"As Australian household debt relative to income has steadily increased, there is now meaningful downside risk to the economy as the housing cycle unwinds. This is specifically due to very high levels of household debt, tight credit conditions, potential downside to jobs and economic activity from the construction sector, and the almost inevitable rise in household savings impacting 60% of GDP via household consumption.
"This resistance and pressure can also be attributed to the implications of The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. While creating tensions within the quality of lending practices, the primary impact has been to create tighter financial conditions for households to borrow.
"In the past, certain households could supplement spending despite low savings by increasing leverage ? that is, borrowing against real assets, as occurred in 2000-2005. In the current credit environment, this is almost certain not to happen again to the same degree."
Chris says the risk is that housing weakness can lead to more tangible economic weakness. As prices fall and credit becomes tight, the construction industry will begin to contract and jobs will be lost.
"If we look at the historic ratio of construction jobs to total jobs, it could be as many as 250,000 jobs (or 2.2% of the total workforce).
"The experience in the US was worse post the financial crisis, as the industry shrunk to a size much smaller than the pre-cycle ratio. Markets tend to overshoot, and the construction job market in Australia is prone to meaningful downside risk.
"While the RBA will be reluctant to cut given the current governors' preference for financial stability over inflation, as far as financial stability is concerned, we fear that horse has already bolted. If the housing market continues to weaken, we believe the risk is that the RBA will face a sharply weaker economy in 2019 and will be forced to consider an official rate cut before the end of the decade."