From Tim Toohey:
A feature of our research over the past 18 months has been to break away from the guide posts that have served us well in obtaining a read on the future direction of economic activity over the past decade. Historically we had looked to easing financial conditions, rising confidence and rising wealth as important touchstones for a future acceleration in economic activity. These were indicators that had proved their worth over the prior 30 years. As such, our decision to adopt a far more cautious view than the consensus over the past two years was not born of the idea that these indicators were suddenly of less worth. They were born from the idea that there were other forces that were likely to be more powerful, namely the likely sharp decline of the terms of trade, the likely sharp decline in mining investment and a lack of economic incentives to drive a pickup in broader business investment, the likely persistent challenge of fiscal consolidation and an uncompetitive production base relative to Australia’s trading partners. In the background the rapidly changing nature of Australia’s demographics also provided amber warning lights challenging the idea that a typical industrial recovery beckoned.
The consequence has been the heralding of false dawns of economic recovery that have lulled investors into the belief that recovery in the non-mining economy had commenced. There has been no shortage of economists that have raced to the conclusion that the Australian economy had commenced an economic recovery pre the 2013 federal election and that momentum was to sustain Australia into 2014 and beyond. A number of economists in March of 2014 expected interest rates to rise in 2014, some before mid-2014, others by year end. More recently the RBA championed the idea of a 3Q2014 recovery led by consumer and business surveys. However, yet again expectation has failed to meet the economic reality.
Our bias was to be more cautious. Goldman Sachs was the last forecaster in Australia to hold on to the idea that a further RBA interest rate reduction may be required. We believed that Australia’s trade accounts were set to deteriorate rapidly, growth data underwhelm, and expectations with regard to the Fed tightening shift such that a change in the RBA policy bias to easing would have been sufficient to cause a material easing in the real exchange rate.
We somewhat reluctantly removed that forecast in August once it became clear that the RBA no longer viewed house prices expansion as a catalyst that may spur consumption spending, and instead began to view house price expansion as a risk to financial stability.
Moreover, the RBA has taken a step further and declared that macro prudential rules are set to be introduced, perhaps before the commencement of 2015.
While there has been some client enquiry as to whether the introduction of macro-prudential rules by the RBA and APRA would provide it with the ability to tighten policy for home lending at the same time as being able to cut interest rates for the broader economy, we don’t see this as the RBA’s intent. Instead, the RBA/APRA would likely implement any changes and choose to pause for several months to assess what impact was achieved. In any case, we believe that investor lending by Australian residents will cool of its own accord. On a post-tax post-expenses basis residential property investors are no longer cash flow positive from investing a marginal dollar into housing and the combination of negative real rental growth and rising vacancy rates will likely see investor demand dissipate in coming months. Of course, expectations of macroprudential measures or mortgage risk weightings that will bias bank lending away from investment lending could well diminish the expectation of future house price appreciation, even if any lending restrictions are relatively minor in an absolute sense.
All very well put. I will only add that the touchstones of accelerating growth of the last 30 years have changed in one important respect: consumers no longer spend asset-based wealth like they used to, knowing that it is in some way ephemeral.
Macroprudential and more rate cuts are coming.