The Australian economy has performed well so far in 2018 although from the regular commentaries from many analysts and the press you might be led to think otherwise. Last week we pointed out in the piece “growth denial” that annualised GDP growth was 1.6% in the second half of 2016, improved to 2.2% in first half 2017 and kept improving to 2.8% in second half 2017 and well-above trend 4.0% in first half 2018. That strong improvement in GDP growth has in turn generated a big lift in company profits – up 11.4% y-o-y according to the Q2 ABS Business Indicators – and employment up 2.5% y-o-y or 306,400 in August according to the latest ABS Labour Force data.
Other very positive features in the August Labour Force report include the national unemployment rate at a 4-year low 5.3% and down from 5.6% in August 2017. In the two big population states, New South Wales and Victoria, the unemployment rates are below 5.0%, down to 4.7% in New South Wales from 5.0% in August 2017 and down to 4.8% in Victoria down sharply from 6.2% recorded in August 2017.
The impressive reduction in the unemployment rate over the past year would have been even bigger but for a big lift in the labour force participation rate (those over the age of 15 either in work or actively looking for work) up from 65.3% in August 2017 to a record high 65.7% in August 2018 and itself a sign of confidence. Importantly, job vacancies are very high and continue to rise providing an indication that employment is likely to continue growing strongly and the unemployment rate should continue to decline.
Against this positive backdrop of strong economic growth, very strong growth in company profits and the best improvement in labour market conditions so far this century, many analysts are looking for what can go wrong. The main point of focus is the potential fragility of future household spending. High household debt; low household savings; falling house prices; a credit squeeze; and low wages growth could cause household spending to snap lower in turn causing weaker economic growth and a shift from strength to deterioration in labour market conditions.
This potential snap weaker in household spending is possible but very unlikely in our view. Much more likely is that economic activity maintains its strong growth or improves. The factors that support a strong Australian growth outlook include very growth accommodating monetary conditions; improving business spending and rising exports of goods and services. We also expect household spending to lift on a rebalancing of demand in the housing market still strong employment growth and rising wages.
Taking these positive factors in turn. The RBA’s cash rate has been left unchanged at an emergency low-point of 1.50% for two years. In that time annualised real GDP growth has more than doubled to 4.0% in the first half of 2018 and annual inflation has lifted from around 1.0% to 2.0%. While lending interest rates in Australia are subject to forces beyond the RBA cash rate essentially most lending interest rates even after the recent small increases announced by many lenders including most of the major banks are lower than where they stood two years ago. Low lending interest rates have been and continue to support borrowing.
It is not just interest that affect ability to borrow. A noticeable tightening (improvement) has occurred in Australian lending standards over the past two years limiting the ability of some investors in housing to borrow. The marked improvement in Australian home lending standards mean that the incidence of default on home loans that has always been quite low by international standards will probably be even lower on the loans that are currently being written and that have been written over the past year. In short, the improvement in lending standards mean that Australia is less likely to ever suffer a “Lehman 2008” style event.
Moving towards better lending standards does however create some transitional stress in the housing market, especially in a housing market that had pockets of excessive price speculation. So far, the adjustments in the previously frothiest markets – Melbourne and Sydney – have been orderly, charting a path that looks similar to housing downturns earlier this century. For example, house prices in Sydney peaked early in the century in Q4 2003 but then fell through to Q1 2006 and bottomed 8.4% below the 2003 peak. Another Sydney house price downturn occurred post-GFC between Q4 2010 and Q4 2011 when house prices fell 3.0% peak to trough. Most recently, Sydney house prices peaked in Q2 2017 and have fallen since (through to Q1 2018, the latest ABS data) by 2.7%.
Interestingly in the current housing price downturn there are already the first signs that one important cohort of buyers is seeking to take advantage – first-time owner-occupier home buyers. In the past two years, first-time home buyers have jumped from 13% of the value of all home loans authorized to 18% (July 2018). The value of total home loans also appears to be steadying after the falls over the past year implying that the worst hit sector of the housing market – investment loans is being offset by improving owner-occupier loans.
It is still likely that house prices could fall a little further over the next 12 months or so, but the first signs of stabilization are starting to show. In more good news for the household sector there are signs that wages are starting to rise faster. Most current wage negotiations are for an annual increase of 3% or better and some are much bigger. Several industries that have underpaid workers over recent years are in the process of providing compensation. However, the main factor why wages look like lifting faster is that the labour market is very tight, especially in New South Wales and Victoria.
Meanwhile Australian businesses face more demand from overseas and at home and are more profitable than they have been for several years. Most likely they will spend more on investment equipment, more people and better pay for those they employ. Something could snap, probably the economy reaching new heights and eventually the RBA’s resolve to hold down the cash rate