Longview Economics: Australian “recession likely” in 2019-20

By Leith van Onselen

Following on from Gerard Minack’s report contending that “a recession in Australia is becoming more likely”, Longview Economics has delivered a similar verdict:

Summary & Conclusion:

Excess in the Australian housing market has been widely discussed by investors and commentators for a number of years. Underpinned by cheap money, house prices have risen significantly (i.e. up until 2017) resulting in extreme valuations (house prices are nearly 9x average incomes). Other signs of a housing bubble have also emerged: Investment in housing is extreme (fig 3); the percentage of people employed in construction is close to bubble-like levels (i.e. similar to those of Spain and Ireland ahead of the GFC); the household debt to GDP ratio is one of the highest in the world (121.3%); and mortgage debt has grown almost twice the pace of GDP in the last 10 years.

With house prices and housing activity now declining sharply, those excesses have begun to unwind and key leading indicators point to ongoing weakness: Building permits, for example, are down 19% Y-o-Y1 (and tend to lead house price growth by ~3 months, fig 7). In addition, transactions are down 32% Yo-Y (on latest data, fig 8) while growth in mortgage lending is contracting at the fastest pace in 8 years (both transactions and mortgage lending lead house price growth)…

Bubbles tend to burst when money becomes expensive. In that respect, rising pressure on commercial bank funding costs will continue to feed through into the housing sector via higher mortgage rates (see point 1) and should result in further house price weakness. As the wealth effect from rising house prices reverses, households should continue to deleverage and their savings rate should start to pick up (as is typical during housing downturns, fig 1). This will, in turn, result in weak/contracting household consumption growth (i.e. the primary component of GDP), and should result in a recession later this year or early next year (see point 2 for full rationale). Whilst a series of RBA rate cuts is therefore likely (beginning in the latter half of this year), that policy response is probably too late, given that policy works with lags and downward momentum in housing is already underway. We expect the RBA to cut rates to zero (and potentially use other policies, e.g. QE).

The below chart shows the four drivers of real final demand:

As at September 2018, these drivers were:

• Household Consumption: 57% share;
• Dwelling Investment: 6% share;
• Public Demand: 24% share;
• Business Investment: 13% share.

Dwelling investment is now falling, and will subtract from growth over the next few years:

Whereas infrastructure investment to peak at $40 billion this year and then fall into 2020:

However, as pointed out by Minack and Longview, the big kicker is household consumption. Consumption has so far held-up by falling savings amid weak income growth, which is clearly not sustainable:

As the savings rate normalises, it will necessarily drain on household consumption, removing Australia’s key growth driver and raising the real prospect of recession.

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