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Is The RBA Wrong?

Australia | Jul 18 2018

The RBA suggests the next move in rates will be up, just not yet, given an economy growing at above-trend. For different reasons, economists disagree.

-RBA forecasts 3%+ growth ahead
-Consumption is the swing factor
-How far will house prices fall?
-What is the impact of population growth?

By Greg Peel

“The recent data on the Australian economy had been consistent with the Bank's central forecast for GDP growth to pick up to be a bit above 3 per cent over 2018 and 2019.”

The RBA has remained positive throughout 2018 on the Australian economy, believing the nearer term outlook has GDP growing at slightly above trend. The excerpt from the minutes of the July meeting above confirms no change to this expectation.

The caveat is nevertheless uncomfortably high household debt, with consumption remaining uncertain as incomes fail to grow sufficiently to offset such debt at a time interest rates remain low. This balance is keeping the central bank cash rate on hold for now, although the board insists the next move is likely to be up, not down, based on a gradual move lower in unemployment and higher inflation, given robust economic growth.

Westpac chief economist Bill Evans concurs that the economy grew comfortably above trend in January to April, but slowed in May, and in June fell to below trend. Evans’ assertion is supported by the Westpac-Melbourne Institute leading economic index, which dropped to -0.33% in June from +0.05% in May.

The index seeks to indicate the pace of economic activity, relative to trend, three to nine months into the future. June’s was the first below-trend reading since September last year and the weakest since last July.

Further readings will be required, Evans suggests, to confirm a shift to a below-trend outlook, but the numbers are in accord with Westpac’s forecasts for the rest of 2018 and 2019.

The biggest drags in the June index reading came from a turnaround in unemployment expectations, lower AUD commodity prices and a deepening contraction in dwelling approvals. Domestic components are now coming to the fore, Evans notes, whereas over the last year or so movements in the leading index have been explained mostly by international factors, being commodity prices, US industrial production and the yield curve.

With a nod to the RBA’s “next move will be up not down”, Westpac continues to expect no change to the cash rate in either 2018 or 2019.

Houses of Cards

Another leading index to be considered is Morgan Stanley’s forward-looking housing model, MSHAUS, which set a new historical low in the six months to June of -1.0, suggesting the recent decline in housing prices will continue into the March quarter 2019. Credit has tightened further, the analysts note, housing market sentiment is slipping and additional stock is still hitting the market.

All categories of the indicator remain at weak levels, but credit supply was once again the main driver of the fall. No prizes for guessing the regulatory scrutiny forthcoming from the Royal Commission is impacting. Other factors were little changed.

The rationing of interest only-loans continues to bite, Morgan Stanley notes, with APRA data showing only 16% new approvals when the regulator’s cap is 30%. Finance commitments fell -14% in the year to May, reflecting tighter lending standards and a deteriorating outlook for property investment returns.

For four years, the analysts point out, dwelling supply growth has outpaced population growth, despite the latter remaining strong. National prices are now down -2.3% from their peak and Sydney specifically down -4.8%. No one expected rising prices to go on forever, but the debate now is to just how far prices may fall.

Morgan Stanley believes that number will be closer to -10%. Any further and the RBA and/or APRA will be forced to act.

In other words, the next RBA rate change would be down, not up.

Because of high household debt and slow wage growth, the RBA cites consumption as being the uncertain factor in the board’s forecast for ongoing above-trend growth. It is a truth universally acknowledged that household consumption will rise if wealth rises, even if that wealth is based only on the market price of the family home which the family has no immediate plans of selling.

Rising house prices make consumers “feel” wealthy, and hence the opposite is true.

Populate or Perish

Australia has famously now posted over 26 years of uninterrupted economic growth. Not even the GFC brought on a recession (using the two quarters of negative GDP measure). The key driver of this success is population growth, UBS points out, and growth in 2017 remained at a robust 1.6%, mostly due to migration.

But what that 1.6% number does not include is migrants on temporary visas. In 2007 they represented 1.4% of the measured population and by 2016 had hit a record 2.7%, UBS notes. More than half are students, the number of which has surged to a record high in 2017.

Surging temporary visa growth will drive ongoing strong population growth in coming years, supporting headline GDP via the “exports” of education and tourism. This will support the need for infrastructure growth, UBS suggests, as well as underpin housing demand.

These migrants are relatively young, skilled, educated and have a much higher participation, providing for a “positive labour supply shock” which caps wage pressure and thus inflation.

This is key, UBS asserts, to keeping the RBA on hold to 2020.
 

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