The Australian economy is underperforming due to continued declines in commodity prices and global economic growth, with further cash rate cuts expected by mid-2016.
The timing of a further interest rate cut depends largely on when the US Federal Reserve decides to raise their rates.
A rise in the USD would lead to a relative fall in the AUD, which is a desirable outcome for competitiveness in Australian exports.
This may hold off a further rate cut in Australia this year.
If the Federal Reserve maintains interest rates the USD is at risk of falling, which would undermine competitiveness of Australian firms and potentially trigger a further rate cut by the RBA within the next few months.
However, it is troubling that the ‘positive’ element of Australia’s economy cited in media is the weakness of the dollar, which averaged US $0.71 in the month of September.
As well as making Australia’s goods and services relatively cheap, a low dollar signals a lack of confidence in the Australian economy.
Annual GDP growth slowed to 2% in the June quarter, down from 2.5% in the previous quarter.
Unemployment in September was 6.2%, while the participation rate also fell from 65.09% in August to 64.86% in September.
As discussed last month, poor economic performance is not always reflected in the housing market in the short term.
This seems particularly the case where the east coast markets have performed counter cyclically.
In fact, besides Perth and Darwin dwellings, most housing markets across Australia grew in the September quarter.
Table 1 shows the summary of growth, sales and rent based on the latest Residex data.
Table 1: September 2015 Summary
Part of the explanation for counter-cyclical performance is the investment and lending frameworks that further wealth, even in times of stagnating wage and GDP growth.
While purchasing power should diminish in the face of rising house values, those who own a house will find their wealth going up.
The ability to borrow against the equity in ones home has staved off a downturn in the market.
Academic consensus is that favourable tax treatment of investors has also prolonged the Sydney housing boom.
The East Coast Downturn
Quarterly growth in Melbourne houses and units was strong, at 5.25% and 2.58% respectively.
Brisbane also showed steady growth, with the median house and unit seeing a quarterly increase of 3.13% and 1.42% respectively.
Growth surges in the Brisbane and Melbourne property markets are expected to continue as these markets follow movements in Sydney, however at a more subdued level.
Sydney growth is slowing. In many suburbs, quarterly growth is starting to contract.
Graph 1 shows 5 years of quarterly growth rates in Sydney, Melbourne and Brisbane for the median house.
The quarterly growth rate is taken at each month in the data set.
Graph 1: Quarterly Capital Growth
The graph shows a contraction in these markets around 2011-2012, and then growth moves upward.
It is also evident that Sydney tends to lead the way and peak before Melbourne and Brisbane.
The last data point in this graph suggests that growth is continuing in the Sydney market but at a slower pace than its peak earlier in the year.
The next 12 months should see slowed or negative growth rates in Sydney.
However, this should not be interpreted as a crash.
Macquarie Wealth Group recently made headlines stating that dwelling prices across Australia may fall as much as 7.5% in the next 2 years – but it is important to remember that this is off the back of a 41.36% value increase in Sydney houses and a 31.59% value increase in Sydney units since 2013.
Downswings are a part of life and whether the Sydney property market undergoes some sort of severe crash will likely depend on the availability of jobs and income growth in the future.
Evidence from overseas markets shows that macro-prudential policy plays an important role in triggering a downswing.
In Australia, it is being used to counter growth in the housing sector as the official cash rate declines.
Increases in housing investment and risk prompted the Australian Prudential Regulation Authority (APRA) to make sure the banks changed their internal risk modelling to reflect this – property risk weights must be increased from 16 to 25%.
The announcement was made in July 2015 and will be enforced from July 2016.
The implication of this is that the major banks, who use their own risk modelling to determine the amount of capital they hold, must adopt this new weighting.
With the major banks typically underestimating the risk weight of property in their internal models, APRA’s regulations will require banks to hold billions of dollars more in reserves to safeguard the financial system.
The cost (for the banks) of holding more capital is passed onto consumers who take out loans for houses.
These costs come in the form of higher deposits and higher interest rates.
The oligopolistic structure of the banking sector allows all the big banks to increase interest rates almost simultaneously, in order to raise more capital.
The table below shows the recent rate increases from each bank.
Table 2: Increase in Home Load Rates by the Big 4
The Long Term
There is risk in the long term of unaffordability in mortgage repayments.
Australian’s have high levels of private debt, with housing debt sitting at approximately $1.5 trillion dollars.
Australia’s GDP is only $1.453 trillion, meanings housing debt currently represents approximately 103% of GDP.
Given Australia has a low cash rate, it is relatively easy to service large amounts of debt.
Furthermore, interest rates are likely to stay low for a long time, as other countries have set precedent (the US official cash rate has remained unchanged from 0.25% since 2008).
However, interest rates will not stay low forever.
APRA has recommended the use of stress testing home loan rates of up to 7%.
It is important to consider whether, especially for owner occupiers who do not receive rental income, dwellings are truly affordable.
The international standard of affordability is a measure called the ‘Median Multiple’, designed by the World Bank.
It is found by dividing median dwelling prices by gross, annual median household income.
An indicator of 5 or more is considered to be highly unaffordable.
Graph 2 shows the Median Multiple Indicator for each capital city market for houses.
To create our own version of this measure, I have used median house values from Residex, divided by median household incomes for each capital city.
Graph 2: Median Multiple Indicator
For each region, with the exception of the ACT, houses in capital city markets are highly unaffordable relative to incomes.
If wage growth continues to fall and interest rates rise in the long term, it will be harder for households to repay large amounts of debt.
Further exacerbating the situation are subdued commodity prices, which the International Monetary Fund expect to hover around the current low prices for the next 5 years.
Australia is not making a smooth transition into other sectors following the mining downturn, despite the services sector being touted for future growth potential in the wake of free trade opportunities.
HSBC chief economist Paul Bloxham spoke positively on education exports earning $18 billion over the past year.
However, this is a relatively small figure considering that all merchandise exports were worth approximately $21 billion in the month of August alone.
In addition, the rate of growth in the value of merchandise exports is declining.
The Australian government faces serious challenges in finding competitive, sustainable sectors of employment for its labour force, especially as the economy is exposed to free trade with economic powerhouses such as China and the US through separate trade agreements.
Source: ABS Catalogue Number 5609.0 ‘Housing Finance, Australia’ – Table 12
This was found by taking the 2011 Census ‘Median Weekly Household Income’ in each city metropolitan area, which was then converted to annual income, and indexed each year by national Annual Wage Growth.
Due to the small number of dwellings in the city of Canberra, Residex measures the whole ACT market against other Capital city metro areas.