Citi says government policy could exacerbate labour shortages and increase property demand

Housing policies announced by the federal and Victorian governments may actually worsen current affordability issues for households.

Though well intentioned, Citi says policies to encourage new home construction may be counter-productive.

Federal and Victorian government intervention to address the housing shortage would keep the prices of existing homes elevated despite rising borrowing costs.

Citi analysts say the recently unveiled policies to encourage the construction of new housing may end up worsening labour shortages, cause additional wage inflation and even increase property demand, which would be inflationary and worsen affordability.

Their comments come ahead of Tuesday’s monthly meeting of the Reserve Bank board, the first under the leadership of the new governor Michele Bullock after she succeeded Philip Lowe last month.

The RBA board is widely expected to decide to keep the official cash rate on hold at 4.1 per cent, the highest in more than 11 years, as it gauges the impact of the rapid lift in the cash rate from a record low of 0.1 per cent over the past 17 months.

However, the central bank is also expected to keep the door ajar for further rate increases amid uneven progress in lowering inflation and the fact that unemployment figures remain near record lows.

CoreLogic’s national average house price index rose 0.8 per cent month-on-month in September to be 6.6 per cent, just 1.3 per cent below its April 2022 peak.

The Australian mortgage market has so far been “immune” to rising borrowing costs due to the combination of strong credit growth and asset quality, and it’s “difficult to see a near-term bear case” because of the current demand-supply imbalance, according to Citi. The upcoming stimulatory benefit from multi-year government policies announced in recent weeks comes on top of an existing “demand-supply imbalance” in the property market.

Reserve Bank governor Michele Bullock. Picture: John Feder

“We believe these policies, which encourage the construction of new housing, may create a fast-spinning flywheel effect in the housing market,” Citi analyst Brendan Sproules said.

Meanwhile a post-pandemic rebound in immigration is driving the fastest population growth since the 1950s, and the supply of new dwellings under construction is slowing because of rising wage and input cost inflation, as well as higher borrowing costs, potentially causing a significant undersupply.

“All these factors are driving residential property vacancies to all-time lows, and driving rents higher, as well as faster than underlying inflation,” Mr Sproules said.

The new policies are designed to incentivise the private sector to lead the development projects required to meet the new housing targets. This is to be achieved through a range of financial incentives, rezoning of government land in key metropolitan areas, removing planning powers from local governments and taxing short-stay accommodation to encourage more long-term rental property availability, as well as encouraging more institutional investment into the market.

But Citi says that achieving the new housing targets won’t be an easy task, with influential property developers highlighting Australia’s dysfunctional planning system and huge labour shortages, despite billions of dollars of public funding pouring into the sector.

The policies have highlighted the difficulties the housing market has in accommodating the influx of migrants needed to meet growing labour needs, and the fact that they will create multi-year employment opportunities for the construction sector, the nation’s third-largest employer.

Mr Sproules said the other challenge that the new government policies brought was the prospect of higher wage growth and a broader inflationary impact on the economy.

“This will add to the overall cost of building the new home targets, and ultimately worn by the end buyer, which will be additive to the affordability issues across the economy,” he said.

Strong demand for housing, despite the higher borrowing costs since the end of the Covid-19 pandemic has been fuelled by wage growth, higher workforce participation and the accumulation of household savings during the pandemic.

The undersupply of houses in Australia is also exacerbating already very tight rental markets, forcing rents up and driving renters to consider buying earlier than they otherwise would have. At the same time foreign demand is returning to the domestic market after the pandemic.

“Buyer demand has been strong but supply remains weak with total listings up from their lows but still below normal,” AMP head of investment strategy and chief economist Shane Oliver said.

“Talk of rising prices and shortages has in turn further boosted demand, with an element of FOMO (fear of missing out) attracting less interest rate-sensitive buyers into the market.

“Expectations that interest rates are at or close to the top has likely also helped.”

But Dr Oliver isn’t confident in his forecast of higher house prices next year as the cumulative impact of interest rate increases on the economy pushes up unemployment. “There is a high risk that just as this year turned out to be far stronger than expected, next year might turn out to be far weaker than expected,” he said.

Morgan Stanley says the rise in house prices over recent months has “removed an important downside risk to the broader economy”, although expectations of significant further uplift are “limited given affordability headwinds and the resumption of supply into the market”.

However, the poor construction dynamics that are likely to emerge in coming months, given the sharp fall in building approvals so far this year, seem “under-appreciated” by investors, it says.

“This will have important implications on construction activity and employment (with the construction sector making up about 10 per cent of the labour market) and should be a key driver of a higher unemployment rate over the next 12 months.”

But amid uneven progress in the battle against inflation, with unemployment figures still at near record lows, the board should keep borrowers on notice that further rate rises could be needed. If RBA were to increase the cash rate for the 13th time in this current cycle, the average borrower with a $500,000 loan at the start of the increases could be paying a total of $1210 more a month on their mortgage, according to RateCity.

An estimated 730,000 mortgages had already come off their ultra-low fixed rates this year, with around another 150,000 still to come off this year, said RateCity research director, Sally Tindall.

RBA data shows there were 590,000 mortgages that came off fixed rates in 2022, and there will be 880,000 in 2023 and 450,000 in 2024.