Australia’s economic growth prospects seem increasingly uncertain as we progress through the early months of 2017. It is still possible to mount an argument that Australia’s economic growth cup is more than half full based on strong housing activity, patchy strength in retail spending, less weak business investment spending and strong export growth. The RBA holding its cash rate at a record low 1.50% and a hint of softness in the Australian dollar exchange rate also support stronger growth. It is also possible to argue that growth is starting to come under downside pressure that could become much more pronounced if slowing housing activity evident in parts of Australia extends to the housing hot spots of Melbourne and Sydney.
When an economy starts to show increasing and broadening growth momentum as seems to be the case in Australia, it tends to develop in to a cycle of economic growth leading to better sentiment and income for businesses and households which in turn fosters more growth. This process of growth leading to more income and even greater growth does not usually halt of its own accord, but is stopped by economic policy changes or sometimes events in the global economy damaging trade or capital flows.
Over the past quarter century or so, growth cycles in Australia have almost never been moderated by the Government changing its tax/spending policies although at times Government has made tax/spending policy decisions that have added to growth when it was already rising strongly. Mostly the role of trying to temper too-strong growth threatening to drive up inflation too fast has fallen on the shoulders of the RBA using the one instrument it has available to temper growth, its official cash interest rate.
The RBA using its own forecasts of growth and inflation determines whether inflation is likely to accelerate and stay too high; be about right (stable and inside the RBA’s 2-3% target band); or fall and drop below the target band. Depending upon what the RBA determines, it will consider moving its cash rate up if inflation is threatening to be a problem; no change if inflation looks set to stay inside target band and down if inflation is threatening to stay too low. This relatively mechanistic, inflation-targeting monetary policy setting approach has been used almost without exception over the past quarter century or so.
The RBA’s current set of inflation forecasts have inflation moving up from under 2% this year to around 2% in 2018 but with no momentum to push up through the 2-3% target band. A straight inflation-targeting approach would imply the RBA leaving its cash rate unchanged through this year extending in to 2018. The RBA, however, is starting to show signs that it may vary its singular focus on forecast inflation as the signal for when monetary policy change is necessary.
The RBA is examining closely a building non-inflation potential threat to Australia’s medium-term economic growth prospects, too great a build-up in household debt, especially in some of the riskier forms of investment housing debt. In essence, the potential threat to economic growth comes about if the household sector perceives that it has taken on too much debt and starts to spend less to run-down debt. In the process, the household sector might try to sell-down assets – investment homes – leading to a sharp fall in home prices adding to the need sell more assets and run-down debt faster. It is not hard to see how this change in behavior by the household sector could not just slow growth, but tip the economy in to recession.
For the time being the RBA while perceiving a serious threat to medium-term growth prospects seems reluctant to lift its cash rate, although it also seems quite happy with banks lifting interest rates on their home lending products, especially those related to investment housing and involving the riskiest lending products, interest only loans. The RBA is working with other financial regulators, APRA and ASIC to place greater direct control on growth in investment home loans. The problem is that direct controls tend to spawn forms of shadow lending outside the scope of the latest controls and where lending risks become worse rather than improve.
At the root of the excessive growth in household borrowing, is a perception that house prices in some cities can only rise because housing demand exceeds supply. The problem can only be resolved by initiatives that dampen housing demand or add to housing supply, or do both. In the near-term, extraordinarily high auction clearance rates in Melbourne and Sydney and still with fast escalating prices point to excess demand being the greater part of the problem. It is hard to see this excess demand being tempered without the RBA reinforcing the lift in bank lending interest rates, but it may still be some time before that occurs.
The housing boom is adding to factors saying that Australian growth is running more than cup half full. The excessive build up in household debt creating the housing boom also indicate that growth is starting to run on empty.