The continuing decline of Australian house prices will remain a key theme for the Australian economy next year, according to Morgan Stanley.
Ongoing threats to domestic consumption -- which comprises 60% of Australia's economy -- were evident yesterday, as Australia's Q3 GDP growth missed to the downside.
The result was largely due to falls in household expenditure, as the economy relied on rising business investment and infrastructure spending to pick up the slack.
While most Australian economists still have a cautiously optimistic view toward 2018, any extended declines in house price growth will need to be closely monitored.
Here's Morgan Stanley on why it's important:
"Australia has not had an official recession for 26 years and built into that narrative is also a perception that housing has not faltered either.
There have certainly been parts of the economy that have seen slowing housing conditions over the last 20 years but the weakness has often been short lived.
If this is a sustained slowdown – our caution towards banks, consumer and housing-linked sectors will prove warranted."
The Sydney-led slowdown in Australia's housing market has seen annual house price growth halve from the May 2017 peak, and data from CoreLogic this morning showed clearance rates remain at a two-year low heading into the end of the year.
Recent price declines have been driven by the lagged impact of lending restrictions introduced by APRA in April.
Last month, real estate agents in the Sydney market told Business Insider they expect market conditions to continue cooling into the end of the year before stabilising in 2018.
However, Morgan Stanley remains unconvinced house prices will rebound as they did following the previous APRA measures in 2015, given the RBA subsequently cut rates by 50 basis points in 2016.
"Our proprietary housing market indicator, MSHAUS, is now at its lowest point in its 28-year history, suggesting conditions will deteriorate further into 2018," Morgan Stanley said.
Morgan Stanley's MSHAUS index is based on six sub-indexes. It's largely comprised of supply/demand balances (30%), mortgage serviceability (25%) and credit supply (30%).
"The key incremental negative has been the sharp fall in the share of interest-only (IO) mortgages," Morgan Stanley said, as banks adhere to APRA's 30% cap on new interest-only loans.
Data released by APRA this week showed a sharp decline in new IO loans in the September quarter, and JP Morgan economist Tom Kennedy raised the prospect of further macro-prudential restrictions to come.
The Morgan Stanley analysts also expect construction activity to decline, given housing approvals and commencement have declined from their record highs.
"However, with housing supply continuing to outpace our estimate of demand, price growth will trend lower and likely see modest falls in Sydney," the analysts said.
"Conditions are worsening more notably in Sydney, while in Melbourne demand has been supported by an increase in net migration."
With auction volumes in decline, "price will now play its part", Morgan Stanley said.
"Post-summer sentiment and credit availability will be key to determining risk or opportunity" in housing, and by extension the broader Australian economy in 2018.