Exclusively from Gerard Minack.
A housing boom prevented the 2014-15 commodity bust pushing Australia into recession. Now, however, pressure on consumer incomes is increasing the risk that even a moderate downturn in housing could cause a recession in 2018.
Australia coped well with the mining boom busting in 2014-15. Even so, growth has run below trend through most of the past 4 years, as evidenced by the rising unemployment rate. The degree of slack in the labour market has been partly obscured by declining labour participation (Exhibit 1).
The cyclical slack in the labour market has been one factor behind growth in nominal labour pay falling to multi-decade lows (Exhibit 2).
Structural factors have also been at work: low trend productivity growth, the disinflationary global environment, and the partial unwind of the mining-boom income boost. The result is that real household disposable per capita income fell by 2½% over the year to the March quarter. Trend income growth (5 year average) is negative, something not seen since the late 1980s (Exhibit 3).
The recent uptick in national income due to the (temporary, in my view) terms of trade recovery has almost exclusively lifted profits. Labour share of GDP is now at a multi-decade low (Exhibit 4).
Total nominal household income growth over the year to March was just 1.8%. The only time income growth has been weaker was in 1962 (data from 1960). Consumer spending growth over the year to March was 3.7%. The only way spending can grow faster than income is for households to save less. The household saving rate has fallen significantly over the past two years. This has been contributing 1 percentage point to GDP growth (Exhibit 5).
This is a classic example of the wealth effect at work: when household wealth rises, saving tends to fall (Exhibit 6, where wealth is inverted).
The wealth effect from rising house prices is now a more important contributor to growth than the direct impact of residential construction (Exhibit 7).
The forward-looking point is that wealth effects seem likely to fade – or reverse – next year as house prices soften. This may not require a housing crash; it may only require a moderate decline in house prices. A decline in house prices seems likely for several reasons, including: poor affordability; new restrictions on negative gearing; looming property over-supply in some segments; and APRA-encouraged tightening in banks’ lending standards. But arguably the most important reason is the out-of-cycle mortgage rate increases now occurring. Given the household sector’s Creosote-like appetite for debt, even a wafer-thin rate increase could cause serious financial indigestion (Exhibit 8).
It remains a moot point what will fill the gap left by even a moderate downturn in housing. Statistically, the end of the mining capex decline will remove a negative, but that will not add jobs. Signs elsewhere remain patchy, at best. My base case remains one of ongoing weak nominal growth, with a one-in-three chance of recession. There are obvious risk factors that could tip the odds towards recession. First, the labour market deteriorates more sharply than leading indicators now suggest, led by lay-offs in construction and manufacturing (due to the shut-down of the domestic auto producers). Second, the domestic gas price debacle could see unexpected weakness in non-mining investment.
Even under the base-case scenario, the RBA will have a bias to ease, the A$ will likely fall, domestic corporates will struggle to grow revenue, and local equities will under-perform global equities in common-currency terms. Under the recession scenario, these trends become more pronounced, and the domestic banks come under pressure.
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