Maxim Economic Insights

• Consumer and business confidence have both been hit over the past month after the political turmoil in Canberra, as house prices continue to fall, and as trade war rhetoric continues globally.
• This fall in confidence and the associated impact on retail sales recently, has again increased the focus on the potential impact on the domestic economy that consumer headwinds are playing – things like high debt levels, low wages growth, and the dip in confidence.
• But while confidence has fallen business conditions, profitability, trading, and employment have remained strong.

 

CONFIDENCE TAKES A HIT, BUT BUSINESS CONDITIONS REMAIN SOLID AND EMPLOYMENT LOOKS POSITIVE STILL

It’s easy to find reasons to be worried about the outlook for the Australian economy. Recently we’ve seen that the political turmoil in Canberra appears to have impacted both business and consumer confidence and we’ve seen the latest retail sales show no growth during the month of July. Likewise, the continued fall in Sydney and Melbourne house prices appears to be taking its toll on the outlook for the economy even though the latest print for economic growth showed Australia has entered its 27th year of this world record beating period of expansion.

The 0.9% growth rate in the second quarter of 2018 goes some way to supporting the RBA’s continued positivity about the outlook for the domestic economy which it continues to see as likely to grow at, near, or above the 3% level for the next few years. That’s solid growth by any stretch when judged by the estimates of potential growth rate for the Australian economy.

Likewise, so too does the fact that even though business confidence has fallen recently business conditions, trading, and profitability are holding in and are likely a better guide to the current business environment – at least in aggregate.

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This is important because while Trading and Profitability continue to be robust, they are allowing the Employment sub-index of the NAB business survey to continue to point to more than 20,000 jobs being created per month according to NAB chief economist, Alan Oster.

Oster added that, “The stabilisation of the forward looking indicators provides some comfort that while business conditions have eased from the levels seen in early 2018, the outlook remains positive. In combination with a rebound in business conditions this month, this suggests that the business sector has continued to perform strongly as we enter the second half of 2018”.

That’s important because that then means “the employment index continues to show a pace of employment growth greater than that of the population which should see the unemployment rate decline further,” Oster said. And what that may mean is that with the decline in unemployment and crucially underemployment and underutilisation Australian workers may be able to start to see an increase in wages begin again soon. This is an important part of maintaining household consumption with a 1% savings rate and falling house prices.

 

HOW FAR CAN HOUSE PRICES FALL? 

If you watched 60 Minutes recently and heard that house prices in Australia could fall up to 40%, you’d be forgiven for reaching for an adult beverage. And while one should never say never on these types of forecasts – especially after 27 years without a recession in Australia and the excesses of debt that flow from that – that would be a possible but remote probability of occurring.

That said though, there does appear to be a continuation of the weakness we have seen in house prices recently in Sydney and Melbourne in particular.

The trouble with falling house prices is that it is both most Australians biggest store of wealth, while Australian’s also carry a lot of debt against housing.

Recently, RBA Assistant governor, Michelle Bullock, said this investment in property is “a boon in the boom times, but likely a handbrake on consumption as the housing market and prices slide".

Ultimately, if there is a shock she said, “this could have adverse effects on the real economy – for example, in the form of lower economic growth, higher unemployment and falling house prices – which could, in turn, amplify the negative shock”.  That’s the fear for the outlook many economists hold.

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The big question is how far and how fast prices will fall. It’s a difficult question to answer because this cycle looks different. That is, unlike previous price falls over the past couple of decades, changes to APRA regulations around investor lending, and with regard to lenders needing to prove to a more realistic level of expenses – and hence serviceability of the loan – have effectively ushered in a credit crunch in home loan lending.

Indeed, given the enhanced oversight expected from the banking regulator of borrower expenses, and the likelihood that this puts an upward bias on expenses, the result is that for any given level of income for a an individual or household, the available loan is smaller now than it was 12 months ago.

That doesn’t imply a crash in housing, but it does suggest it is less easy for leveraged borrowers to chase prices higher. That means they stagnate and start to fall back as we have seen. That in turn puts marginal borrowers, those on interest only loans in need of switching to principal and interest, and those who have bought off the plan at risk. So, it is reasonable to expect that a 10% peak to trough fall in prices could result in Sydney and Melbourne, perhaps even 15%. Newcastle and the Hunter however, are expected to fare significantly better.

 

WHAT DOES IT MEAN FOR THE AUSSIE DOLLAR AND INTEREST RATES

Despite the 3.4% year-on-year growth rate in Q2 2018, the RBA is firmly on hold. That’s for at least 2019 according to market pricing while some notable economists believe the RBA will be on hold until 2020. Naturally, these forecasts are subject to revision, but the primary drivers of expectations the RBA’s will hold rates at 1.5% is driven by the uncertainty around the housing market and the potential uncertainty surrounding both the upcoming election and the potential further downward impact on housing from the end of negative gearing should Labor win the next Federal election and institute policies as planned.

This period of low rates when the Fed is raising rates and the global economy is at risk from trade wars should see the Aussie dollar fall toward 0.6850, perhaps even 65 cents.

Financial conditions in Australia would ease as a result providing a shock absorber for the Australian economy.

 

Written by Maxim's "economic expert", Greg McKenna 

 

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