Fabo and Deverell say the downward forecast revision largely reflects an expectation that prices will fall much further in Sydney and Melbourne, not only the largest and most expensive housing markets in Australia but also the capital cities that have seen the fastest price declines this year. “Sydney and Melbourne average dwelling prices have fallen 9 per cent and 5 per cent, respectively, but are currently falling at annualised monthly rates of roughly 10 per cent,” Macquarie says. “This suggests that Sydney and Melbourne housing prices are now more likely to fall by 15 to 20 per cent from the peak. The fall in Sydney prices is already one of the largest on record.” Near-term, Macquarie says the rate of decline in Melbourne housing prices could outpace falls in Sydney given an increase in new property listings in the city over recent weeks, adding to already elevated levels of stock currently up for sale. While undoubtedly an ominous forecast on the outlook for prices in Australia’s largest cities, Fabo and Deverell say such declines need to be put into perspective.

“Because of the extent of the rise in Sydney and Melbourne housing prices in recent years, even a 20 per cent peak-to-trough decline would merely take prices back to April/May 2015 levels,” they say. The expected declines in the housing market would take prices back to 2015 levels. Credit:Macquarie So while large in nominal terms, such a decline would only leave median valuations where they were just over three years ago. But what about the potential for these large declines, potentially wiping hundreds of thousands of dollars in paper wealth for household balance sheets, to lead to negative impacts on the broader Australian economy, including the possibility that the downturn in prices could become disorderly leading to sharply lower household spending and weaker economic growth? While that remains a risk, Fabo and Deverell say such a scenario is unlikely to eventuate unless labour market conditions start to weaken.

Credit crunch fears overblown “The most important question in our view, and for the RBA, is whether the adjustment in housing prices continues to be orderly as it has been to date in our view,” they say. “We think it will as long as the broader macro backdrop remains solid. “The unemployment rate in Sydney is just 4 per cent, which is equal to the lowest it has been for at least 30 years. In fact, since Sydney housing prices peaked in mid 2017, employment in Sydney has risen by more than 4 per cent and provides strong evidence that housing is not ‘the economy’. “Melbourne’s jobless rate has also fallen sharply of late.”

Along with strengthening labour market conditions in these cities, Fabo and Deverell says recent fears over a potential credit crunch is overblown. Loading “A significant curtailment of the availability of credit should see declining average loan sizes in addition to weak aggregate lending. We are seeing neither of those,” they say. “APRA data also show that only around 18 per cent of new housing debt in Q2 2018 were close to the largest loan size allowed, 90 per cent or more of the maximum. This is not an indication of severe credit curtailment.” As for the risk posed by proposed changes to negative gearing and capital gains tax from the Labor Party, Macquarie says that while they’ll have some impact, it will likely be small.

From an external perspective, Macquarie says the risk of a sharp downturn in the global economy remains the greatest threat to its forecasts. “Housing price falls against a deteriorating economic backdrop are much more likely to become disorderly and perpetuate economic weakness,” Fabo and Deverell say. Loading Replay Replay video Play video Play video Global economy risks While they admit the risk of a sharp slowdown in the global economy within a few years “appear to be increasing”, for the moment they say their central case is that “solid growth continues for some time”.