The impacts of interest rate hikes on consumers are well known; higher interest means that mortgage debt servicing costs will go up which is negative for consumer spending.
Rate hikes are also bad news for home prices, which will create another negative for households via the destruction of wealth and the associated “wealth effect”.
Housing as a Source of Wealth
Household wealth is a measure of the value of physical assets owned like homes and the land they sit on and business premises as well as financial assets like shares.
Housing is both a source of wealth but also a form of consumption. Households can be a homeowner while non-homeowners “consume” housing through paying rent. As a result, changes in home prices do not have an equal impact across households, which can make measuring a direct wealth effect difficult.
For example, higher home prices are positive for investors and homeowners with no plans to upgrade but are negative for households looking to get into the market or upgrade. Renters may also be worse off as higher home prices could lead to higher rents. However, the composition of home ownership in Australia means that the majority of the population benefits from higher home prices, with two thirds of households (or around 7 million households) either owning a home outright or paying a mortgage. Housing is the largest single source of wealth for households, at 65% of total household wealth.
National home prices peaked in April 2022 and have fallen by nearly 5% to mid-September. We expect a peak-to-trough decline in prices of 15-20% with prices declining into 2023 before stabilising late next year. Our expectations for a further fall in home prices means we also expect household wealth to decline.
The Wealth Effect
The “wealth effect” is an economic concept referring to a change in consumer spending following an adjustment to household wealth. The historical relationship between wealth and consumer spending shows that rising wealth coincides with rising consumer spending and vice versa. Intuitively this makes sense – when you feel like your assets are worth more, you feel more confident to spend.
Our expectations for declining home prices in 2022/23 and, as a result, household wealth, means that consumer spending growth will also slow. We expect a weakening in consumer spending to just under 1% (year on year) by December 2023 which will weigh on GDP taking it well below normal levels of around 3% growth in consumer spending.
Other Impacts of Falling Home Prices
There are also other impacts of falling home prices including:
Higher risk of negative equity loans (which means that the market value of the home is less than the debt taken against the home) which increases the risk that the household will default if they can’t repay the debt by selling the property.
Lower bank profitability and increased risk of bank stress. Declines in home prices mean lower lending which is negative for banks as housing makes up 60% of bank lending. Falling home prices also increases the risk of defaults, which means that banks could take a hit to their capital. The loans which are most at risk are those with high loan-to-value ratios but the share of new lending to these areas is low (at around 5% of new lending).
Conclusion
So far, consumer spending has held up well in Australia despite high inflation (especially on essential items), rising interest rates, a collapse in consumer confidence and the negative wealth effect. Spending is holding up thanks to high household savings, housing prepayments, a shift in spending from goods to services and lags of changes in RBA interest rates to minimum housing repayments. In our view, consumer spending is set to slow down significantly in 2023 as consumers start to feel the impacts of rate rises, household wealth deteriorates and accumulated savings decline.
On our forecasts, annual growth in consumer spending will be under 1% by late 2023, well below its usual levels of around 3% per annum. This will weigh on GDP growth (household consumption is over 50% of GDP) and we see GDP growth slowing to under 2% per annum by late 2023.
To discuss how you may be impacted, book a time to chat here, and let’s talk over what is best for you.
Source: AMP Capital
