Housing slump 'the biggest threat to the Australian economy'
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Housing slump 'the biggest threat to the Australian economy'

They might be labelled rivals but Sydney and Melbourne have much in common. Their economies especially are increasingly aligned.

Knowledge-intensive service industries have transformed both cities over the past two decades. Each has a population around the 5 million mark.

The four largest industries by output in Melbourne and Sydney are now the same – financial services, professional services, healthcare and construction. They employ some of Australia's most productive and well-paid workers.

Australia's two biggest cities are experiencing a downturn in house prices.

Australia's two biggest cities are experiencing a downturn in house prices.Credit:Rob Homer

The performance of the national economy is also hugely dependent on the fortunes of our big urban twins. Together they contributed 44 per cent of the entire output of the Australian economy last financial year.

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And now Melbourne and Sydney are in the midst of a house price slump.

The median dwelling price in Sydney is down 9.5 per cent since the property market peaked in July last year, according to CoreLogic figures released on Monday. Melbourne’s median price, which peaked in November 2017, has fallen 5.8 per cent.

Illustration. Simon Letch

Illustration. Simon LetchCredit:

So how much of a drag on the broader economy could falling prices become?

When that question was put the Reserve Bank’s deputy governor, Guy Debelle, a few weeks back he said the answer was still very uncertain. Although, he did say our economic guardians at the RBA “are paying pretty close attention”.

Dr Shane Oliver, an expert on asset booms and busts and AMP's chief economist, is less circumspect: “It’s probably the biggest threat to the Australian economy at present,” he says.

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According to Oliver the downturn is far from over – he expects property prices in Sydney and Melbourne to fall by 20 per cent from peak to trough.

There’s a number of ways a property slump can dampen activity in the wider economy.

As prices fall, and fewer properties change hands, home builders and property developers may respond by scaling back their construction plans. That, in turn, can reduce activity and employment in the construction industry. And that sector has been a key driver of growth in both Melbourne and Sydney.

The ups and downs of the property market can also influence household spending.

Rising house prices can encourage consumers to spend – economists call this the "wealth effect". But when property values are falling consumers typically become more cautious.

The RBA’s Guy Debelle warns these things are notoriously difficult to predict.

“It’s not entirely clear how much of a boost the rise in house prices provided to the economy on the way up, which also means it’s not entirely clear how much of a drag it may constitute on the way down,” he said.

But the longer the slump continues, and the more gloomy headlines about falling house prices consumers read, the more likely it is that spending will be affected.

Falling house prices and lower property market turnover also crimps stamp duty revenue, a key source of state government revenue. That potentially imposes another economic constraint by reducing the amount governments can spend, especially on infrastructure.

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A report on the economic performance of Australian cities and regions released by consultancy SGS Economics and Planning this week suggested the drop in house prices has already taken a toll on some important industries in Sydney.

The good times are over in city’s real estate services sector – it shrank by about half a percentage point in 2017-18.

More worrying were softer conditions in the industry that makes a bigger contribution to Sydney’s economy than any other – financial services.

About one dollar in every six generated in Sydney comes from the financial sector and its fortunes are linked to the property market. Conditions in the industry were weaker in 2017-18 than in several previous years.

Another report suggests economic conditions might be softening in Victoria as well. The ANZ Bank’s latest “statometer”, which tracks the performance of states, showed activity in Victoria dipped below trend in the September quarter for the first time since 2014.

History suggests the economies of our big cities are influenced by the ups and downs of the property market.

“There’s a long history of property booms in Sydney, and more broadly in NSW, driving swings in the health of the state economy,” says Oliver.

Analysis by Terry Rawnsley, the economist who authored the SGS Economics and Planning report on regional economic performance, shows that during the past three decades Sydney’s economic growth rate averaged between 3 and 4 per cent in periods of strong house price growth. But when the property market has been flat the city's economic growth rate has only averaged around 2 per cent or even lower.

Sydney’s last big housing boom, which peaked around 2003, was followed by a protracted downturn in home building activity which contributed to a long phase of below par growth for the NSW economy.

Rawnsley says there’s similar, although less pronounced, links between house price movements and economic performance in Melbourne over the past three decades.

This time Melbourne and Sydney are fortunate that the house price slump has come at a time of relative economic strength. Low unemployment and solid population growth make a disastrous house price crash unlikely. A pipeline of infrastructure projects in Victoria and NSW will help offset weaker conditions in home building.

Even so, a lot will depend on how households in Sydney and Melbourne react to the unfolding housing downturn.

Matt is a senior writer for The Sydney Morning Herald.

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