"The long lead times on higher-density construction mean the supply response is likely to be slow. The tight conditions on lending to developers may mean it is even more protracted. The growth in demand without a meaningful supply response will lead to a larger price response.

"Hence some large developers tell us that they are prepared to retain their employees through the coming trough in activity."

On Wednesday, the Commonwealth Bank's economics team estimated that dwelling investment, which has already fallen 9.2 per cent from its peak, would bottom out by mid-2020.

"Demand is still continuing to increase given population growth," Dr Debelle said. "While there are pockets of oversupply, particularly in parts of Sydney where the vacancy rate is high, they are not widespread. Prices have turned in Melbourne and Sydney, which probably brings the investor back into the market."

The CBA estimated that the full downturn would cost the economy 1.4 percentage points worth of overall growth, less than the 2 percentage points subtracted by past residential construction downturns.

RBA deputy governor Guy Debelle: "One other area where the spillover from housing to the rest of the economy has been larger than we had expected, is its impact on inflation." Alex Ellinghausen

Dr Debelle estimated that the overall downturn in residential construction would subtract around 1 percentage point from GDP growth from peak to trough, given that dwelling investment accounts for around 6 per cent of GDP. But the broader economic impact could be more.

He said the concern was that many smaller operators would not survive this downturn and that had big consequences for the broader economy.


"Gross mixed income, which is primarily small business income, declined by 3.8 per cent over the past year ... a sizeable part is low income growth from contractors in the residential construction sector. This has contributed to the overall historically low growth in household incomes."

"We estimate that this explains around half of the recent slowing in consumption."

He also addressed lending conditions, suggesting that banks had not created a credit squeeze and that it was more demand driven rather than supply.

"The slowdown in housing credit growth to households has primarily reflected the housing cycle rather than driven it. That is, the slowdown in credit growth is primarily a demand story rather than a supply story."

Negative equity is low

However, Dr Debelle did note a slowdown in credit for small businesses.

"While I believe that the slowdown in housing credit is more a result of weaker demand than tighter supply, I said last November the effect of a tightening in lending to developers seems to me to be a higher risk to the economic outlook than the direct effect of the tighter lending standards on households ...

"Relatedly, there may also be a bigger impact on lending to small business given the extensive use of property as collateral for small business loans. This still is very much the case nearly 12 months on."


The deputy governor also said the housing construction downturn was a key determinant of low inflation readings at the moment and a reason why the central bank had cut interest rates by 75 basis points to 0.75 per cent.

"One other area where the spillover from housing to the rest of the economy has been larger than we had expected, is its impact on inflation.

"The two largest housing-related components of the consumer price index basket are rents and new dwelling purchases by owner-occupiers, which together account for around one-sixth of the CPI basket."

Dr Debelle said the level of negative equity in households was quite low even after the fall in home prices up to May this year.

"We estimate that around 3.75 per cent of mortgage balances [by value] are in negative equity, up from around 2 per cent a year ago."

'The infrastructure spend will stay'

In the question and answer session after his speech, Dr Debelle was asked whether the bank expected house price growth to exceed income growth and what role macroprudential policy had to play if that was the case.

He said macroprudential policy had never been about house prices, but about lending standards.


“House prices and lending are not the same thing – they are often highly correlated but they don’t have to be the same thing. From a prudential point of view, it’s the quality of lending that is paramount.”

One of the issues the Reserve Bank is considering is whether those that have been employed in the housing sector will be able to find new work in the broader construction industry, as states ramp up their infrastructure spending.

Dr Debelle was asked whether a "chippie installing kitchens" was going to be hired on a complex infrastructure project.

He said a “decent amount” of workers had been able to transfer out of residential construction but it depended on the skill set and not all of them were completely transferable.

“The infrastructure spend will stay at a high level for the foreseeable future. It's not just the big infrastructure projects but smaller-scale projects where there will be a transferability of skills."

Build to rent

Dr Debelle was also asked about housing affordability, given the run-up in house prices that had not been accompanied by income growth.

He said there had been “a distributional impact” – ie there were winners and losers, and that there was an intergenerational aspect. Some Australians would have parents who owned a house and had therefore benefited, while others did not and would not.


But it was not something the Reserve Bank could do much about, he said.

“It is actually related to the supply response, in terms of building affordable housing.

“There has been an interest in ‘build to rent’ for instance, which from an investment point of view is an interesting proposition and seems to be gaining momentum.”

Dr Debelle said the investment demand for housing from foreigners did play a role in the recent house price cycle “but not as much as some have emphasised”.

“We have had foreign demand with various migration flows through time. This time more a store of wealth than a place to live but foreign demand had always played a role.”