Mini credit crunch bites property prospects
Business Outlook Q2 2018
23 July 2018: The globe is galloping, but 2017 saw the UK drop off the pack, and 2018 is seeing growth ease in Europe, Japan and Korea. Yet overall global growth is lifting as the US and much of Asia strut their stuff. Then again, this global cycle is already elderly, and a jump in energy prices is taking a growth toll in Japan, Korea and Europe. Even more importantly, the cost of credit has been edging up in both the US and in China, the first time that monetary policy has tightened in both nations at the same time in over a decade. That trend is already pressuring liquidity in Chinese markets. And interest rates will likely rise even more in the years ahead. That will be much more painful than it used to be, as the world carries much more debt than it did before the GFC. But, China caveats aside, those are mostly issues for late 2019 and beyond: although global growth is now flying on fewer engines, it is still flying. That provides a strong backdrop to prospects for Australia.
Australia sells into those parts of the world that are still doing well, and the pace of our growth has lifted. Yet rising global interest rates are combining with a bout of bank caution on lending (via extreme vetting of loan applications in the wake of Royal Commission revelations) to generate a mini-credit crunch. That’s putting further pressure on house prices, whose falls are gathering pace (though those falls remain contained enough that they don’t pose larger problems for the overall outlook). More challenging, that mini-credit crunch is occurring at the same time energy costs jump. But business confidence is generating a capex recovery and consumers, despite falling wealth, will be getting support from a nascent recovery in wages and from personal tax cuts. On balance, that leaves the outlook for Oz where it’s been for some time: good without being great.
Inflation is on the rise, but not much, and not fast. Strengthening demand is giving businesses a bit more pricing power, wage momentum is building, and import prices are rising. But all of those factors are well and truly in the slow lane. Outside of an immediate ripple effect from higher energy prices, the current lift in consumer inflation is emulating the tortoise rather than the hare. And the same is true of wages: the wage recovery has begun, but it’s still a case of watching paint dry.
Credit markets are tightening, squeezing economies such as Turkey and Argentina by draining them of capital. Yet although the US Fed is continuing the march to costlier credit, less positive news in the Eurozone and the UK may see rate rises there lag more than markets expect. More importantly still, a world awash in debt will be careful about the pace at which it raises rates. That’s equally true for Oz, though the new factor locally is just how much the mini-credit crunch is biting. Australia’s big banks are being super careful with their credit, accelerating house price falls. But the flipside of that is the Reserve Bank won’t be going on the warpath until mid-2019 at best (and possibly even later still).
That mix of a strong US, a matchingly strong greenback, plus an RBA slow to leave the starter’s blocks on rates may see the $A continue a very modest slide.
Trade wars be damned: the current account deficit is still sweet (calendar 2017 saw the smallest current account deficit as a share of national income since the 1970s). But it may slowly widen once more. The combination of easing commodity prices and rising global interest rates may be the one-two punch that sees recent good news ever-so-slowly fall back more deeply in the red.
Full-time job gains have been great and, while unemployment hasn’t slipped much, that reflects an upswing in the willingness to work that lifts Australia’s productive capacity. Although the pace of job growth is already easing, and we forecast it to ease further, we still expect continued falls in unemployment and underutilisation to drive more growth in the size of workers’ pay packets.
The revenue surge is continuing, boosted by Federal profit taxes and State stamp duties, leaving government budgets looking the healthiest they’ve been in a decade. The Feds have recycled that into personal tax cuts, but it’s too early to lock in large long term promises. China’s slowdown will slowly seep into commodity prices, winding back profit-driven boosts to Federal revenues, while a mini-credit crunch will sound the death knell for the east coast stamp duty bonanza. So Oz has repeated an old mistake: spending a temporary revenue boom on permanent promises. We’d prefer to see the Budget in better health before any such promises were made.
Yet, despite what you’ve heard, this tax cut is a fairness nothing burger. It (1) merely hands back what bracket creep otherwise adds to the tax take and (2) doesn’t change the shares of tax pain by low, middle or higher income earners. (If you do want to pull a microscope, then it’s higher income earners – the top 10 and 20% of adult Australians – who’ll end up paying a larger share of personal tax).
The tussle at the top
Australia’s industry landscape is healthy, but four key waves are affecting prospects by sector:
- The first is global strength. Although world growth is a little less synchronised than it was, and although China continues to slow, the demand for industrial inputs such as iron ore, coal and gas remains huge. That's delivering dollars to resources and energy. To date that sector and its satellites have been cautious with their resurgent profitability, given they were so badly burnt last time. But a few new capex plans are finally starting to get the green light, such as BHP giving the tick to iron ore expansion in the Pilbara;
- The second wave to watch is energy prices. Developments in Venezuela and Iran have pulled a lot of oil supply. The Saudis are making good some of that, but prices are still up. Add in higher gas prices on Australia's east coast, and industrial energy users are facing a wave of higher costs;
- The biggest wave – certainly in terms of potential impacts – is that higher global funding costs are combining with a sudden tightening in credit availability from the big banks to turn the screws on credit-related sectors. That's a big problem for property, and for some linked sectors as well;
- Finally, don't forget that what was going to be personal tax increases (a higher Medicare levy) will now be tax cuts instead, though the dollar impact of that is still a year away.
The east coast is key to growth in Australia this financial year
The east coast will dominate the State growth leader board this financial year, with Victoria surfing its “people power”, NSW spending big on infrastructure, and surging gas exports in Queensland.
Yet there’s good news on show pretty much across the board. South Australia’s economy has motored through the loss of car manufacturing, Western Australia is seeing some green shoots as the good global economy supports its continuing recovery, a virtuous circle of positives is cementing Tasmania’s lifting population growth in place, and better Budget news is reducing risks for the ACT
For this financial year, though, it looks as if the Top End will be at the bottom end of Australian growth
NSW remains a truly top notch performer, but partly as the surge in house prices to silly levels saw it borrow some growth from the future. Infrastructure is still the key to current strength, but keep an eye on Australia’s mini-credit crunch: it could prove more problematic in NSW than elsewhere.
Victoria’s “people power” continues to power growth in its economy, though recent modest falls in the $A help too. But prospects are vulnerable to the toxic politics surrounding migration. And while infrastructure spending is great, it has to be: more people means more infrastructure is needed.
The Sunshine State is now well and truly through the worst of its mining construction downturn. Eye-watering house prices south of the border are finally sending more economic refugees north to Queensland, while gas exports are leaping and tourists also continue to flock to the State.
No more Commodores didn’t mean no more growth: South Australia’s economy took the recent turmoil in its stride. Growth is still the best it’s been since the global financial crisis, but the ongoing exodus of SA’s youth will act as a drag on growth going forward, as will its ageing population.
Western Australia’s economy is out of the woods, but it isn’t quite yet out of the doldrums. The State is recovering from being dragged under the wave it rode during the resources boom, and a good global economy is a godsend. But the speed of WA’s recovery is steady rather than sharp.
Good global growth and a lower $A are giving Tasmania its strongest economy in years. Farm exports to Asia and tourists from elsewhere in Oz are creating job opportunities, and that’s attracting more Australians to move to the Apple Isle. The recovery in population growth looks like it’s here to stay.
The Northern Territory economy is learning the hard way that it takes far fewer workers to operate an LNG plant than it does to build it. Onshore spending has cratered, and growth in the Top End is temporarily taking something of a backseat despite a striking surge in gas exports.
The ACT is benefiting from a growth trifecta of government spending, population gains and foreign students, making it one of the best performing in Australia. Even better still, the rapidly improving Federal Budget reduces the risks the ACT could have faced from future cutbacks in public spending.