The RBA’s tight-rope walk

By Colin Lee
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Interest rate on hold—for a balanced market and better outlook

The Reserve Bank of Australia’s quarterly statement on Monetary Policy predicted that core inflation would be below their 2-3% target for 2018 and unlikely to exceed the lower end of the range in 2019.

Low inflation, weak retail spending and a huge household debt sets up a tightrope for the RBA to walk, in part as a result of a housing boom underpinned by its cutting of rates to record lows as the mining boom came to an end after a decade-long run.

The RBA’s outlook is that economic growth is still expected to reach an “above-potential” rate of 3.25% next year while unemployment is expected to remain at 5.5% before a fall to 5.25% in late 2019.

It also says that ‘GDP growth should strengthen over the rest of the forecast period as the drag from mining investment comes to an end and non-mining business investment and public demand for goods and services continues to support growth. Following the recent recalculation of inflation figures by the Australian Bureau of Statistics, the RBA cut its forecast for inflation to 1.75% till end 2017, making allowance for changes in consumption patterns. Although this was a technical change, analysts deduced that the RBA would be unlikely to lift interest rates unless inflation reaches the lower end of its target band.

Westpac Bank’s chief economist Bill Evans believes that “the rhetoric around a long period of steady rates will gain further emphasis”. The lower inflation forecast by the RBA had “significant policy implications” and reinforced his belief that rates will not go up for two years.

UBS economist George Tharenou said that a reweighting of the consumer price index to reflect changes in spending patterns lowered the inflation forecasts more than expected. The slashing of the forecast for core inflation in 2019 by 0.5% was a “dovish signal”. “You can also forget about near-term rate hikes,” he said.

Lower auction clearance rates and early signs of a cooling market have also eased any pressure for rate increases. Housing credit growth “has eased a little”, noted that RBA, helped in part by bank lending restrictions that led to a shift away from high-risk lending and interest-only loans.

It also noted a potential stress point to the economy of high household debt that continues to increase faster than household income. “A highly indebted household sector is likely to be more sensitive to changes in income or wealth, which could have implications for consumption growth.”

On the property front, Sydney’s median house price remained largely unchanged over the past six months. This is a dramatic slowdown from last year when the median price shot up by 16%. Over the past five years, the median house price has risen by more than $400,000 from $560,000 in 2012 to $970,000, based on figures from CoreLogic.

QBE Lenders Mortgage Insurance’s report forecasts that flat activity will continue in years to come. Over the next three years, Sydney’s median house price is expected to inch down 0.3%. With new units coming on the market, price falls of 3.8% is predicted.

Angie Zigomanis of BIS Oxford Economics says a crash is “off the cards” as Sydney’s population is growing rapidly, creating strong demand for housing. According to him, the current slowdown is caused by a drop in investor activity. Banks are lending less to investors, who as a result are not buying as much.

This breather is a welcome change in the scene, creating a greater balance from the best for sellers and worst for buyers in recent years. 19% more homes are listed for sale compared to a year ago, giving buyers the much needed choice of properties they lacked when prices were at their peak.

Buyers now have a better chance of a foot on the property ladder and a wider choice instead of being locked out of the market by fierce competition and runaway prices. This could well be the best outcome—a normal balanced market that allows buyers to secure their homes and potential sellers to sell up with the knowledge that they can buy back into the market without having to chase continually rising prices.

According to Cameron Kusher, head of research at CoreLogic, sellers on the whole are in a slightly weaker position compared to six months ago but their prospects of getting a high price relative to what they had paid for their properties remain excellent.

Nerida Conisibee, chief economist of Realestate.com.au, sees the major challenge for sellers in being realistic and having to revise their high expectations. “They will get a good price, just not perhaps that dream price they could have got six months ago,” she explains.

On the business investment front, the RBA is confident in its outlook—“more positive than it has been for some time”. Non-mining business investment rose more than previously thought—10% higher than at the beginning of last year. This upturn is supported by low interest rates and a predicted lift in GDP growth.

It also expects the unemployment front to improve, taking some credit for the strength of the labour market in that the stimulation of interest rates “helped generate a decline in unemployment”, which has eased from 5.9% to 5.5% over the course of this year so far.

According to the latest NAB survey (Nov 14, 2017), Australian business conditions are the best in two decades, with rises across all industries including retail. Its monthly business survey found that business conditions Australia-wide rose by 7 points to 21 points in October, a record high and up to four times the long-term average since the report began in 1997—“an extremely strong result and of itself would suggest a better than expected performance for the economy”, according to Alan Oster, NAB chief economist.

 

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