Falling house prices are often thought to impact on consumer spending in the wider economy, but the Reserve Bank believes this link is more subtle than many realise.
House prices have typically been a strong indication of the health of the property marketand with it the economy, but RBA assistant governor of economics Luci Ellis suggested following house prices alone may not deliver a reliable glimpse into spending patterns and the health of the broader economy.
Speaking at the Housing Industry Association’s March Industry Outlook Breakfast in Sydney, Ms Ellis said the impact of rising or falling house prices is not as simple as “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 decisions to buy a car,” she said.
“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.”
Aside from the effect of housing turnover, the Reserve Bank identified a weakness in income growth for several years, and that the current rate of income growth must move to match the rate of consumption growth.
“Income growth is noticeably more volatile than consumption growth,” Ms Ellis said.
“So the usual pattern is that gaps between the two resolve with shifts in income growth, not shifts in consumption growth.”
Over time, however, households are likely to realise that the rate at which their household income is growing has slowed but is unlikely to be a short-term issue.
In terms of property investment, Ms Ellis said that despite interest rates for investment loans being higher than those for owner-occupiers, mortgage rates are still lower now than they were a few years ago.
This means landlords will have lower tax deductions for interest payments on investment loans, Ms Ellis continued.
“At the same time, the significant run-up in housing prices in some cities over the past decade will have increased the Capital Gains Tax liability paid by investors selling a property,” she said.
“Turnover in the housing market has declined. But as best we can tell, the price effect has dominated the effect of declining volumes, and total Capital Gains Tax paid has increased.”
Ms Ellis also pointed out that rental income has been somewhat weaker in recent months.
“This is not surprising considering that rents have been rising only slowly in most cities, and falling for a few years in,” she said.
“But rental income is only earned by 15 per cent of taxpayers, and lower cash rental income for landlords is also lower rent paid by renters, leaving them with more money to pay for other things.
“So the weakness in rental income is unlikely to be a large driver of any slowdown in consumer spending.”
The drivers that boost taxes paid are likely to hang around, but Ms Ellis said they are only temporary.
“For example, the earlier period of strong housing price growth will only increase Capital Gains Tax revenue if the asset was owned during that period,” she said.
“It can be expected to become less important, the further into history it passes.”
Ms Ellis concluded that income growth and consumption growth are both areas that need to be watched closely, by regulators and property market stakeholders – including investors.
“It's clear that conditions in the household sector more broadly are highly consequential for the housing sector,” she said.
“Whatever other forces might be affecting housing market developments, 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.”