Australia’s primary economic shock-absorber is broken

Via BofAML:

Can the RBA ever raise rates?

That’s the provocative question posed by Bank of America-Merrill Lynch’s Aussie rates strategists.

Friday’s very disappointing retail sales figures reinforced the fact that consumers are, collectively, the Achilles’ heel of the economy. It’s sent economists into a bit of a tizz, although none, the BAML team included, expect the RBA to do anything but hold rates at a historic low of 1.5 per cent tomorrow.

What’s more, inflation also continues to languish, with the latest consumer price index print “disappointing in more ways than one,” the strategists write.

“The [RBA] lacks a narrative to signal an eventual move to a more normal rates structure,” they say, which means monetary policy is “sidelined” for now.

“While a weaker currency should keep open the option of a shift to a more optimal policy mix next year, the risk is that the RBA will stay on hold. If this is the case, medium-term macro risks would rise and leave the economy even more vulnerable to shocks, in our view.”

“We concede that official rates at 1.5 per cent did not get to levels seen in the major economies during the ‘race to the bottom’ of global QE, but the longer that rates remain on hold, then the greater the number of marginal households that take on debt at the current level of rates will make any future adjustment more painful,” they write.

“In our view, the continued rise in system credit growth well above real income growth, especially for housing, means that the cost of money is too low.”

Friday’s update of the RBA’s forecasts in the Statement on Monetary Policy will be watched closely, as the range estimates in its forecast table will be replaced with point forecasts, the BAML analysts write.

“We expect the Bank to retain its upbeat tone. A falling unemployment rate would change market expectations for rates in 2018.”

This is the first time that I’ve seen MB’s end-of-cycle bear thesis for house prices expressed elsewhere. Recall that we’ve been saying for some time that the housing cycle is caput owing to:

  • very little rates relief in the chamber during the next shock;
  • increasingly limited fiscal scope as well, and
  • immigration levels that are generating an intensiying political economy backlash.

Of these, the most important is interest rates. If the RBA cannot reload the chamber this cycle – and not only do we see that as improbable but also that it will likely empty further – the next global shock will leave households denuded of relief when spending freezes. During the last three shocks the mortgage relief has been large:

  • 1990 global recession -8.25% in mortgage rates
  • 2000 global recession -2% in mortgage rates
  • 2008 recession -3.7% in mortgag rates

The next shock will lower rates by 50-75bps at best as banks hold back half what is left to boost flagging margins and we hit zero (or as close to it as we dare go).

Australia’s primary economic shock-absorber is broken with no sign of it being repaired.  This means house prices will fall further than they have during future shocks than they have in the past.

It’s not all bad news. The failure to reflate internally does not end the world. It shifts the reflation externally, meaning that the Australian dollar will have to do more of the heavy lifting to restore Australian growth. That is, go much lower than during previous shocks.

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