Weekend Economist: Bubble bunkum

The Westpac Melbourne Institute Index of Consumer Sentiment  increased by 1.9 per cent in November from 108.3 in October to 110.3 in  November.  The survey was conducted in a week when house prices were reported to have risen by 1.9 per cent in the September quarter, with  prices in Sydney rising by 3.6 per cent to be up by 11.4 per cent for the year. 

Melbourne house prices were reported to have risen by 1.9 per cent for a yearly gain of 6.8 per cent, while movements in Brisbane (1.2 per cent per quarter; 4.1 per cent per year);  Perth (0.2 per cent per quarter; 8.6 per cent per year) and Adelaide (–0.6 per cent per quarter; 1.0 per cent per year) were less  impressive.

Not surprisingly, the confidence of respondents who wholly own their house was boosted by 6.1 per cent, whereas those folks  who are renting registered a drop in confidence of 2.8 per cent.

This theme around the impact of house prices on confidence was apparent in the state measures. State consumer sentiment indexes  were up 7.7 per cent in NSW and 3.2 per cent in Western Australia but rose only 0.9 per cent in Victoria and fell by 4.2 per cent in Queensland and 8.3 per cent in South  Australia.  The unemployment expectations Index rose by 0.9 per cent in November  to reach 144.7.

That is 11 per cent above the level in November 2011  whereas the consumer sentiment Index is 6.7 per cent above its level  in November 2011. In effect, despite the Reserve Bank reducing interest rates by 225 basis points since November 2011 and consumer sentiment increasing, respondents are more concerned about the outlook for unemployment, and by implication their job security,  than they were two years ago. 

Confidence around the housing market was also apparent in the  Index of House Price Expectations which rose by 3.1 per cent to be 23 per cent  above its October 2012 level.

There was also a rise in the Time to Buy a Dwelling Index of 4.2 per cent, including a very strong increase  in NSW (up 15.8 per cent), solid rises in Western Australia (up 7.1 per cent) and  Queensland (up 6.4 per cent) partly offset by falls in Victoria (down 6.2 per cent)  and South Australia (down 6.3 per cent). This strong housing theme was also apparent in components of the  consumer sentiment Index.

The sub-index tracking assessments  of "family finances vs a year ago" increased by 13.3 per cent, presumably  boosted by respondents' assessment of the increasing value of  their housing asset. However, in a sign that the medium-term outlook may not have been as supportive, the sub-index tracking  expectations for "family finances next 12 months" fell by 7.9 per cent.

This national disparity between housing markets is also apparent  in the momentum of house prices.

Relative to six months ago, the six-month annualised growth rate of house price inflation in Sydney has  increased from 8 per cent to 17.5 per cent; Melbourne from 5.3 per cent to 6.2 per cent; Brisbane  from 2.2 per cent to 3.3 per cent. In contrast, Adelaide has slowed from 3.1 per cent to  2.3 per cent and Perth from 9.5 per cent to 2.0 per cent. While Sydney house prices are rising rapidly, the story around  the rest of the country ranges from topping out in Melbourne and  Adelaide; to slow recovery in Brisbane; and marked slowdown in  Perth.

We do not perceive a "housing bubble" in any city. The chart shows  the relative growth in house prices and household incomes since  the mid 1990's. History can be divided into 2 periods – 1995 to  2002 and 2002 to present. It shows that in the earlier period, house  price growth outstripped income growth markedly as the Australian  housing market experienced a structural change. Households took  a number of years to accept that mortgage rates were not going to  return to the painful years of 1986 and 1989 when they approached  20 per cent. Once this confidence did solidify from around 1995, house  prices outpaced income growth to 2002.

From that point to present,  house prices have broadly moved in line with income growth. With  early signs of price momentum peaking everywhere but Sydney and  Brisbane, we expect that this broad trend for prices to track income  growth will be sustained. After outpacing income growth through to  2002, house prices in Sydney have lagged income growth between  2002 and 2012.

The recent surge in house prices in Sydney is a  "catch up" to income growth and appears to have further to run. The broad conclusion is that the recent increase in house prices is  really only moving in line with income growth. We do not think that  the Australian housing market, including Sydney, is showing signs  of a bubble where prices move well ahead of incomes, as we saw in  the US between 2001 and 2007. A balanced view on housing takes pressure off the Reserve Bank  and allows it to concentrate on other sectors including business  investment; consumer spending; the labour market and the  Australian dollar.

The Capex survey, which will provide the first  quantitative estimate of the impact on investment plans following  the election result and the associated surge in business confidence, will print on November 28. Recall that the August survey was  quite downbeat with services investment plans flat and mining  and manufacturing expected to fall. We expect a similar result  in November confirming the Reserve Bank's recent observation: "surveys of firms' intentions suggest that there  will be little growth in non mining business investment over the next  year or so".

We think consumer spending intentions will continue  to be constrained by households' concerns around job security as  noted in the consumer sentiment survey. Further, we are predicting a rise in the Australian dollar through to year's end  ($US0.96) reflecting the markets' reluctant acceptance  that the Fed has no intention of tapering until well into 2014. (Our  formal forecast is no taper throughout 2014).

These observations support our "out of market" call that the Reserve Bank will be  cutting rates further in 2014. 

Bill Evans is Westpac's chief economist.