The strength of the Australian labour market will be tested over the next six months as jobs related to the housing sector decline.
We estimate that housing related jobs will fall by 6% from current levels which equates to around 50-60K jobs over the next year – close to the job losses associated with car manufacturing closures.
We expect the unemployment rate to rise to 5.5% towards the end of the year and peak around this level.
However, we expect RBA rate cuts to start before the unemployment rate rises substantially. Signs of weakening employment growth will be enough to get the RBA to cut interest rates twice over the next six months.
An unexpected feature of the Australian economy in 2018 was a divergence in two key economic metrics – economic growth (as measured by GDP) and the unemployment rate. GDP growth declined in 2018, rising by 2.3% over the year to December, well below the 3% the Reserve Bank of Australia (RBA) consider as “trend” or potential in Australia and missing the RBA’s forecasts. Over the same period, the unemployment rate declined from 5.5% to 5.0% which is close to Australia’s “full” level of employment. The discrepancy between the two can be explained by a decline in productivity growth, with a lot of the jobs created in 2018 in lower productivity, less capital intensive (and more labour intensive) areas like government administration and professional services. Despite the weakening in GDP growth and the step down in inflation, the strength in the labour market has been a key reason behind the RBA’s optimism on the economy and its reluctance to cut interest rates.
However, we see the labour market deteriorating this year as the housing downturn leads to job losses and a higher unemployment rate. GDP growth is also expected to remain constrained. Consumer spending growth remains mediocre (in the face of uninspiring wages growth, falling home prices and high housing debt), residential construction is falling and non-mining business investment growth is only rising slowly. We see GDP growth averaging at just over 2% in 2019. Below-trend GDP growth and a rising unemployment rate will keep inflation low, putting pressure on the RBA to cut interest rates.
In this Econosights we run through our expectations of how the housing downturn will impact jobs growth over the next year and the implications for the RBA.
The outlook for the housing market
Australian home prices have been declining since September 2017 because of a number of factors including more stringent lending standards for both investors and owner occupiers, lower foreign demand, an increase in housing supply, an increase in the number of households moving from interest-only loans to principal and interest loans, weakening sentiment towards housing assets (particularly from investors) once prices started to fall and concern around changes to negative gearing and the capital gains tax concession with a Labor government. These factors still remain in place and we see further falls in home prices occurring across Australia until mid-2020, although recent data suggests that the pace of falls is moderating, but it is becoming more broad based across the capital cities (and not just in Sydney and Melbourne). We expect home prices to have a peak to trough fall of 15% nationally with falls in Sydney and Melbourne larger at around 25% (see chart below). This means around another 5% fall in prices nationally and more in Sydney and Melbourne.
Lending standards may be tightened again with another stage of Comprehensive Credit Reporting rolling out in the second half of the year, although this may be partly offset by some recent cuts to fixed mortgage rates.
Another factor to consider is potential RBA interest rate cuts and the flow through to mortgage rates. Historically, home prices take a few months to respond to interest rate cuts so potential rate cuts would likely slow the pace of home price declines and it could mean that home prices bottom earlier than expected, around the end of the year, rather than in mid-2020 as we are currently expecting.
Concerns about tax changes related to housing are also weighing on investor sentiment. The Labor party will restrict negative gearing concessions on housing (this is a tax policy that reduces taxable income from losses made on investments) and will reduce the capital gains tax discount on housing investments from 50% currently to 25% from 1 January 2020 (with existing arrangements exempt). A Labor party victory at the May election could mean that in the short-term there will be a bounce in housing demand and a boost to prices as investors make opportunity of current concessions before 2020.
However, in the long-run, abolishing negative gearing could hit home prices by another 5-12% which is risky as the property market is already weak. The Labor party could announce a First Home Buyers grant to offset these negatives on home prices.
Changes to these long standing housing policies would still need to get through the Senate which is uncertain given the high probability of independents holding the balance of power in the Senate.
Impacts from housing downturn on labour market
Residential home construction accounts for close to 6% of GDP. On our estimates direct jobs related to the housing market are just over 6% of the labour market which includes residential construction jobs, services related to construction, real estate services and retail jobs (that benefit from household goods furnishings).
Tracking housing jobs against home prices we find that changes in home prices lead housing jobs growth by around a year (see chart below). Housing-related employment peaked in early 2018 and has been moderating since then. With home prices down by around 8.4% over the year to April, we expect housing related jobs to fall by around 6% from current levels which translates to around 50-60K job losses over the next year – close to the job losses that occurred when Australian car manufacturing closed.
However, even with these job losses, outright falls in employment are unlikely. Housing job losses should be offset by employment growth in government services, construction jobs related to infrastructure spending, tourism-related areas and mining over the next year. However, the pace of government related employment will also start to weaken over the next year as construction jobs related to government infrastructure spending reach a peak this year. We see employment growth declining to around 1.5% year on year over the next six months. Forward looking indicators of employment growth (job vacancies, job advertisements and business survey hiring intentions) are slowing (see chart below) but not collapsing. We expect these indicators to continue weakening over the next few months.
Weakening employment growth should see the unemployment rate to increase to 5.5% towards the end of the year. While this is not historically high for Australia, it is an increase from recent periods and comes at a time when GDP growth is running below trend and underlying inflation is declining.
Implications for the Reserve Bank of Australia
Labour market data is now the RBA’s focus. The central bank expects the unemployment rate to remain around 5% for the foreseeable future before declining to 4¾% in 2021. The RBA May post meeting Statement indicates that “further improvement in the labour market was… needed for inflation to be consistent with the target” which means that jobs growth needs to remain strong to keep the unemployment rate from rising. The two questions now are i) how far does the employment data need to deteriorate before the RBA cuts interest rates and ii) how much “bad” data is needed for the RBA to be confident that the labour market is deteriorating? We think that the answer to these questions is “not much”.
Any sign of slower employment growth from here will be enough to push the RBA to cut the cash rate because it would mean that there is no progress in lifting inflation. For this reason we still have a June rate cut pencilled in as we expect the pace of jobs growth to continue slowing, although the rate cut could still come later. Following a June rate cut, another one is likely in August, following the next set of inflation numbers which should indicate only a small lift in underlying inflation.
Implications for investors
Interest rate cuts from the RBA will impact investors through a few areas.
Firstly, we expect that lower interest rates will push the Australian dollar lower, to below 0.70 US dollar which could help unhedged investors exposed to global share markets.
Interest rate cuts could also assist the housing market in stemming further price declines as discussed in the note.
Australian shares performed well over the first few months of the year on expectations of interest rate cuts. But once these cuts are already factored in by investors, further gains in shares will need to be driven by better earnings growth which still looks challenging in Australia. Rate cuts could assist some sectors as consumer demand lifts.
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