The surprisingly large fall in home building approvals in November 2015 is a warning shot for those sailing on a sea of complacency with respect to the Australia’s economic outlook. This posts updates our previous analysis of the housing market and highlights the growing downside risks this important sector poses for the economy over the coming year.
We have previously warned of downside risks to the economy in 2016 due to the housing sector. While many analysts last year simply celebrated the high level of home building construction, we began to worry that downside risks were growing. This fear is beginning to show through in the data. Indeed, home building approvals slumped by 12.7% in November, which was much larger than market expectations, which had generally anticipated a relatively minor 3% fall. As is typical, the larger than expected monthly change in building approvals was driven by the very lumpy apartment sector, where approvals declined by 23%. Some analysts might dismiss this decline as just “monthly volatility”, but as seen in the chart below, this argument is starting to wear a little thin as – even with such volatility – the overall trend in approvals has been downward since early 2015.
Even if we assume that approvals bounce back by, say, 8% in December (to around 18,500), the quarterly number of approvals in the December quarter would still be down 7.6% from their March quarter 2015 peak.
What does this mean for the economy? As seen in the chart below, there is a reasonably close relationship between quarterly approvals and the value of new dwelling construction as reported in the national accounts. In the year to end-September, new dwelling construction rose by 12.8%, contributing 0.4pp to annual growth in GDP of 2.5%. In line with the rise in building approvals, new dwelling investment has enjoyed a nice upturn since mid-2012. That said, the decline in approvals in recent quarters suggest new dwelling investment likely declined in the December quarter – indeed, there’s a good chance new dwelling construction peaked in the September quarter.
As I’ve noted previously, even if new dwelling construction levels out (at an albeit high level) its contribution to economic growth will fall away to zero. If building approvals continue to trend down, however, it’s more likely new dwelling investment will decline through 2016. Assuming, for example, a relatively gentle decline in quarterly building approvals to around 50,000 by the December quarter 2016, the real value of new dwelling construction (in 2013-14 prices) should decline to at least around $13 billion by then. If so, that would represent around a 5% annual decline in spending, or a detraction from annual economic growth of 0.2pp.
Such a downturn in housing construction would represent a sizable swing in its direct contribution to annual economic growth of around 0.6pp from the September quarter 2015 to the December quarter 2016. This is only a direct effect, moreover, and ignores the substantial multiplier effects that housing construction has on the rest of the economy – which would likely at least double the swing in its contribution to annual economic growth to around 1.2pp.
Together with the ongoing mining investment downturn, an imminent turn in the housing cycle presents a major challenge for the economy this year.