Weekly economic briefing: The housing cycle – aiming for balance in our most cyclical sector

The Weekly Economic Briefing is written by two senior Deloitte Economists, David Rumbens from Deloitte Access Economics in Australia and Ian Stewart Deloitte’s Chief Economist in the UK. They provide a personal view on topical financial and economic issues. Subscribe to receive the Weekly Economic Briefing in your inbox!

In this week’s blog:

Australian economic briefing
UK economic briefing
International economic briefing

Australian economic briefing by David Rumbens

This section of the briefing provides a snapshot of key economic data and issues of relevance to Australia.

The housing cycle – aiming for balance in our most cyclical sector

Based on current population growth, we are building too many houses.

However, we are also still catching up on a long period of underbuilding, and with population growth picking up once again, the emerging construction downturn may be more gentle than feared.

With housing affordability and density in the news, we look at the level of residential building activity against the demand from growth in households, and provide an overall assessment of the market.

Given its cyclical nature, the housing sector tends to go through periods of overbuilding and underbuilding. We estimate that there was noticeable underbuilding for a number of years (from 2006 to 2013), which helped to fuel recent rapid house price growth. However, since 2014 we have been in a phase where we are building more homes than underlying need would suggest (see chart below). This growth in dwelling commencements has raised fears of oversupply, particularly in some capital city apartment markets. But overall, Australia’s housing market is still characterised by relatively low vacancy rates and positive rental growth.

With an upturn in national population growth and an easing in forward indicators of housing construction (residential building approvals), the gap between building activity and underlying demand looks set to close.

Chart: Dwelling supply and demand

Source: Australian Bureau of Statistics, Deloitte Access Economics

 

Residential building approvals peaked in the second half of 2016 and have retreated modestly since. This has been driven largely by a fall in apartment approvals, particularly in the high-rise segment. The fall in residential building approvals likely reflects factors such as tighter developer financing, higher taxes on foreign investors (levied at the state level) and fears of oversupply and future price growth. This indicates residential building activity, which has been a driver of economic growth, is set to moderate.

Against this moderating supply outlook, population growth has surprised on the upside. Spurred by an increase in net overseas migration, national population growth was over 389,000 over the year ending March 2017 (up from over 343,000 the year to March 2016). This has tempered expectations of an oversupply of housing, although dwelling completions will remain elevated in the short term.

The supply-demand balance has been an important driver of recent strong house price growth, along with low mortgage rates and strong investor interest. CoreLogic’s Home Value Index shows price performance varies significantly across the country. Long-time standouts Sydney (+10.5%) and Melbourne (+12.1%) have continued to record robust growth over the year ending September 2017. The relatively affordable Hobart (+14.3%) has seen substantial price growth amid a healthier local economy while the Canberra market (+7.8%) has also been a solid performer. Other markets have been more mixed, with Perth (-2.9%) and Darwin (-4.7%) still experiencing falling prices amid challenging local economic conditions.

More recently however, national price growth looks to have slowed, with CoreLogic’s five capital city aggregate up by a more sedate 0.6% over the past quarter, or around 2.5% price growth on an annualised basis. This may reflect a range of factors domestically, such as stretched affordability (particularly in Sydney and Melbourne) in a low wage growth environment, tighter lending standards (and a crackdown on interest-only loans) and increases in mortgage rates by major lenders. It may also reflect an easing in foreign investment, with higher foreign investor taxes (for example, New South Wales’ stamp duty surcharge for foreign investors recently increased from 4 to 8%) and a continued clamp down from Chinese authorities on capital flight.

As a result, while there are still many risks in Australia’s housing market (and far too much household debt for comfort), the short term outlook might be more about balance than wild swings – and prices levelling out at a time when housing activity moderates and population growth remains buoyant

 

For more information on the Australian brief, please contact the co-authors, David Rumbens and Andrew Ponsonby.

 

UK economic briefing by Ian Stewart

A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. Subscribe to and view previous Monday Briefings at: http://blogs.deloitte.co.uk/mondaybriefing/

Interest rates rises, slowly does it

  • In four weeks’ time the Bank of England is likely to raise UK interest rates for the first time in ten years. The Bank’s Governor, Mark Carney, has gone out of his way to signal that a rate rise is on the cards. Financial markets and economists are betting that the Bank’s Monetary Policy Committee will hike by 25 basis points at their 2nd November meeting, taking UK interest rates up to 0.5%.
  • Other central banks are also edging away from ultra-easy monetary policy, with America leading the way.
  • The Federal Reserve has raised US interest rates from 0.25% to 1.25% over the last two years. Later this month the Fed will start unwinding its Quantitative Easing (Qprogramme. Canada raised rates in July for the first time in seven years. The European Central Bank is a lot further from raising rates, but it is upbeat about prospects for euro area growth and later this month will announce how it plans to unwind its programme of QE.
  • The Fed and the Bank of England have shared motives for raising rates. Asset prices and consumer borrowing look frothy in the UK and US. Both countries are more than eight years into their recoveries. Raising rates now hardly seems premature and would provide headroom for future rate cuts when, as is inevitable, recession strikes again. Wage growth is subdued, but unemployment in most of the Anglophone world is at historically low levels, pointing to future inflation risk.
  • In the UK Mr Carney argues that Brexit is likely to slow UK productivity, weaken sterling and raise inflation pressures.
  • The tilt towards tighter monetary policy brings with it new risks. The 2008-2009 monetary easing bolstered liquidity, asset prices and credit. The unwinding of easy monetary policy should have the opposite effect.
  • For asset markets which have become accustomed to cheap money this could be the moment of truth. In the UK and US housing, equities and bonds look demandingly priced. As the current edition of the Economist puts it, there is a bull market in everything. The US Nobel Laureate in economics, Robert Schiller, estimates that on an underlying basis US equities are more expensive today than at any time since the dotcom bubble and, before that, the 1929 crash. An index of equity market volatility, the VIX, is close to a 25 year low, suggesting a level of optimism that, to some, borders on complacency.
  • Cheap money has helped reboot growth and has raised household debt in advanced and emerging economies above 2008 levels. Yet growth rates for GDP and household incomes are still below pre-crisis norms. Asset valuations, and the ability of households to cope with debt, seem dangerously dependent on low interest rates. Last week Warren Buffett said that equity valuations would look cheap in three years’ time if interest rates were one percent – but not if they were three percent.
  • Central banks understand the vulnerabilities and will work very, very hard to avoid a crash. That points to a softly, softly approach to raising interest rates and unwinding Quantitative Easing. Policymakers can take comfort from the fact that the Fed’s campaign to tighten policy, which has seen interest rates rise by 1.0% in the last couple of years, has not derailed asset prices or growth.
  • The Fed wants to avoid a repetition of the “taper tantrums” of 2013, when financial markets, especially in emerging economies, reacted negatively to reports that US rates were about to increase.  The unwinding of US QE, which is set to start this month, is likely to be prolonged, extending beyond 2023, possibly by several years.
  • The Bank of England has said it will not start unwinding QE until UK rates have risen to levels from which they could be “cut materially”. That implies rates of at least 3.0%, which looks some way off.
  • If the Bank raises rates on the 2nd November it is likely to portray the move as the removal of the precautionary, 25bp rate cut, made last July following the EU referendum. Slowing UK growth, Brexit-related uncertainties and falling inflation, suggest further rate rises will come only gradually.
  • Financial markets have bought into the idea of slow tightening and see UK base rates, which currently stand at 0.25%, ending this year at 0.5% and 2018 at 1.0%. The market is pricing in US rates of 1.5% by the end of this year and 2.0% by the end of 2018.
  • The hope is that it a gradual unwinding of easy monetary policy will avoid a sharp fall in asset prices. The fact that institutional fund managers see equities as overvalued and are buying protection against declines shows that not everyone is counting on a happy ending. 

OUR REVIEW OF LAST WEEK’S NEWS

The FTSE 100 ended the week up 2% at 7,522 buoyed by a decline in the sterling dollar rate which boosts overseas earnings for many large UK quoted businesses.

The Catalan independence vote hit Spanish stocks while US stocks rallied on renewed optimism about prospects for US tax cuts.

 

International economic briefing by Ian Stewart

Economics and business

  • The IMF warned that policy makers are becoming complacent and doing too little to prepare for future downturns
  • At least 11 UK lenders have raised interest rates on fixed rate mortgages in recent weeks
  • Euro area job creation in the manufacturing sector hit a record high
  • Business investment in the euro area rose sharply and to pre-crisis levels
  • Ireland sold its first ever bond with a negative yield with purchasers paying the country to lend it money
  • Business conditions in Japan are better than for a decade according to the Tankan index
  • Brussels proposed an overhaul of EU value added tax to clamp down on an estimated €50bn of annual fraud
  • London Mayor, Sadiq Khan has asked car manufacturers to contribute funding to help the UK combat pollution, as they have done in Germany

Brexit and European politics

  • A number of corporates announced plans to move HQs from Catalonia following the independence vote
  • The EU has said it will not recognise an independent Catalonia
  • German businesses operating in the UK were warned to expect a “very hard Brexit” by BDI, Germany’s largest business lobby group
  • Goldman Sachs leased more office space in Frankfurt, increasing its capacity for up to 1,000 members of staff in Germany
  • Sam Woods, a Bank of England official, urged the UK and EU to secure a transitional arrangement deal by Christmas to avoid banks executing their worst-case contingency plans
  • Michel Barnier, the EU’s chief Brexit negotiator, said “sufficient progress” over Brexit divorce issues had not been made by the UK to move onto the future EU-UK partnership negotiations

And finally…

  • Somerset County Council have paid out £1,836,000 to a single claimant for damages following an accident “involving a pothole defect” – having also paid out a total of £900,000 for pothole-related compensation last year – pot luck

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