Given the problems and the position of global economies, Australia has done well by comparison and in global stakes it remains one of the few bright spots.
Adverse comments and the position currently surrounding European economic problems have certainly had an impact on Australia’s economy; however it is important to recognise the position Australia holds, and that if things do go horribly wrong, Australia has the capacity to simulate its economy by increasing borrowings and decreasing interest rates.
Our housing markets ended 2011 in a better position to where they started and I am confident that the year ahead will be better for residential property owners compared to last year.
Most owners should see their assets hold value or increase and this year could in fact be a good time for investor activity provided the world economy doesn’t move into severe recession as a consequence of the problems in Europe.
Consumers remain cautious
In the graph ‘House and Unit Trends’ I present the monthly trend for Australia over the last two years.
The data suggests that we are exiting a period of negative adjustment however, in my view, we should not expect any rapid uplift in housing values because current economic conditions are not capable of supporting strong consumer activity.
Retail activity during the Christmas period certainly suggests that consumers are cautious.
A number of capital city markets are now trending up. I present the “good and the bad” outcomes in the following graphs*.
While most of us will not be happy to see the adjustments that have taken place in the last year, we should recognise that our markets were overvalued and affordability was a real issue.
Realistically, affordability is still an issue but provided growth rates over the next few years are in line with long term growth trends of close to one percent real growth (one percent above inflation), and interest rates decrease a little further, last year’s adjustments have been good and ensured that we avoid the speculated housing “bubble bust”.
The bottom line is that we have achieved a good result and it looks like an overall improving position may be the trend in the coming year.
Employment & Property
The unemployment rate is going to play a significant role in Reserve Bank decision on the cash rate this year. Employment growth has slowed to less than 1 per cent and in annual terms the rate has ranged from 5 per cent to 5.3 per cent since mid-2011.
The Reserve Bank closed out 2011 with two consecutive rate cuts of 25 basis points and the RBA will be closely monitoring unemployment figures.
Any increase in unemployment will trigger further interest rate reductions and with the slowing in retail activity we should expect an increase in layoffs in this sector in the first quarter of 2012.
Cost of funding
A further potential driver of RBA interest rate reductions this year is the trading bank funding costs. The eurozone crisis has seen an increase in the spread between the Reserve Bank’s cash rate and its cost of funds.
Should this continue, it will cause banks to hold back on passing on the full benefit of RBA cash rate reductions. This in turn will cause the Reserve Bank to make larger reductions than it might not have otherwise made.
I believe that the top of the current interest rate cycle has passed and from here we will see rates decrease. Interest rate decreases have an added benefit in that they will reduce the value of the Australian dollar and help to stimulate exports.
Should the time come when Australia does find it necessary to stimulate the economy, as I mentioned before, there is plenty of monetary adjustment available to do so.
Where to from here?
Overall, the outcome for the year ahead will depend on interest rates, the eurozone crisis, inflation, the employment level and the carbon tax.
The recent move by the ANZ Bank, which will probably be followed by others in due course, to set its home loan rate independently to any interest rate adjustments by the Reserve Bank has reduced the power of the only economic lever that the RBA had.
The banks tell us, and it seems very reasonable to believe, that borrowing rates are not significantly aligned with the Reserve Bank cash rate as banks are significant off-shore borrowers.
Consumer confidence and recent retail activity points to a cash rate reduction by the Reserve Bank in February as the most probable outcome. The issue will then be, will lenders pass on the cut and how much will they opt to pass on.
The interest rate separation will probably lead to larger RBA cuts in the cash rate than what would have otherwise been necessary.
For Europe, we are approaching the point where decisions and actions are needed and it is likely that the markets will force an outcome.
We expect the 17 nation eurozone to change and that it will spend a significant part of this year in recession; in particular the first part of 2012. Further, Standard and Poor’s has just cut the credit rating of nine countries using the euro, including France.
This action has the potential to make things worse as the cost of funds is likely to rise as a consequence.
Domestic inflation will be critical to the actions of the Reserve Bank. Recent inflation outcomes have been favourable and in November, the RBA lowered its inflation forecast for 2012 to 2.5 per cent which is within its target band.
Inflation doesn’t appear to be an issue in 2012 and should not be the cause of any rate rises.
The new carbon tax comes into effect from July 2012 at $23 per ton of carbon pollution. Tax payers with incomes of less that $80,000 get a reasonable tax cut but we are not prepared to guess the actual impact on the economy and the resulting behaviour of consumers.
In light of all of the above, it is easy to form a negative view about the likely outcome in 2012.
I urge you to acknowledge how lucky Australia is and recognise that if the year does unfold in a negative nature, it also provides opportunity.
Australians are much better placed than many other people in the world and the adjustment period we have recently seen, with a clear upswing in our markets in the last few months, means that there is a reasonable chance that our markets will advance positively, albeit by a relatively small amount, in the current year.
Additionally, in this situation there will be bargains for the astute house hunter along with quality growth in many suburbs.
* The graph ‘Poor Outcome Trends’ contains some unit data for Sydney while all other cities use data is for houses only. The purpose for doing this is to highlight the significant difference between the two market segments. In fact, the Sydney unit market is performing well and really belongs in the ‘Good Outcome Trends’ graph. The most likely cause of the significant difference is the affordability issue that is forcing people away in the house and land market and into better located units closer to the CBD. We will see similar outcomes in other cities also.
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