Opinion: House prices have only just begun to soften, but a deeper and more prolonged downturn could weigh on household spending, construction and economic growth, argues Stephen Koukoulas.
Australian house prices have started to fall. The drop is not large at this stage – it is less than one per cent from the peak in March 2026.
At one level, the fall to date should be viewed in the context of the recent price surge where house prices rose more than 40 per cent in five years, but it is enough to warrant a close look at how a protracted or deep fall in prices could impact the economy.
In simple terms, falling house prices will undermine economic growth. As growth slows, employment and inflation also come under pressure. The deeper the fall in house prices, the weaker economic growth is likely to become. Inflation will also fall, both of which would prompt the RBA, in time, to cut interest rates to help stabilise the economy.
Impact of falling house prices
The importance of house price changes and their impact on the macro-economy are evident through several well-established and well-understood channels.
Falling house prices have an obvious negative effect on household wealth. Australians have over $12 trillion of assets linked to residential property. For each one per cent fall in house prices, housing wealth falls by $120 billion. It is clear how falls of 5 or even 10 per cent, as some are forecasting, will hit wealth.
Falling wealth crimps the growth rate of household spending as future borrowing capacity is lowered, consumer sentiment is undermined and the “surplus” cash from those downsizing is reduced.
Falling house prices will also undermine dwelling construction for the simple reason that property developers and builders will postpone or cancel construction projects if there is a heightened risk, or certainty, of low or no profits.
If the expected selling price of a dwelling for the developer drops as house prices fall, for a given and inflexible change in the cost of materials and labour in the construction process, there is a financial incentive not to build.
Builders will not undertake a project if there is a material risk the eventual selling price is lower than the cost of building. It is that simple.
The R word
This probable fall in new construction reduces the pace of economic growth. Manufacturers and suppliers of building materials will experience falling sales while workers in the construction sector will have their hours of paid work reduced.
In addition to these negative factors is the heightened probability of problems for banks and other lenders. Falling house prices in concert with higher unemployment feed into a rise in bad and doubtful debts for the banks as householders struggle with mortgage repayments.
This drives bank share prices lower, eroding the wealth of shareholders. Banks will scale back and tighten their lending which leads to a credit crunch – an event that sees lending levels weaken. The difficulty for householders in getting loans compounds the broader economic downturn.
If the housing price downturn is sufficiently large and protracted, it will trigger a hard landing for the economy – a recession in other words.
Even as the economy approaches this unwelcome and unnecessary position, there will inevitably be a major economic policy response. The most effective and easily implemented of those will be cuts in interest rates.
The interest rate buffer
On that score, the RBA currently has a substantial interest rate buffer with the cash rate currently at an equal 14-year high of 4.35 per cent.
In other words, the RBA can potentially ease monetary policy by many hundred basis points if the economic fall-out from the house price declines spark a meaningful rise in the unemployment rate with a substantial decline in inflation.
By way of historical examples, during the COVID crisis, the RBA cut interest rates by 140 basis points to a record low 0.1 per cent and it implemented a series of interventions in the banking system which further lowered retail borrowing interest rates. During the global financial crisis in 2008 to 2010, interest rates were cut by a total of 475 basis points; in the “tech wreck” of 2000 to 2001, rates were cut 200 basis points.
All of which shows the RBA has the capacity and where necessary the willingness to stem the negative economic effects if the house price decline gets intense and percolates through the economy.
The state of play
At this stage, there is little to suggest that the current cyclical downturn in house prices will be sufficiently extreme to require such an extreme policy response. Indeed, it could be a healthy development that improves affordability and triggers a lift in first home buyer activity.
That said, falling house prices are inevitably a significant economic event that the government, consumers, the RBA and investors will be watching closely.
A soft landing for house prices, which is a peak-to-trough fall of the order of 5 per cent, is unlikely to have a large impact on the economy other than confirming slower overall economic growth and lower inflation.
If the price falls approach or look to exceed 10 per cent, there will be intense concern about the destruction of household wealth and the problems this will mean for the economy, jobs and the banking sector.
This is a scenario that would likely trigger a hard landing for the economy, a free-fall in inflation and aggressive interest rate cuts from the RBA.
Stephen Koukoulas is Managing Director of Market Economics, and has 30 years’ experience as an economist in government, banking, financial markets and policy formulation. Stephen was senior economic advisor to prime minister Julia Gillard, has worked in the Commonwealth Treasury and was the global head of economic research and strategy for TD Securities in London.
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