The likelihood of additional RBA interest rate cuts is again being discussed.
Almost everybody who had that prospect in mind at the start of 2014 subsequently moved to rule out interest rate reductions; some forecasters have publicly predicted that interest rate cuts will occur during 2015. At one stage early last year there was even a forecast for rates to start increasing before the middle of 2014. Financial markets are now pricing in for the next move to be down.
The federal government’s budgetary landscape has deteriorated by more than expected, largely due to additional revenue write-downs but also due to greater than usual political intransigence. In December’s Mid-Year Economic and Fiscal Outlook (MYEFO), the deficit for 2013/14 was projected to reach $40.4 billion, more than $10 billion higher than forecast in the May Federal budget. The cumulative deficit over the four years to 2017/18 has risen to $103.9 billion, an increase of $43.7 billion since May’s estimates.
The deteriorating budgetary position has dragged business and consumer sentiment downwards. Other areas of weakness have prevented any kind of recovery from gaining traction.
Key areas of weakness include: the commodities price shock in 2014, which has further to run; the rise in unemployment, with particularly large increases in youth unemployment and; weak real household income growth, which has dominated 2014 and generated a ‘feedback loop’ to further repress consumer sentiment. These circumstances mean household expenditure and business investment has been weaker than would otherwise have been the case.
In this context, national new home building activity has been the healthiest area of domestic demand in recent times. The number of new home starts is estimated to have increased by 11.9 per cent in 2014. This was a slightly higher rate of increase than the 11.1 per cent growth rate recorded in 2013.
There are two particularly impressive aspects to this result. First, the estimated level of commencements in 2014 of 188,020 was the highest on record, narrowly surpassing the 187,000 dwellings started in calendar year 1994. Second, the back-to-back years of growth in 2013 and 2014 represented the first time since the early 2000s that new dwelling commencements increased in consecutive years. According to the latest forecasts in ACI’s Spring 2014 Outlook report, commencements are forecast to ease by 2.2 per cent in 2015 to a level of 183,856. This outcome would still represent a strong level of building by historic standards.
It is possible that new home building will reach even higher levels than predicted by our latest forecasts. Further interest rate cuts in early/mid-2015 would enhance the outlook of new home building. Despite the low interest rate regime, several impediments to new home building persist. Supply side blockages, of which a lack of titled residential land and excessive infrastructure charges are but two examples, are locking out an otherwise willing cohort of additional new home buyers. Addressing such blockages would generate growth in economic activity and productivity. The new home building recovery is very good for the Australian economy, but it could be even stronger.
The characterisation of the national new home building market is a little misleading. The all-time high achieved during 2014 nationally is underscored by significant differences across different market segments. There is a considerably larger divergence than in previous cycles. A broad-based new home building recovery is still not being experienced by many in the industry as a result of these divergences. It is unclear whether all policy makers fully grasp this fact.
Despite hopes of recovery, 2014 was yet another disappointing year for renovations activity.
It would be a beneficial outcome if there was greater balance to the composition of residential construction in 2015. This would involve the new home building and renovations side of the market growing at a similar rate to one another.
During 2013, the volume of home renovations fell to a decade low, with activity falling by five per cent during the year. It is estimated that renovations activity grew by 2.4 per cent during 2014 as a whole. However, the latest official results show that renovations activity eased back by 0.7 per cent in the September 2014 quarter to a level only 4.1 per cent higher than the low point reached during the March 2013 quarter.
Activity in the renovations market is determined by a mix of factors. These include home price developments; dwelling stock age; the composition of new builds; interest rates; and the household savings rate.
The combination of very low, stable interest rates and substantial dwelling price growth in several key markets is a good operating environment for the renovations market. This setting will boost renovations activity over the short term. Over the medium term, unemployment will start to decline as economic growth picks up. This will cause earnings growth to strengthen with the renovations market receiving further support as a result. The current picture of unemployment on the high side and flagging earnings growth will limit the degree to which renovations activity can grow over the near term.
We estimate that renovations activity increased by 2.4 per cent during 2014 to $28.6 billion. Growth will ease to 1.3 per cent during 2015, with the value of renovations work projected to total $28.9 billion in the year. Detailed analysis of Australia’s home renovations market structure and outlook is provided in the new ACI publication Renovations Roundup.
During 2014, capital city dwelling values increased by 7.9 per cent. However, there were wide variations from city to city, with these geographical differences likely to persist throughout 2015.
Sydney and Melbourne were the fastest growing price markets in 2014 (12.4 per cent and 7.6 per cent, respectively), followed by Brisbane with 4.8 per cent annual growth. The situation was far more subdued in the remaining capitals, with annual growth in dwelling values ranging from 4.3 per cent in Adelaide to less than two per cent in Darwin and Canberra. In both cities, this is equivalent to a price decline after general inflation is deducted.
The pace of dwelling price growth has been gradually slowing since mid-2014. This process of moderation is likely to continue through 2015. In December, Australian Prudential Regulation Authority (APRA) announced that it would ’enhance’ its processes for bank lending practices. This move is likely to further soften price pressures in the Sydney and Melbourne markets, one of the factors behind the projected reduction in new home building activity this year.