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Housing prices: Gravity starts to catch up with stupidity

Business Outlook June 2017

17 July 2017: The world is motoring. Growth in the US, Europe and Japan is near 2%, with China and India doing the heavy lifting to raise overall global growth above 3½%. But China has been tightening the screws, which will see its growth slow during 2018, with flow on effects for the wider world. And there are structural headwinds for the medium term: the developed world is ageing, with its potential growth sapped by rising retirements. That’s true of China too. And at the same time the business world has been reluctant to invest for a decade, spooked by rising political and economic uncertainty, as well as fears of regulatory and technological developments – creating an additional headwind.

Both the world and the Reserve Bank have been doing Australia favours, with China throwing red meat at those bits of its economy that buy big from the Lucky Country, and with the RBA’s 2016 interest rate cuts revving up housing prices. Despite that, production growth has been weak, as big gas projects finish construction, as the big home building boom of recent years starts to peter out, and as Cyclone Debbie took a toll. Yet our stuttering pace of production was still enough – thanks to higher commodity prices – to see national income chalk up a gain of near $100 billion in 2016-17. That brought an emphatic end to five years of “income recession”, though to date it has been profits rather than wages which have benefited, while the pace of home building is set to shrink further amid increasing evidence that gravity may soon start to catch up with stupidity in housing markets. And the gargantuan Chinese credit surge is finally easing back, suggesting the global economy won’t be doing Australia quite as many favours from 2018 onwards. Yet those are merely caveats on an otherwise solid outlook. Relative to the rest of the rich world, Australia’s economic outlook may not be quite as impressive as it once was, but we are still kicking goals.

Consumer price inflation remains a dog that isn’t barking, both locally and globally. And although global and local leading indicators of inflation are stirring in their sleep, they don’t look like getting out of bed any time soon. We see wage growth set to climb from 2018, as inflation lifts a tad, as retirement among boomers restrains growth in potential workers, and as the “income recession” of the post-2011 period gives way to more settled gains in national income (and workers get their share of that). Even so, the pick-up in inflation and wage gains is likely to be both modest and slow.

The past decade saw a growing global gap between economies and interest rates, but the US Fed is continuing a slow grind towards closing the gap. The rest of the world will eventually follow, with Australia’s turn starting during 2018. Yet as J. Paul Getty so neatly put it, “If you owe the bank $100 dollars, that’s your problem, if you owe the bank $100 million, that’s the bank’s problem”. Australia’s heavily indebted families are now the Reserve Bank’s problem, which is why, although interest rates will indeed rise in the next few years, they won’t rise sharply. On the currency front, Australia will sit more towards the back of the queue for global interest rates normalisation, and there’s the risk of further price pain on commodities. That combination will weigh on the Australian dollar, but not by much.

Australia is within a hair’s breadth of a current account surplus for the first time since bell bottomed jeans were all the rage. However, just like bell bottoms, Australia’s dash for cash looks set to be very short-lived. We got close courtesy of spikes in coal and iron ore prices, but those same global commodity prices are once again curled up into a ball and rocking. That will increasingly show up as lower export earnings over the next year or so, cementing a return towards our customary deficits.

Job growth in the next couple of years will be solid: not as good as 2017 to date, but not as bad as 2016 either. There’s good news in the better gains in national income of late, but overall macro trends aren’t really giving a strong signal either way on job prospects. And while the bugaboos of the moment (disruptive technologies and new business models) grab the headlines, they do more by way of generating churn at the level of individual businesses than they do to ruffle the surface of overall job numbers.

The Federal Budget saw the Coalition abandon Plan A (a return to sustainable fiscal finances via spending cuts) to Plan B (tax and spend, amid increases to the Medicare levy, a bank tax, and Gonski2.0). Given Plan A spent years going nowhere, we see great sense in Plan B. But it’s a real worry that a conscious shift to the centre still didn’t unleash much bipartisanship in Canberra. That says official figures (which assume stuff passes the Senate) remain at risk. And, speaking of risks, commodity prices could yet spell trouble for the Federal, WA and Queensland Budgets, while – a little further out in time – housing markets may yet do the same for the NSW and Victorian Budgets.

The tussle at the top

Among industries, it’s still a tussle for the top of the growth leader board, as mining output rides the crest of earlier investment decisions, while health care rides a demographic dividend topped with technological treats. Both sectors look set to keep growing rapidly, with mining seeing huge gas projects ramp up their production levels (to meet export contracts, and to keep the home fires of domestic markets ticking over), and with health demands marching ever upwards. But the prospects for both also come with caveats, as mining’s fortunes remain chained to China’s, and health to Canberra’s.

Like Manny Pacquiao, the reign at the top of the pops for finance has been long and gloried, but it’s looking a little long in the tooth as the cost of credit finally gets back off the canvas. That said, there’s a long tail of growth still left in finance, and its return to the growth pack may take a few years.

Challenges loom for property services too, where a slowdown has already commenced.

Similarly, the $A -fuelled rise of fast growth in recreation (thanks to more tourists) and education (thanks to more students) may soon start to moderate from here – the $A’s fall was a while ago, and its benefits are starting to fade. But at least the education sector has the lift in the birth rate over the last decade or so to provide better base demand via extra kidlet numbers.

Construction and manufacturing are both bumping along the bottom, but for construction it may be a relatively brief spell in the doldrums, whereas manufacturing’s challenges look rather more structural).

Question marks lie over the utilities, where balancing divergent aims (power that’s clean, reliable and cheap) is hard, but becomes even harder now that Hazelwood has closed and with the nation’s onion-eaters arguing the toss on Finkel. That suggests investors may stay sidelined, which is where they’ve already been for an awfully long time. Add in rising prices, and this sector – a pathway to growth for many other industries – is left reliant on population gains to generate much by way of growth.

It’s just a jump to the south and east

On the State and Territory front, the jump from a China boom to a housing price boom sent the nation’s money and momentum from its north and west towards its south and east. Yet although the ‘sunbelt’ – WA, Queensland and the Top End – is feeling pain as a result of that, much of the drama for those regions already lies in the rear view vision mirror. Their next phase will be one of recovery, albeit not quite yet.

And don’t forget that today’s heroes – NSW and Victoria – have clay feet. A house price boom borrows growth from the future, and both NSW and Victoria will have to pay back some of that in the years ahead as today’s housing prices gradually reconnect with reality.

Luck’s a fortune, and NSW has it in spades amid the shift to lower interest and exchange rates since 2012. But storm clouds are building, as the housing price boom has artificially supported retail and home building. There’ll be an eventual butcher’s bill to pay as those supports reverse.

Victoria has benefited as key cyclical drivers – exchange and interest rates – moved in a "Victoria- friendly" direction in recent years. And this State is experiencing its strongest population gains for many a decade. Yet, relative to other States, its population and housing cycles may be near their peaks.

The key headwind to Queensland’s economy for some years now has been falling engineering construction, but that pain is increasingly history. While Cyclone Debbie and slowing housing construction are current negatives, Debbie’s impact will be temporary and gas exports are lifting.

South Australia has benefited from favourable shifts in interest rates and exchange rates. In fact, and despite popular opinion, the State economy’s growth actually picked up of late. Even so, some big challenges remain, given both demographics and an unfavourable industry structure.

The construction cliff is still weighing on Western Australia. This State saw a virtuous circle of reinforcing growth drivers during the boom, but it has been seeing a vicious bust for a while now. But there has been better news recently out of China, and even vicious cycles run out of steam.

Tasmania has been one of the bigger beneficiaries of the lower Australian dollar and lower interest rates, and the State economy’s growth is currently looking pretty good. But structural negatives on the longer term outlook remain entrenched, suggesting caveats on current conditions.

The Northern Territory’s economy isn’t a one hit wonder, but recent years saw a Gangnam-style blockbuster hit the charts. As construction on the Ichthys project increasingly winds down and its export phase ramps up, the Territory’s challenging conditions won’t disappear for a while yet.

The good news for the ACT is that, after the cutbacks and public sector hiring freezes of recent years, the Feds are returning to more of what might be considered business as usual. On top of that, the impact of lower interest rates on the ACT’s economy remains a powerful positive.

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