MNI ANALYSIS: Risk to RBA Policy As Hsg-Build Becomes Headwind

By Sophia Rodrigues

     SYDNEY (MNI) - Australia's housing construction sector, once regarded as an

engine of growth in the economy's rebalancing away from resources investment, is

no longer expected to be a contributor and may even become a headwind for the

economy's growth and inflation prospects.

     If that headwind becomes strong, it could force the Reserve Bank of

Australia to switch from a hold-for-longer stance to leaning toward a rate cut.

     Back in November 2012, when the peak in the mining investment boom appeared

to be nearing, then RBA governor Glenn Stevens pointed to dwelling construction

as an area of stronger potential demand growth.

     He noted that housing construction had been unusually weak due to various

reasons, including too high interest rates, falling housing prices, zoning

restrictions, planning delays, construction costs, and general lack of

confidence, but some of the pre-conditions for an improvement seemed to be

coming into place. 

     By March 2013, then Assistant Governor for Economics Christopher Kent said

dwelling construction was beginning to pick up and leading indicators pointed to

further growth in the months ahead. 

     "In line with this, our expectation is that there will be a further gradual

increase in dwelling construction activity over this year and the next. This

moderate growth in dwelling investment will play some role in helping to support

a gradual pick-up in economic growth more broadly from what is expected to be a

rate a little below trend this year," Kent said in a speech.

     Since then, dwelling construction has been a contributor to growth -- not

as major as resources investment -- but enough to prevent growth from falling

significantly below trend. According to current Assistant Governor for Economics

Luci Ellis, it added around 0.5 percentage point to annual GDP growth at its

peak, compared with the 1-2 percentage points added to growth in 2011 and in

2012 from mining investment.

     In its latest Statement on Monetary Policy (SOMP) published earlier this

month, the RBA appears to have slightly downgraded its view on dwelling

construction, saying it "looks to have peaked earlier than previously expected."

While it is expected to remain at a high level over the next couple of years, it

won't "contribute to overall economic growth."

     In August, the RBA had already said "dwelling investment is not expected to

make a material contribution to GDP growth."

     So while dwelling construction is not expected to add to GDP from now on,

headwinds from the sector are growing due to the big pipeline of construction

projects, mainly apartments.

     The headwinds come from three important sources:

     -- the risky nature of the loans for development of residential apartments

that could increase the potential for losses and hence cause a fall in dwelling

prices;

     -- the impact of increased dwelling supply, particularly oversupply in some

areas, on housing prices;

     -- the impact of increased supply on the housing rental market.

     The first two sources could pose risks to both the economy and financial

stability, while the third could impact the economy's inflation and growth

prospects.

     In a speech Monday, RBA's head of financial stability Jonathan Kearns

referred to risks from residential property development loans which he said

could be riskier than residential mortgage lending.

     "The surge in apartments recently completed and under construction in the

major cities raises the risk of price falls," he said.

     Because residential building work is at a high level and faster than would

be needed to house Australia's growing population, there is already a risk of

oversupply. It is a common theme in construction-related booms and RBA Assistant

Governor Ellis warned about it in her recent speech.

     "The sectors identified as new 'engines' of growth produce long-lived

stocks of things: mines, buildings, bridges and railways. You can produce

above-average amounts of these things for a while, but you can end up with an

excess you don't really need if the boom continues for too long," Ellis said.

     In the November SOMP, too, the RBA pointed to the risk of above-average

housing supply growth "which would tend to weigh on housing prices and rents in

some markets."

     While the RBA doesn't want to see house prices rise too fast, it doesn't

want to see any sustained weakness, either, because of the impact it could have

on household consumption.

     So as more dwellings get constructed, the RBA will be alert to the risk

that it could impact overall housing prices.

     Apart from housing prices, increased supply is also expected to weigh on

rents. The RBA has already factored this risk into its forecasts. But there's a

risk that rents could be weaker than it expected, which would in turn pose

downside risks to its already subdued inflation forecasts.

     Downward pressure on rental growth has been one of the factors keeping

inflation below target in recent years.

     Expenditure on housing - which includes rents, the cost of building new

dwellings, utilities and maintenance costs - has the largest weighting in the

consumer price index basket, accounting for over 20%.

     According to the RBA, the micro-level CPI data show that, nationwide, a

larger proportion of rents are declining than at any point since at least 2001. 

     "Over the next few years, rent inflation is expected to stabilize, but

remain well below average, as the additions to the dwelling stock get absorbed

by population growth and economic conditions strengthen," it said in the

November SOMP. 

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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