Australia’s flying house prices – a catch-22?

Is our record rise in household wealth set to unleash consumer led recovery?

Household balance sheets are the catch-22 of macroprudential regulation on the housing market. Strong balance sheets mean that consumers spend more, boosting economic activity and lifting employment. EY’s latest modelling of the boost in household wealth shows just how big that tail wind can be.

The catch? The components of household balance sheets are homes, financial assets and liabilities, so a big component of our strong balance sheets is rising house values, which raises important questions about housing affordability and inequality, and financial stability.

Make no mistake about it. Household balance sheets are on the move since the beginning of the pandemic, reaching $13.4 trillion in June, up $2.1 trillion in just 18 months. A large portion of this build up has been in house values, increasing by 18 per cent in the same period.

Importantly cash deposits are also a substantial contributor to this balance sheet strength, with enforced savings as a result of health restrictions helping drive total household deposits to $1.2 trillion, up $167 billion since February 2020. That’s an extra $6,500 per person in bank accounts across Australia.

The strength in the housing market is clearly putting policy makers on edge, with the Treasurer publicly putting the introduction of macroprudential controls to slow the housing market on the table, a strong indication of increasing concerns about financial stability, and particularly debt to income ratios with more than one in five new loans exceeding a six times ratio.

The Council of Financial Regulators’, which includes APRA, ASIC, Treasury and the RBA, quarterly statement, released last week, noted that “credit growth [has been] materially outpacing growth in household income would add to the medium-term risks facing the economy”. Flagging that APRA would be publishing an information paper on its framework for implementing macroprudential in the next couple months. This framework will be keenly watched by economists and home buyers alike. 

Interventions in housing are complex and multi-faceted, with the three main issues at play being housing affordability, financial stability, and the all-important wealth effect.

In the conversation, we tend to focus on affordability and stability, which are undeniably important, but, when you are recovering from a significant economic shock – as we are undoubtedly will be in coming months - the benefits of the wealth effect become more important than when the economy is doing well.

Why? Broadly put, the wealth effect is that when household balance sheets are strong, people feel more confident, and tend to spend more, which supports jobs, incomes and economic activity.

This effect has long been at play in Australia, two thirds of households own their own home, so the record house prices we’ve seen over the past decade has helped fueled the economy, as equity in the home has given people confidence to go out and spend.

EY modelling of the latest Finance and Wealth data from the Australian Bureau of Statistics shows just how big a tailwind the wealth effect can create. EY’s macro model suggests that the lift in Australian’s household balance sheets we’ve seen since the pandemic began should unleash a wave of consumer spending and support a 2 per cent rise in GDP by 2024.

Further boosting this impact is the fact that for many households, it will come as a pleasant surprise. Back at the start of the pandemic, many expected the housing market to collapse, which would have crushed confidence and household balance sheets. Now, households are looking at record gains and an unexpected lift in their household wealth - as we all know from the last time we found $20 in a jacket pocket – surprise gains get spent.

The link between the wealth effect and consumption is strong, stable and well researched, however, the big question as we head towards Christmas is where will this wealth flow as we open up?

Typically, discretionary spending on things like motor vehicles and household white goods see the largest benefits. Motor Vehicle sales have certainly risen strongly, now 29 per cent above pre-COVID levels.

This time around the flow of money may take a different route. Australians have already bought cars, boats, caravans, home goods and renovated at a rate we’ve never seen before.

So coming out of this set of lockdowns, we expect services – travel, experiences, restaurants and entertainment – to get a much larger boost. How many people do you know will be asking for concert tickets, cooking tours and go-karting trips  – not PlayStations and leafblowers or a breadmaker for Christmas presents? We’ve already seen spending on household goods fall from their record levels. 

While improvements in household balance sheets will undoubtably be a positive for the economy given our modelling indicates the wealth effect could create an additional 160,000 jobs, the outlook is deeply intertwined with how consumers react to living and working with the virus, and the challenges of ensuring that businesses can manage workforce disruption.

Getting the health settings right is therefore all the more important, as consumers need the confidence to go out and spend – especially if they choose to spend on entertainment and experiences, which have been so difficult to plan for since the Pandemic began.

Without that confidence and having the right settings in place, the wealth effect will be blunted, staggered over a much longer period and delaying the recovery we all want to see.