A house bet that may not pay off for the bank

The Reserve Bank has wagered much on the strength of the housing investment boom -- but if dwelling approvals continue to decline over 2014 that boom will be a relatively short one.

Despite sharp falls in March, building approvals remain at an elevated level and point towards a solid boost in dwelling investment over the next couple of years. But the recent downward trend suggests that approvals have hit their peak and the boost to investment may not be as great as the Reserve Bank of Australia hopes.

Building approvals fell by 3.5 per cent in March, failing to meet expectations of a rise, to be 20 per cent higher over the year. The decline was led by a fall in approvals for high density living – which are down in four of the last five months.

Graph for A house bet that may not pay off for the bank

On a trend basis, approvals for housing continue to rise – albeit at a slower pace – but for high density living we can see a distinct downward trajectory following a strong 2013. Nevertheless, building approvals remain at an elevated level, with both housing and high density approvals either at or around their historic highs.

High density approvals provide a good indication of investor activity – on those rare occasions that investors purchase new rather than existing dwellings – so there are tentative signs that investor optimism is subsiding. We will get a better feel for investor activity next week when the ABS releases their housing finance data.

At the state level, New South Wales remains the best performer and was the only mainland state where approvals rose during March. The biggest declines were in Victoria and Western Australia. Approvals in Queensland have declined significantly. 

Graph for A house bet that may not pay off for the bank

The high level of building approvals suggests that the rebalancing of the Australian economy continues to take place. But we should be concerned about how long the boom will persist for.

It goes without saying that investment lags approvals but if approvals continue to decline over 2014 then the investment boom will be a fairly short one.

With the Australian dollar remaining stubbornly high and sharp cuts coming in the budget, the RBA has placed a lot of eggs in its housing basket. However, based on historical data, I’m far from convinced that residential investment provides much upside for the Australian economy.

Building approvals remain well below their 2003 peak and a long way down on their peak during the mid-1990s. On that basis, I see dwelling investment rising by no more than around half a percentage point as a share of GDP over the next couple of years – well short of the potential 3-4 percentage point hole left by the impending collapse of mining investment.

Graph for A house bet that may not pay off for the bank

Building approvals remain at an elevated level but may have already hit their peak. Residential investment is likely to pick up throughout the year, since investment lags approvals, but the boom could be short-lived. The biggest unknown is whether the recent weakness is temporary or a sign of things to come.

If this really is the peak for building approvals then the Reserve Bank might need to find itself another source of growth. Housing investment is unlikely to increase significantly as a share of GDP and will do little to fill the gap left by the expected collapse in mining investment.

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