated pre-auction withdrawals, and end-of-year seasonality all make clearance rates less reliable than usual.

“More importantly, the RBA’s interest rate tightening cycle — now the dominant factor for housing markets — has further to run.”

Rate hikes, spikes, but then … who knows?

Predictively speaking, Westpac said it expected the Reserve Bank of Australia (RBA) to raise rates by another 1 percentage point (ppt) between now and mid-2023, a view broadly shared by the market, it added.

Beyond 2023 and its unpredictability, Mr Hassan reminded that history shows housing market corrections usually come in two distinct phases: the first when rate rises are the main driver and a second when rates are on hold but still high and the economy is weakening.

“Stabilisation and recovery usually only emerge once interest rates start to move lower and the economic backdrop is stabilising,” he explained.

Citing ABS, CoreLogic, and Macrobond, Westpac Economics chart data showed how these phases unfolded during the five material national price corrections during the early-80s and early-90s recessions, the GFC, and in 2010–11 and 2017–19.

“Every correction has its own characteristics, but the two phases are reasonably clear. They are most distinct during the recession and GFC corrections, when rising unemployment was a big factor,” Mr Hassan highlighted.

“A lengthy period of high interest rates was also a clear compounding issue during the two recessions, reflecting the high inflation backdrops at the time that reduced the scope for (and delayed the timing of) policy easing.”

He contrasted this with the 2010–11 and 2017–19 corrections, which were against relatively benign inflation and economic backdrops and had more muted ‘second leg’ price declines (the 2017–19 correction had more to do with investor-related policy issues than the interest rate and economic cycle), he described.

“Inflation constraints on the RBA, and how its actions impact the economy will factor again in 2023–24,” Mr Hassan warned.

“As noted, we expect the RBA to raise rates by another 1 percentage point with a pause coming from mid–2023.

“How long rates remain high will depend on how quickly inflation dissipates.

“Global inflation is already showing signs of passing a peak, with freight rates retracing most of their supply-shock spike, and commodity prices unwinding most of the Russia-Ukraine war-related gains.

“But for Australia, the focus will increasingly turn to domestic pressures, particularly around energy costs, rents and wages.

“Wages will be of special concern given the extent of labour market tightness, their most recent surge, prospective changes to industrial relations policy, and what are often long lags between shifts in labour market conditions and wage setting.

“On balance, we expect the RBA to hold rates at a high level through to the end of 2023 with policy easing coming through in 2024, but only if a sustained return to 2–3 per cent inflation appears secure.”

The economist outlined that the extent of further price weakness during this second phase of the correction will also depend on the extent to which policy tightening impacts the economy.

“Household financial stress will ratchet higher with rates and then be impacted by a downturn in the labour market,” he said.

Housing price declines slowing — but much later

Westpac expects the unemployment rate to start tracking higher from about March next year, with a material 1 percentage point rise coming over the six months to September, he predicted.

For housing, this essentially locks in a further period of correction through 2023 before a recovery in 2024, he calculated.

Notably, the second phase of a correction does tend to see some slowing in the pace of price declines — “what we are seeing now may even be the beginning of a transition to this slower pace,” he said.

“But to really draw a line under the current correction, we will [need] more than just an end to hikes — at the very least we will need to see a clear signal from central banks that the next move in rates will be down, which in turn depends on their confidence that inflation will make a sustained return to target,” he said.

“And it’s likely that we will also need to have seen off the worst of the economic downturn, particularly as it relates to jobs.”

[Related: RBA adopts ‘dovish tilt’ despite data revelations: Westpac]