Australian capital city dwelling prices fell another 0.6% in October, marking 13 months of consecutive price declines since prices peaked in September last year. This has left prices down 4.6% from a year ago, their weakest since the GFC.

The decline is continuing to be led by Sydney and Melbourne. Sydney dwelling prices fell another 0.7% and have now fallen 8.2% from their August 2017 high. Melbourne prices fell another 0.7% and are down 4.9% from their November high. Perth (-0.8%) also saw prices fall, but Hobart (+0.9%) and Adelaide (+0.2%) saw prices rise with prices flat in Brisbane, Darwin and Canberra.

Source: CoreLogic, AMP Capital

Tighter bank lending standards particularly around tougher income and expense verification and total debt to income limits, poor affordability, rising unit supply, falling price growth expectations and FOMO (fear of missing out) risking turning into FONGO (fear of not getting out) for investors are pushing prices down in cities, which have seen strong gains since 2012, i.e. Sydney and Melbourne. This is continuing to be evident in very weak auction clearance rates and auction sales volumes in those cities. Recent auction clearance rates averaging around the mid 40s in Sydney and Melbourne are consistent with ongoing price declines of around 7% p.a.

Source: Domain, CoreLogic, AMP Capital

Source: CoreLogic, AMP Capital

The decline in Sydney and Melbourne property prices likely has much further to go as these considerations continue to impact potentially accentuated by further out of cycle bank mortgage rate increases and expectations that negative gearing and capital gains tax concessions will be made less favourable if there is a change of Government at the coming Federal election. In these cities we expect to see a top to bottom fall in prices of around 20% spread out to 2020. If anything, the risks are on the downside, particularly if negative gearing and capital gains tax arrangements are changed. So there is more to go yet!

Source: CoreLogic, AMP Capital

Having not had the same boom over the last five or six years, other capital cities are likely to perform better. Perth and Darwin are likely close to bottoming (albeit the bottoming process is taking a lot longer than I have been expecting!), Adelaide, Brisbane, Canberra and Hobart are likely to see moderate growth, with Hobart slowing down after its recent mini-boom.

Similarly, home prices in regional centres are likely to hold up better with modest growth as they haven’t had the same boom as Sydney and Melbourne and offer much better value and much higher rental yields. The average gross rental yield for regional areas is 5% compared to just 3.6% in the capital cities.

Overall, Sydney and Melbourne are likely to see a top to bottom fall of around 20% spread out to 2020, but for national average prices the top to bottom fall is likely to be around 10%. A crash landing – say a national average price fall in excess of 20% - remains unlikely in the absence of much higher interest rates or unemployment, but it’s a significant risk given the difficulty in gauging how severe the tightening in bank lending standards in the face of the Royal Commission will get and how investors will respond as their capital growth expectations collapse at a time when net rental yields are around 1-2%.

Implications for interest rates

Ongoing home price falls in Sydney and Melbourne will depress consumer spending, as the wealth effect goes in reverse. Homeowners will be less inclined to allow their savings rate to decline. It’s also a negative for banks. It’s consistent with our base case view that the RBA will leave rates on hold out to late 2020 at least. However, home price weakness is at levels where the RBA started cutting rates in 2008 and 2011 and the 2015-16 property slowdown was also turned around by rate cuts in May and August 2016. So we still can’t rule out the next move in rates being a cut rather than a hike – but at this point the RBA is a long way from contemplating a rate cut, as it would need to see evidence that the slump in home prices and the drag on consumer spending is seriously threatening to push inflation even lower - so it’s probably a second half 2019 story at the earliest.