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Interest rates Australia: the outlook for 2019

This post was first published in In The Black on 8 March 2019 at https://www.intheblack.com/articles/2019/03/08/interest-rates-australia-outlook-2019

When the Reserve Bank of Australia (RBA) last changed interest rates Malcolm Turnbull was still prime minister, Donald Trump had yet to seize the White House, the UK had just voted for Brexit and house prices were booming.

During all the subsequent turbulence locally and abroad, the RBA cash rate has been a rare constant. In two and a half years it has not budged from a record-low 1.5 per cent.

However, markets and economists increasingly believe this period of policy stability is coming to an end, though views diverge sharply on whether the next move will be down or up.

The Reserve Bank recently indicated that it has shifted from a bias towards increasing interest rates to a more neutral stance. Governor Philip Lowe said in a recent speech that “over the past year, the next-move-is-up scenarios were more likely than the next-move-is-down scenarios. Today, the probabilities appear to be more evenly balanced.”

Unemployment falling

CommSec senior economist Ryan Felsman.

Some, such as CommSec senior economist Ryan Felsman (left) and ANZ’s co-head of Australian economics, Cherelle Murphy, think the time is coming when the RBA will be able to raise interest rates.

Despite weakening house prices, the employment rate was steady at 5.1 per cent in January, supported by strong participation in the labour force, according to the Australian Bureau of Statistics. The trend ratio of employment to population rose to a 10-year high of 62.4 per cent.

Felsman says the central bank will look past the continued slide in house prices and unexpectedly soft growth in the September quarter to developments in employment.

“The labour market is the key indicator going forward as far as interest rates are concerned,” he says.

Demand for workers has been building – about 284,000 jobs were created in 2018 and the unemployment rate has dipped to 5 per cent – and Felsman expects this pressure to gradually force wages higher and enable households to increase their spending.

Eventually, he expects wages growth to reach 3.5 per cent, which would be consistent with an inflation rate of about 2.5 per cent – the mid-point of the Reserve Bank’s 2 to 3 per cent target band – “which the RBA has previously identified as a level they would like to get to before they lift interest rates”.

Interest rates to rise in November?

ANZ’s co-head of Australian economics, Cherelle Murphy.

 

Felsman thinks this point will most likely be reached in November, convincing the central bank to lift the cash rate to 1.75 per cent.

Murphy (right) shares Felsman’s upbeat outlook for the economy but foresees a more gradual improvement.

She does not expect the RBA to lift the cash rate until August next year, followed by another increase in November 2020 to take the cash rate to 2 per cent.

Murphy says national income is holding up. Businesses are being buoyed by good profits, encouraging them to invest and hire, and feeding more company taxes into government coffers.

Just as important, tighter credit conditions are working to cool the once-rampant property market without triggering widespread mortgage defaults.

While homeowners may see a peak-to-trough fall of 20 per cent in house values before the market stabilises, Murphy says the fact that mortgage rates are stable means few are being forced to sell.

“This helps explain why consumer confidence has not fallen in a hole, and instead has stayed at pretty high levels,” she says, along with the strong jobs growth.

Given the importance of private consumption for economic activity (accounting for almost 60 per cent of GDP), this is an important plus for growth.

Further interest rate cuts

AMP Capital Markets chief economist Shane Oliver.

 

AMP Capital Markets chief economist Shane Oliver (left) and Market Economics principal Stephen Koukoulas are much gloomier about the economic outlook and believe tepid growth, elevated global risks and inflation that is stubbornly below target will leave the Reserve Bank board with no choice but to cut official interest rates in 2019. Oliver tips the rate to drop to 1 per cent by the end of this year; Koukoulas reckons it will hit a record low 0.75 per cent.

Both forecasts are more aggressive than financial market estimates which, which nonetheless have fully priced in a rate cut to 1.25 per cent by the end of the year.

Concerns about growth, falling house prices, stagnant wages and soft household spending have been underlined by the release of figures showing underlying inflation has been below the RBA’s 2 to 3 per cent target range for most of the past four years.

China’s slowing economy

Internationally, China – Australia’s largest export market – has slowed. In the 12 months to the December quarter it expanded by 6.4 per cent, its weakest pace in almost three decades as consumers eased the pedal on major purchases such as cars. The unresolved US-China trade war has deepened concerns about Chinese growth.

Against this, the Chinese Government has pledged to support the economy and is expected to unveil tax cuts and relax bank cash reserve requirements.

Nonetheless, the International Monetary Fund (IMF) expects the US economy to soften in the next two years as the effects of the Trump tax cuts fade, recent Federal Reserve rate hikes bear down on activity and the trade war with China rumbles on.

These developments are buffeting other economies. In Europe, the IMF expects Germany to be hit particularly hard. The euro zone’s largest economy is heavily reliant on exports to the US and China, and the Fund has sharply downgraded its growth prospects, forecasting it will expand by just 1.7 per cent this year.

Slowing European growth

Add to this mix the Brexit fiasco, and the IMF thinks the euro area as whole will struggle to grow by just 1.9 per cent in 2019 – and that is assuming Britain and the EU reach agreement on an orderly exit.

While these issues have been on the Reserve Bank board’s radar for some time, Oliver says the way they have evolved in the last few weeks will have it worried.

“I think they would be feeling more nervous about things than they were in December when they last met,” he says. “We have seen another round of volatility in markets, and a lot of the issues around that haven’t been resolved. Locally, the housing downturn has worsened, [and there are] more concerns about tight credit conditions.”

Despite this, Oliver does not expect the central bank to be in a rush to cut the cash rate and will instead want to see spending measures in the April Federal Budget and the promises made by both the major parties in the lead-up to the federal election before moving.

Amidst such uncertainty, the RBA and its counterparts around the world appear poised to act meeting to meeting, examining data in forensic detail for the faintest hints of how key aspects of the economy are faring.

As Felsman says, “Every policy meeting is now live.”

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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)

australia-households-debt-to-gdp.png

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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