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Australian households ‘world-beating borrowers’

When Atlassian co-founder Mike Cannon-Brookes reportedly paid close to $100 million for the Fairfax family home in Point Piper this past week, it helped confirm that housing in Sydney and Melbourne has become seriously expensive.

The world’s longest property upswing (55 years and counting according to the Bank for International Settlements[1]) and a surge of more than 60 per cent in the past five years (notwithstanding a modest downturn in the last 12 months) will do that.

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But just how expensive has Australian property become?

One way to look at it is how much buyers have to borrow to be able to afford a home in Australia, and on this front recently-released figures compiled by the International Monetary Fund[2] provide an intriguing insight.

They show that, when it comes to going all-in to buy a house, no-one comes close to Australian borrowers.

In the three months to June, almost two-thirds of all loans (by value) in Australia were mortgages, which is far higher than any other nation for which the IMF has published figures.

Of the 79 other countries, including 23 advanced economies, that provided financial data to the IMF for the June quarter, none had a home-to-total-loan ratio above 46.3 per cent – a figured dwarfed by Australia’s 63.7 per cent.

The huge share of loans that are for mortgages isn’t being driven by more people borrowing. In fact, the number of owner occupiers taking out loans has been remarkably stable over time. In July 2005, there were 55,123 such borrowers. Twelve years later, in July 2017, there were 54,881.

But over that same period, the proportion (by value) of all loans that were for housing jumped from 56.3 to 63.75 per cent. Some of this growth was surely down to more investors getting into the property market. But the biggest driver was likely to be the surge in house prices over that time.

The preparedness of homebuyers to borrow so heavily to buy housing indicates a number of things:

  • a belief that a mismatch between supply in demand in key city markets will persist;
  • that this mismatch will drive house values up in the longer term;
  • that a mixture of fear and greed is at play – fear of being permanently priced out of the property market, and strong desire to grab a share of housing capital growth; and
  • that residential property will deliver better returns than other asset classes (noting that many are exposed to the sharemarket through their superannuation accounts).

The heavy borrowing required to compete in the recent property market has, of course, made households heavily indebted.

Household debt as a proportion of gross domestic product was at 104.9 per cent in the middle of the year, according to the IMF (Trading Economics/Bank for International Settlements reported it was 122.2 per cent)

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Current low interest rates have until now helped households carry this burden without too much distress, and less than 1 per cent of loans are ‘non-performing’. This is a world away from the situation in European countries hit hardest by the GFC, who are still climbing out from under their debt mountains. In Italy, for instance, more than 14 per cent of loans are still considered non-performing, and in Greece the ratio is a disastrous 45.6 per cent.

But the Reserve Bank of Australia, for one, sees, the level of household debt as a risk for the economy.

As a proportion of disposable income, the central bank warns it is high. The slowdown in wealth accumulation from the cooling property market, along with stagnant wages, has the RBA concerned that household consumption – a key driver of economic growth – could be weaker than it expects.

Moreover, others warn that a significant proportion of borrowers will struggle financially as interest only-loans transition into standard principle-and-interest mortgages in the coming year or so.

Against this, the jobs market is tightening, and there are nascent signs that wages are finally picking up.

The RBA’s core scenario is for above-trend growth driven by solid business investment and a gradual improvement in household consumption, which is underpinned by bigger pay packets, more jobs and low interest rates.

But the not-insignificant risks to this outlook posed by high household debt mean the current period of monetary policy stability – the RBA’s cash rate of 1.5 per cent hasn’t changed in more than two years – is set top continue for a while yet.

 

 

[1] https://www.smh.com.au/business/banking-and-finance/bis-says-australias-55year-house-price-upswing-the-longest-in-the-world-20171016-gz1kdc.html

[2] http://data.imf.org/regular.aspx?key=61404589

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Why the gloomsayers are overdoing it

When national leaders talk up how good things are, it is often taken as a sign that they are about to turn very bad.

So when Barack Obama and Malcolm Turnbull each delivered upbeat speeches in the past week, more than a few pessimists probably took them as vindication of their bleak outlook.

After all, there seems to be plenty to be worried about.

The new year has begun in a flood a red ink on global sharemarkets as China growth fears, weak commodity prices, terrorist attacks and natural disasters have all weighed heavily on investor sentiment.

For those determined in their gloom, the latest update on the Chinese economy suggested additional reason for pessimism. The world’s second largest economy expanded at an annual rate of 6.9 per cent in the last three months of 2015, its the slowest pace in 25 years.

Taken together with the decision by the International Monetary Fund to trim its global growth forecasts for 2016 and 2017 by 0.2 of a percentage point each to 3.4 per cent 3.6 per cent respectively, and the bearish mood would seem to be well founded.

But in striking discordantly upbeat messages about the outlook, Messers Obama and Turnbull are not just handing around warm cups of cocoa.

There are concrete reasons to think the gloom is overblown.

Although a sudden upsurge in economic activity appears as likely as a return by Tony Abbott to the Lodge, there are several pointers – local and international – that suggest optimism is not misplaced.

Most importantly, the US economy – still overwhelmingly the largest in the world – appears well established on a growth path.

If the US Federal Reserve’s much-anticipated interest rate increase late last year did not confirm it, a streak of sustained jobs growth that has seen the unemployment rate halve from 10 to 5 per cent ought to allay doubts.

Yes, many jobs have been part-time or casual, and wage growth is weak. And there are headwinds from the weak oil price, which has kicked the stuffing out of the shale gas industry, and the increasing US dollar, which will weigh on export competitiveness.

But cheaper petrol has also boosted real household income, and the American consumer is back shopping and spending, which in turn is encouraging businesses to hire and invest.

As has been widely recognised for some time now, China is engaged is engaged in a highly challenging phase in its economic and political development.

The investment-led growth model that has powered its expansion for the last 25 years has run its course, and left a massive overhang of excess capacity and troubling debt.

If this was not challenge enough, the central government’s reluctance to loosen its control over the economy is coming back to bite it. As The Economist notes, its current situation of a slowing economy, a semi-fixed currency and increasingly porous capital controls is a volatile combination – if the government loosens monetary policy to boost consumption, it will weaken the currency and encourage even more capital to flow offshore.

Still, the Chinese government has plenty of ammunition if recession threatens – $US3 trillion of foreign exchange reserves and ample room to trim interest rates and devalue the yen.

The gloom about Australia’s prospects is also overstated.

The fall in commodity prices has been steep, but so was their rise. As Rod Sims recently pointed out in The Australian Financial Review, the current dominant market narrative of a “collapse” in commodity prices is underpinned by a short-term view. From a historical perspective, they are more accurately depicted as returning toward their long-term average.

Pessimists also point to soft wages growth and a weakening housing market as causes for concern.

But the country is generating sufficient jobs to edge the unemployment rate lower – it fell to 5.8 per cent in December – setting a firmer base under pay rates and raising the prospect of an eventual consumption-boosting lift in household incomes as spare capacity shrinks.

And although capital gains in housing have slowed as some of the heat has gone out of the property market, sentiment toward buying shows signs of picking up.

On the question of whether now was a good time to buy a dwelling, the Westpac-Melbourne Institute Consumer Sentiment Index found a sharp improvement in mood. The index jumped almost 14 per cent this month to 113 points – the highest reading since May last year and only a little below the level of a year ago.

Westpac chief economist Bill Evans says the reading should be treated with some caution, but nevertheless “ma be signalling some improving optimism in the housing market”.

This interpretation is supported by a jump in house price expectations following a plunge in the second half of 2015.

Late last year, Reserve Bank of Australia Governor Glenn Stevens estimated the economy was “roughly half way” through the decline of resources investment, and a rebalancing in the sources of growth was underway – a process that will be greatly aided by the falling currency.

Economic commentary often exudes an unjustified air of certainty.

But the sharemarket’s current bloodletting, but a focus on this has tended to blot out some of the more positive big picture developments occurring.

This is one of those seemingly rare occasions when it may pay to heed the message of political leaders.

 

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Weak jobs, weak budget

Forget Tony Abbott’s boasts about how many jobs have been created since his government was elected.
The facts are that the labour market is weak, and the incentive for business to put on more staff is low (though the ANZ job ads survey out early this week indicated employers are increasingly looking to hire).
Not only has the unemployment rate (6.4 per cent last month) jumped to its highest point in almost 13 years, the average hours worked each week is stuck around a record low 31.7 hours.
In practice, it means there is plenty of scope for employers to bump up the hours of existing staff before they need to start thinking of hiring someone extra.
Today’s labour force figures simply reinforce Reserve Bank of Australia warnings that the growth outlook is underwhelming – the central bank expects the economy to have expanded by just 2.25 per cent in the 12 months to June this year, and doesn’t expect any major improvement until into 2016.
There are some positives. The exchange rate is hovering around $US0.76, interest rates are at a multi-decade low of 2.25 per cent, petrol prices have tumbled in recent weeks and consumer sentiment has jumped.
But the improved outlook of households is likely to be short-lived as worries about job security and political turmoil in Canberra drag on confidence.
Altogether, it is not a great time to be framing a federal budget, with little reason to think that the huge slowdown in revenues from company and personal income tax will be reversed any time soon.
If ever the nation needed to have a serious conversation about broadening the tax base and reigning in tax expenditures (which were worth $113 billion in 2009- 10 alone), this is the time.
As Stephen Bartos noted in testimony to the inquiry into the establishment of the Parliamentary Budget Office, “tax expenditures are the unloved orphan of fiscal scrutiny, paid little attention and not well understood and analysed”.
It is time to change that.

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Nothing to see here, move along

The Reserve Bank of Australia is dangling a prolonged period of record low interest rates in front of businesses and consumers as it tries to foster economic growth in the face of what is expected to be an austere Federal Budget.
The release of the National Commission of Audit report has amped up concerns, particularly among retailers and other businesses directly dependent on household spending, that a severe Budget will crunch spending and stall growth.
While the forthcoming Budget would undoubtedly have figured in the discussions of the RBA Board, Governor Glenn Stevens was content to repeat his observation from last month that “public spending is scheduled to be subdued”.
Instead, the central banker drew attention to developments in the labour market, and their implications for inflation and, hence, interest rates.
The surprise drop in the unemployment rate in March to 5.8 per cent had some speculating that the labour market was on the improve, raising the prospect that monetary policy might soon have to tighten.
But the RBA thinks this outlook is premature.
Mr Steven admitted that there were signs conditions in the labour market were improving, but cautioned “it will probably be some time yet before unemployment declines consistently”.
Budget cuts to the public service and Commonwealth spending (including welfare payments) are only likely to prolong the period of softness in the labour market.
While this is bad news for job seekers and those hoping to trade up to a better position, weak employment growth has had a silver lining.
As Mr Stevens explains, the slack labour market has helped keep a lid on wages, which in turn has limited the ability of retailers to jack up their prices.
The result is that the cost of domestically-priced goods and services (often the driver of inflation) has been contained, and the RBA Governor said “that should continue to be the case over the next one to two years, even with lower levels of the exchange rate”.
What that means is that the Reserve Bank does not see inflation breaching its 2 to 3 per cent target band in the next two years, giving it ample room to hold interest rates down for an extended period.
While it is unlikely that they will still be this low in early 2016, it could well be late this year or even early 2015 before the RBA feels compelled to begin edging them up – notwithstanding the surge in house prices in the major cities.

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Unemployment rate drop unlikely to trigger rate hike

As economists are often wont to say, the March labour market figures are decidedly ‘noisy’.
The unemployment rate is down (a 0.2 percentage point drop to 5.8 per cent), but so is the participation rate (also slipping 0.2 of a percentage point to 64.7 per cent.
So, jobseekers were more successful last month, but there were proportionately fewer of them.
In addition, the Australian Bureau of Statistics tell us, more than 22,000 full-time jobs were lost, offset by the addition of more than 40,000 part-time positions, to push the aggregate hours worked in the month up by eight million.
A review of recent jobs data shows these numbers have been volatile. Until last month, the unemployment rate seemed to be on an inexorable rise. After hovering around 5.7 to 5.8 per cent for most of the second half of 2013, it climbed in quick succession to 6.1 per cent by February.
Over the same period the participation rate slid down to a seven-year low of 64.5 per cent (in December 2013) before jumping to 64.9 in February and settling a little lower last month.
The trend measure, which is offered as a way to ‘see through’ the monthly volatility, says the unemployment rate held steady last month at 6 per cent, and the rate of increase has slowed and may be levelling off.
Looking at the labour market through the prism of demand for workers, the ANZ job ads series suggests more employers are looking to add staff, which would be a concrete vote of confidence that better times lie ahead.
Turning points in indicators of economic activity often seems to be characterised by a period of volatility before a definite direction asserts itself, much like a sail that momentarily flaps in the breeze as a ship changes tack.
Often such turning points only become really apparent with hindsight.
But other evidence suggests that jobless rate might not have much further to climb, bringing the prospect of an interest rate hike into sharper focus.
Retail sales are firming (strong monthly gains in December and January were consolidated in February), building approvals are up more than 23 per cent from a year earlier, and business conditions and confidence are improving.
But the recent appreciation in the exchange rate (the Australian dollar surged to US94.3 cents following the release of the jobs data) is a clear risk for the RBA, which has been keen to see the currency lose much of its altitude.
Today’s activity shows the currency markets are primed to exploit even the hint of an increase in the interest rate differential between Australia and the US, where confirmation by the Federal Reserve of a US$10 million cut in bond purchases under the quantitative easing program saw the greenback lose ground.
The stronger $A will also hamper the shift in the economy away from resources-led activity toward other sources of growth, possibly prolonging the nation’s lacklustre GDP performance.
A turn in the labour market, if that is what this proves to be, is unlikely by itself to convince the RBA Board to hike rates – particularly while wage inflation appears so tame.
A more probable prompt for a rate rise would be increasingly uncomfortable signs of heat in the housing market, particularly credit growth. So far, the warning signs on this front are amber, rather than flashing red.

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The case for regulation

Taking unfashionable positions seems to be part of the job description for central bankers.
And the Reserve Bank of Australia was at it again yesterday.
The Abbott Government has been trying to endear itself to the business community by talking up its campaign to slash red tape, headlined by its so-called Repeal Day on March 26, when 10,000 pieces of legislation and regulation were put on the chopping block.
Few would quibble with the move to get the Dried Fruits Export Charges Act 1927, which set a levy of one-eighth of a penny for each pound of dried fruits exported, off the books.
But, as the RBA pointed out in its submission to Financial System Inquiry, the mania to be rid of regulation must have its limits.
Reflecting on the nation’s ability to endure the global financial crisis in much better shape than most other major developed economies, the Reserve Bank said Australia’s “sound prudential framework” had served it well, and saw no need for major change to current arrangements.
Many in the finance sector chafe under what they see as the unfair regulatory burden and capital requirements placed on Australian banks in complying with the terms of the international Basel III rules.
The rules were developed to help reduce the vulnerability of the global financial system to future credit shocks, including by increasing capital adequacy requirements for banks.
While the RBA and APRA are among those who successfully argued for some leeway in applying the new standards to take account of different business models and operating environments, Australian banks have nonetheless – like their overseas counterparts – had to increase the amount of capital on hand to help offset liabilities.
Often, regulation is seen as a dead-weight cost without any perceptible redeeming benefit.
In this it is like investing in education with the aim of boosting national productivity – the upfront cost is all-too apparent, while the pay-off is distant and rather nebulous: you know that a better educated and higher skilled workforce will be more productive, but credibly quantifying the effect is difficult.
That is why there was some benefit out of the gloom caused by the GFC. As the RBA said in its submission, it showed “that the costs imposed by effective regulation and supervision are more than outweighed by the costs of financial instability, even if that differential only usually becomes apparent after prolonged periods”.
That is, financial crises only happen every now and then, but when they do, the insurance of a robust financial system is worth the regular but relatively small cost of regulation.
In keeping with this “nothing good comes for free” theme, the RBA also backs the idea that the banks be charged a fee for the protection to depositors provided under the Financial Claims Scheme.
One of the key lessons the central bank draws from the GFC is that “the financial cycle is still with us”, meaning that risks have to be managed.
In its submission to the inquiry, the RBA made a number of other noteworthy observations and recommendations.
While much attention in recent years has been on competition in the mortgage market, the central bank said competition in small business lending was much weaker and deserved greater attention.
It also warned politicians off the idea of forcing superannuation funds to invest in certain sectors or asset classes, and questioned whether or not the fees and costs charged in managing retirement savings were reasonable.

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Timely warning for home buyers

As fears for the stability of the global financial system continue to ease, the thoughts of a central bank inevitably turn to more home grown concerns.
So it is that the Reserve Bank of Australia has issued a timely reminder to homebuyers that interest rates will not remain at record lows indefinitely.
In its biannual stocktake on the health of the local and international financial system, the Financial Stability Review, the RBA has devoted some attention to developments in the local property market.
This is hardly surprising – as the US sub-prime crisis so spectacularly demonstrated, what goes on in real estate can have explosive and devastating consequences for the rest of the economy.
Low interest rates are usually seen as a good thing (except by those trying to live off interest-bearing investments), but they come with risks.
The longer that rates stay low, the more desperate the competition among lenders for customers, and the greater the temptation for borrowers to increase their debt.
While rates stay low, many borrowers may be comfortable servicing their loan. But, inevitably, rates will rise, and as the financial squeeze increases, an increasing proportion of borrowers may find themselves in over their heads. And if they can’t unload their assets at a price to cover their debt (as can occur when many people simultaneously find themselves in trouble) things can get ugly very quickly.
This is the scenario the RBA is keen to avoid, and explains why it is watching borrowing behaviour and lending practices like a hawk.
It warned in today Review that there are already “indications that some lenders are using less conservative serviceability assessments when determining the amount they will lend to selected borrowers”.
It goes on: “It is important for both investor and owner-occupiers to understand that a cyclical upswing in housing prices when interest rates are low cannot continue indefinitely, and they should therefore account for this in their purchasing decisions.”
In other words, don’t bank on the idea that the recent surge in house prices will be sustained. If you are borrowing to your limit to buy a house, don’t be surprised when interest rates eventually go up, and the price you paid turns out to be at the top of the market.
None of these dangers are in immediate prospect.
The international economic recovery is still in its early days, and subdued local growth means there is little pressure at this stage to inch official interest rates higher.
But, while financial markets don’t expect the RBA to begin tightening monetary policy until at least early next year, the RBA might be tempted to act sooner if it sees a risky build up in household debt.

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