Slower growth ahead, but not just yet

Stephen Roberts

We see spending on housing and household consumption spending as the key elements determining near-term strength in GDP growth, but also longer-term weakness. Reasons abound why Australia’s annual GDP growth rate is likely to moderate over the next year or two. The list includes 1) Moderating growth in Australia’s major international trading partner economies. 2) Weak growth in Australian household disposable income with no end in sight to slow wages growth. 3) Over-supply developing in parts of the new housing market. 4) Extremely high household indebtedness starting to add to reasons why banks are periodically tightening lending standards. 5) Government policy focus on limiting growth in government spending. While this list points to lower GDP growth at some point, stronger annual growth may have occurred in the recent past extending into the immediate future.

Preview for Q2 GDP out soon

Australia’s Q2 GDP report is due on 7th September and at this stage is shaping up around 0.6% q-o-q or 3.4% y-o-y. While the quarterly growth rate is likely to be down from the unusually high 1.1% q-o-q in Q1, the annual rate should be up from 3.1% y-o-y and is briefly tracking above Australia’s long-term average annual GDP growth rate. Main contributors to the firm Q2 GDP result on our forecasts are spending on housing, household consumption spending and exports. We see spending on housing and household consumption spending as the key elements determining near-term strength in GDP growth, but also longer-term weakness.

Encouraging outlook in near term for household spend In the recent past and in the near-term the household sector has and is still likely to spend comparatively freely although the strength is predominantly in New South Wales and Victoria where labour market conditions and the housing markets are much firmer than elsewhere in the country. Factors encouraging households to spend more beyond the constraint of limited income growth include rising wealth - substantially driven by higher house prices, very low borrowing interest rates - enabling the servicing of extraordinarily high and still mounting levels of debt plus also some help from persistently low petrol prices sustaining a quasi-tax cut.

RBA cuts may not be fully passed on

The latest RBA cash rate cut at the beginning of this month briefly added a bit more fuel to the household spending fire but already there are signs that its impact was limited and may be quickly fading. The first sign was that banks decided to hold back part of the 25 bps cash rate cut passing through around 14 bps to variable rate housing borrowers. What incentive there was from that small home loan rate cut is being whittled away by further moves by banks tightening their lending standards since, including reductions in discounts on home loan interest rates and even an increase in the interest rate charged to “interest-only” investment home loans by one lender.

This process of banks tightening lending requirements and even raising interest rates on home loans seems likely to continue as banks try to limit growth in home loans and reduce the risk of future bad debts among the current cohort of home loan borrowers trying to buy homes at unsustainably high prices. Bank lending restrictions have become especially tight for the buyoff-the-plan and newly constructed home unit market, where over-supply is threatening to be a major problem over the next year or two.

The progressive tightening of bank lending requirements is threatening to counter the positive impact on household borrowing from the latest RBA cash rate cut. From now on this neutralisation process seems likely to repeat on any further RBA cash rate cuts. In short, it is hard to see any further lower interest rate relief for banks’ home loan customers almost regardless of what the RBA does in terms of cutting its cash rate and that will surely count in bringing to a head the last vestiges of the long housing price boom in Melbourne and Sydney.

Housing is still strong, outlook is difficult to predict

It is hard to forecast precisely when the house price boom in Sydney and Melbourne will top out, but the relentless tightening of lending conditions by the banks makes it highly likely that the boom will end before long. While housing remains strong (even with much of the strength confined to New South Wales and Victoria) that is probably sufficient to keep annual GDP growth at 3% y-o-y or more. When housing activity starts to weaken throwing total household spending on to a much more cautious footing, annual GDP growth will lose altitude quickly to 2% y-o-y or less unless something else turns up to boost prospective spending such as a material lift in spending by the Government.

Australia’s economic growth outlook really is unusually tricky. For the time being annual growth is among the best of the advanced economies, but heavily dependent upon a housing boom that is becoming more precarious, as banks do what is prudent and find more ways of rationing lending, slowly squeezing the leveraging life-blood feeding the boom. When the housing boom fades GDP growth is likely to moderate noticeably.

Article contributed by Altair Asset Management: (VIEW LINK)


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