Aussie household wealth to be hit by housing correction

Oksana Patron

2 November 2022

The anticipated house correction will put serious pressure on the Australian household wealth and spending and will likely erase price gains seen during the Covid period.

Australia is the third most rate sensitive housing market globally, with the high level of household debt, which makes it the fifth most indebted economies among the OECD (Organisation for Economic Co-operation and Development) economies, and the Aussie borrowers are still yest to feel the full effect of the Reserve Bank of Australia (RBA’s) interest rates hikes.

According to T.Rowe Price head of Australian equities, Randal Jenneke, in this case the wealth effect would be real given that housing made up roughly 68% of household sector net wealth ($10 trillion) and the RBA is determined to bring inflation down and seemed comfortable with a modelled 20% decline in housing price falls over the two years.

“A simple calculation tells us that for a 20% fall, A$2 trillion of household wealth would be destroyed. In turn, falling prices should deflate some of the more boisterous consumer activity witnessed when homeowners saw the value of their primary asset rise so dramatically,” Jenneke said in a note.

One of the reasons why Australian housing market is so highly sensitive to any change to interest rates was because of the substantial proportion of loans which were written during the Covid periodat very attractive fixed rates.

As a result, according to T.Rowe Price’s estimates, fixed rate mortgages ballooned from 15% pre-covid to 46% of new lending, as a percentage of all loans, at its peak, with an estimation that 50% of the current residential mortgage loans having been written over the Covid period.

Jenneke stressed that this would translate into a new wave of mortgages that would transition to variable rates in 2023, with an average fixed rate of around 2% moving to variable rate of 6.5% at current forecasts.

At the same time, the debt servicing ratio would be expected to rise to a record high of 18.4%.

By comparison, variable rate mortgage made up only 5% of US mortgages, with debt servicing there expected to only rise to 7.6%.

On top of that, Jenneke said that the savings buffer that Australian households managed to accumulate during Covid, and which is expected to help now bear the brunt of mortgage increases in the near-term, would be under the threat from rising costs of living expenses and higher energy prices and would not sufficiently protect households from their mortgage adjustments next year.

Additionally, according to the RBA’s Financial Stability Report, even if variable-rate borrowers reduced their spending by 20%, a third would deplete their buffers within six to 24 months.

“We have had the boom, and now we will have the bust. The question is just how big the fall will be? We believe the correction will likely erase all the house price gains seen during the Covid period, when prices soared to unsustainable heights. This would equate to the largest peak-to-trough decline on record, vastly eclipsing the previous correction of 10.2% in 2017,” Jenneke said.

“At the same time, we emphasise the importance to understand these issues and position appropriately. Our outlook and positioning has been cautious since late last year and we continue to prefer more defensive quality exposures that we believe will be better placed to weather the downturn.

“Some of the effects of rate increases across the globe have been more obvious than others (see prices of high valuation tech stocks). However, in Australia the most interest rate sensitive area of the economy and one yet to fully bear the pain of interest rate adjustments is housing. This has big implications for the broader economy and investors.”