A new bullhawkian argument

Today’s bullhawkian charge cannot go without a prod. According to Chris Joye writing in Smart Company:

There is mounting evidence to suggest that Australia’s housing market rests at a critical juncture…In my opinion, the near-term destiny of Australia’s housing market very much depends on next week’s second-quarter inflation numbers. If inflation is low, the RBA will likely be on the sidelines for the rest of the year. It can argue that it was vindicated for not responding to the very high first-quarter results, and will in any event be downgrading its economic growth forecasts for 2011, which were always on the high side.

Talk in the media will galvanise more firmly around rate cuts. Consumers will start to scale back their still extraordinarily hawkish interest rate views (see chart below), with 84% anticipating rate hikes. Given the average Australian thinks he will be hit by two or more rate hikes in the next 12 months, it is no surprise that underlying economic conditions have been so soft.

In this low-inflation scenario with no future hikes and the prospect of cuts, our forecasting models predict that Australia’s housing market has the ability to start grinding out very modest capital growth, which, of course, should be complemented by healthy rental returns.

In the less favourable alternative, where inflation next week is reported high – at, say, 0.8% for the quarter or more – it saddens me to say that our beloved central bank will be very much on the interest rate warpath. That means the likelihood of a rate hike, or hikes, before the year is out. And the half-nelson that the RBA currently has Australia’s housing market in will only tighten.

…Who is right? We cannot tell at this point. It all depends on inflation. So, if you are looking to buy but have not found a place yet, you should be hoping for a high inflation outcome, which will inevitably result in persistent, interest rate-induced pressure on prices. If, on the other hand, you are looking to sell, you should be praying for a low number next week.

As we know, for the past few months Mr Joye has argued vigourously that the inflationary forces emanating  from the mining boom are intense. Indeed, just last week, Mr Joye described anyone contempleting rate cuts as a “bloody nancy”

Some of us at MB have counter-argued that these inflationary forces are increasingly being offset by the disinflationary forces associated with disleveraging.

So what’s suddenly changed in this debate to indicate a “turning point” for rates and for house prices?

If the mining boom is intensely inflationary, and it is, why would we conclude that one June quarter inflation number ends that inflation? There’s no dimunition in the terms of trade, nor in capex intensions, so far as I know.

One reason we could conclude that is if the major offsets to that inflation – the disinflation emanting from a strong dollar and weak housing – start to get the upper hand, and house prices accelerate downwards. In that event, sure, we’d get a rate cut. However, that’s not the turning point Mr Joye seems to have in mind.

The other reason we might see a rate cut has been argued by Westpac’s Bill Evans who reckons another blow to local confidence arising from an external shock would tip the consumer into a withdrawal from spending that would overwhelm the mining boom. But again, is that a scenario in which we can look forward to house price increases?

I accept Mr Joye’s argument that if the inflationary and disinflationary forces remain in balance and rates remain on hold then housing may stabilise and even grow a bit. But the question is, what does that change?

If housing begins to grow, and consumer confidence with it, then the RBA will raise rates again. They will do so quickly becasue, as Mr Joye has made abundently clear, the inflationary forces emanating from the mining boom are intense and there is not enough room in the economy for both a confident consumer and a confident miner. House prices will then stall and fall again.

In summary, and I’m happy to be corrected, I can’t see any evidence of a “turning point”.

Houses and Holes
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  1. For starters, I don’t agree with the RBA/Bullhawk’s premise that the mining boom is intensely inflationary.
    Mining employees a miniscule percent of the labor market and whatever capex there is, much of it (machinery, fabrication) goes overseas.

    • I agree Mav.

      We’ve been told ad nauseum that its inflationary, but the inflation stubbornly refuses to happen.

      For most of the economy there are powerful deflationary forces at work — strong dollar, disleveraging, increased saving. Inflation might be a problem in the Pilbara, but its not in the cities and towns of South Eastern Australia where most of us live.

      • According to the report by the Australian Local Government Association mining contributes about 20% to our economy directly and through mining exposed industries such as construction, IT services, transport etc. etc. Although our CPI is not terribly high the Analytical Living Cost Index for employee households was 4.9% last time I looked at it a few months ago. With global markets for commodities some of the Chinese inflation is definitely getting transferred here. Despite a large chunk of our economy going slow I seriously doubt that interest rates will go anywhere for quite some time unless obviously there’s some major global slump, the risk of which seems to be abating not because there’s organic improvement but because governments and central bankers are ready to hit the bailout/print button again. This obviously will not solve any problem but they will delay the day of reckoning probably one more time.

  2. We have falling asset prices, flat retail, holiday makers flooding overseas, very high currnecy yet 3% or so inflation. That’s a lot of disinflationary forces at work. Where’s the inflation coming from then?

      • I think that’s true in the electricity sector. Much of the infrastructure upgrade in the distribution network is government owned (from memory). The Garnaut Review argued that there a fair bit of “gold plating” of infrastructure going on. There’s also desal plants etc.

        But these engineering projects are, I would have thought, competing pretty head to head with the resources-related construction boom.

        So the inflation is connected.

        • Agreed, its coming from utility bills. The spending binge on home airconditioning has resulted in the need for peaking power stations, which are massively expensive for the amount of time they are used. They also require network upgrades which are only actually required for a few hours (or days) of the year. In most cases the generators (ie power stations) are privately owned but the distribution network is public. Gas prices going up as domestic starts to compete with international buyers. The third wheel is water (ie desal).

          In WA we’ve seen electricity bills go up 25% per year for the past 3 years… and water… and gas…

        • I think that’s true in the electricity sector.

          I’ll think you’ll find that’s the carbon tax. Water rates up? That’s the carbon tax too. Health insurance up? Carbon tax. Landlord raised the rent? Carbon tax. Mobile phone bill blew out? Carbon tax. Got the flu? Carbon tax. Bad hair day? Carbon tax…

          • Lorax – we agree!!! The carbon tax will contribute to inflationary pressures – no doubt. Good observation.

      • At the risk of just being plain repetitive…….
        If you look through the groups domestic inflation, utilities, health education etc is somewhere between 5 and 6%.
        This is offset by cheaper prices for imports in terms of fuel for transportation and manufactured goods ex China.
        It’s just my opinion but I think that anyone who doesn’t work on increasing prices for fuel has his/her head in the sand. So we need a continuously rapidly rising dollar to maintain declining fuel and transportation costs.

        Further FOB prices from China are rising at some 15% odd per year and that will accelerate in coming years. Again without a rising dollar we will start to see a (very)positive feed into inflation from imported goods.

        Our low inflation over the past 20 years or more has been largely due to declining prices for products based on cheaper imports. That is about to end.
        You need to look at what is actually happening. There is no use just looking backwards and thinking the world is going to go on the same ad infinitum.

        Whether any of this is in the RBA’s sights and therefore affects interest rates in the short term is another matter. However I DO think, that in relation to inflation, everyone (RBA, Treasury, Govt, politicians of all persuasions, and more or less everybody) is just putting their hands over their eyes in the hope that if you don’t see it… it isn’t happening.

        The real question, rather than talking about 0.25% one way or another, is what the heck we are going to do a little down the track with inflation at say 7, 8 or 10%. Will the RBA just ignore it, let inflation run to higher levels, or will it try, in vain, to squash it with interest rate rises?

        I know there is no answer to this right now. We ought just keep this likely scenario in mind in our prognostications.

  3. ‘So, if you are looking to buy but have not found a place yet, you should be hoping for a high inflation outcome, which will inevitably result in persistent, interest rate-induced pressure on prices’.

    I do not understand why he thinks that a small increase in interest rates would cause any pressure in the market given our relatively low price/income ratio of approx 4.4.

    I am also at a loss to explain why given that the majority of our stock is in highly sought after cities and our incomes are rising strongly that a 0.25% increae in rates would make a brass cracker of a difference.

    Did I mention that most of our hosuing debt is also held by those on higher incomes….

    Chris, pick a story and stick to it.

  4. The_Mainlander

    Sorry to be lame… Houses and Holes who are you… can someone ‘defrock’ H&H for me or is he a true undercover blogger?

    Sorry for being so off topic but I have been wondering for ages… and ‘others’ seem to be in the know!

    It does not matter if ‘no one knows’ but I am intrigued!

    H&H please do not take offence I am just intrigued!



  5. H&H I’m with you. The CPI basket has only a few links to mining, and with our Aussie at 1.08 or what ever it is today our imports for say steel/cement etc. for housing or say clothing/footwear. The ABS CPI figure for 2010/2011 is 2%. I get the inflation/disinflation and that makes sense, but how is that going to benefit housing? Builders I talk to have commented the rising costs are mostly in compliance, and not materials. Anyway, for existing housing no impact.

    There is quite a bit of stress in non mining employment (retail e.g.) now and I wonder how long it will be before we see some job losses. Then what?

    For now I’ll bet the RBA does hold rates. Given the EU can has been kicked, and the US is likely to be kicked (11th hour) …everything is fixed …not, but for now we might see stability.

    However, how is Aussie housing going to take off again like all the spruks think. IMO it’s not.

    CPI -6401.0
    The total basket is divided into 11 major groups, each representing a specific set of commodities:

    Alcohol and tobacco
    Clothing and footwear
    Household contents and services
    Financial and insurance services.