The housing market might be entering a short-term 'air pocket' but greater turbulence does not imply a crash, says Westpac's chief economist

By Luci Ellis^

Since the Federal Budget in May, alarmist predictions about the housing market consequences of the announced tax changes have become commonplace. Recent interest rate rises, together with these changes, are clearly weighing on housing turnover and prices, leaving both buyers and sellers more uncertain.
As the pandemic experience made clear, when fiscal and monetary policy work together, they make for a powerful combination. The current situation is an example: a tightening of tax policy affecting housing coinciding with tight monetary policy. Given housing is a notably interest-sensitive sector, the conditions are therefore in place for a weaker housing market. Importantly, though, this is not the same kind of policy shock as the prudential policy changes and Royal Commission response of the 2010s. Credit supply is not directly affected and remains readily available.
There are, however, signs that things are turning out a bit weaker than our projections, released in late June. Housing price growth has turned down across all cities, with outright declines for most in the latest month; while we expected prices to move lower, the momentum is running a little ahead of our projections.
How people interpret this weakness is an open question. In recent times, when prices have been expected to fall, consumers have seen this as meaning it is a less bad time to buy a home. This contrasts with the usual historical pattern when strong price growth was seen as heralding a good time to buy.
A slightly-less-bad view of affordability as prices decline is not currently translating to buyer interest, though. The uncertainty around the effects of the tax changes could be inducing some negativity, or at least some divergence of views across the household sector, especially between investors and prospective owner-occupiers. Timely industry data show home loan credit enquiries have declined to levels last seen in late 2022 and are falling at a monthly pace of around 4%. This is broadly consistent with our forecast for turnover to decline by around 20% this year.
Indicators of conditions in the physical market are also weaker. Auction clearance rates have fallen to previous cycle lows in Sydney and Melbourne. Turnover has declined sharply in most jurisdictions, and while new listings are also starting to move lower, they are falling more slowly than sales. As a result, stock on market is rising relative to the flow of sales and turning established housing into more of a “buyer’s market”. That said, the data also show notable divergences across cities, highlighting that local market conditions matter, and often differ materially.
While things seem a bit softer than we earlier projected, consider the starting point. In all major cities other than Melbourne, housing prices had run up considerably in recent years. A moderate decline would still leave prices notably higher than a few years ago. As the RBA has pointed out recently, the number of people in negative equity (home value below mortgage balance) is very low, and even a moderate decline in prices will not add much to this figure. While unemployment is forecast to drift up from here, this is mostly a story of job growth failing to keep pace with strong population growth and rising participation, not outright job losses. “Fire sales” by distressed borrowers are therefore unlikely to add downward pressure to housing prices while job prospects for mortgagors remain reasonable.
Meanwhile, the grandfathering of tax changes means that current owners of investment properties have little incentive to sell, while owner-occupiers are also likely to want to stand back and avoid catching the “falling knife”. A period of low turnover is likely; this kind of thin market can result in prices being volatile, but it typically lacks the wave of distressed selling that is needed to induce large, self-reinforcing downward price spirals.

RBA will not take fright

The question then becomes how the RBA will respond. Will it see a softer housing market as simply the normal channel of policy transmission, or an additional shock with the potential for a more alarming over-correction? Some of the more dovish perspectives we have heard from customers tilt to the “over-correction” story, but in our view, the RBA was never likely to react strongly to the fourth housing downturn in a decade.

The RBA’s mandate relates to inflation and full employment; housing prices are not a policy objective – and in any case, it is not obvious what such an objective would entail. Would a financial stability lens favour gently rising prices to avoid negative equity and loan distress? Or would an affordability lens favour declining prices? There are good reasons why Parliament has not charged the RBA with targeting housing prices, and good reasons why the housing element in the RBNZ’s mandate was dropped after a few years.

As RBA officials have been at pains to point out, the Bank does not target housing prices but instead gleans information from them. Weak prices tend to induce weak turnover, which contributes to softer economic activity. Lower housing prices can over time induce negative wealth effects on consumption – though any period of decline must be set against earlier run-ups. How the housing market is performing tells the RBA something about how monetary policy is playing through the economy. Some softness is expected when interest rates are high; the question is whether that softness is greater or less than expected. The experience of 2018–19 shows that soft housing markets and weak growth in household incomes can weigh on consumption – and so inflation – more than expected. But recall that was when inflation and interest rates were already subdued, fiscal policy was contractionary and there were no offsetting boosts to demand from infrastructure, data centres, or other forms of investment.

We also note that, since our last published release of housing price forecasts in the late-June Housing Pulse, we have taken out the two RBA rate hikes we previously expected and brought forward the timing of the subsequent rate cuts from February 2028 to August 2027. A period of stability for rates in the near term might be enough to temper the downside risks in housing or even allow for some stabilisation. Whether this plays out will become clearer as we head into the spring selling season.

In addition, earlier rate cuts mean the outlook for 2027 is a bit brighter than before, further supporting the idea that weakness this year is an “air pocket”, not a lasting downturn. We will formally revise our housing price forecasts in next week’s Market Outlook, after the RBA decision. Directionally, though, the story is near-term weakness in 2026, not a downturn stretching into 2027.

Luci Ellis is the chief economist at Westpac Group.