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Hostels:

Long Term:
If you are planning to stay in Sydney for a while backpackers tend to settle in around six different suburbs around the city - Bondi (eastern suburbs - lots of Irish and English), Coogee (eastern suburbs - mainly English), Bondi Junction (eastern suburbs - nearly exclusively Irish), Surry Hills (city centre), Glebe/Newtown (west city - an alternative area popular with the gay community), and Manly (northern suburbs - English and Irish). All of these suburbs have their own separate communities, places to go out and necessities such as supermarkets etc.

Short-term:
Loads of hostels to choose from here, in all suburbs. Kings Cross in particular has loads of hostels. There is a great YHA in the city centre, and a variety of hostels can be found in Bondi and Manly.