It looks like inflation will soar to nearly 8 per cent by Christmas and be chased by interest rates that together will send people’s ability to pay for things further into reverse, halt the jobs boom, and put the brakes on economic growth.
I know many people are preparing for a rocky road ahead.
But I don't necessarily agree with them.
If the government and Reserve Bank get their settings right, inflation will moderate next year and slowly return to within the RBA’s target range, unemployment will hover around 4 per cent, real wages will start to grow, and we will end up with that desirable soft landing.
However, I'm a fan of being prepared and not having a crisis rather than ending up in a crisis and not being prepared.
So once a month, I catch up with leading economic commentator Pete Wargent in these monthly Big Picture podcasts when we look at the macro factors affecting our economy and our property markets.
One of the big changes over the last month is the falling consumer and business confidence which can be a self-fulfilling prophecy – it’s one of the many topics, I discuss today with leading analyst Pete Wargent.
In its quarterly Statement on Monetary Policy, the Reserve Bank recently outlined the challenge it expects to face to counter decade-high levels of inflation.
The Bank has lowered its growth forecasts and substantially lifted its inflation forecasts since the May Statement on Monetary Policy.
It has been forecast that our CPI would reach 7.75% by the end of the year, dropping to a little more than 4 percent by the end of 2023.
The unemployment rate is expected to fall even lower, fuelling more wage growth, and house prices are tipped to decline further.
The Australian economy is forecast to grow 3.25 percent this year, then slow down, driven by an easing in household consumption growth.
We know the Reserve Bank hasn’t had the best reputation for forecasting over the last few years, so what are your thoughts on these predictions?
- Many observers say the Reserve bank is in “catch-up” mode to tame inflation, having left interest rates low for too long, but it expects the economy to slow next year and hopes to pull off a difficult-to-achieve soft landing.
- However, despite the financial pressure the Reserve Bank of Australia is imposing on households, Governor Philip Lowe wants to get inflation under control.
- Clearly, Lowe believes the far worse alternative for living standards than higher interest rates crippling household budgets would be allowing inflation to run out of control and becoming entrenched in people’s expectations via wage claims and business price rises.
The news keeps reminding us that inflation is rising, interest rates are on the up, and the Reserve Bank is trying to slow down our economy.
And I know this is worrying many homeowners and property investors because they haven't experienced rising interest rates or inflation, but as a student of history, it’s just part of the typical cycle we see in investment markets.
- No two cycles are the same, but they do have common features, usually being set off by economic or financial developments accentuated by swings in investor sentiment optimism and pessimism.
- There are cycles within cycles.
- Despite various attempts to smooth them out (via economic policies) or declare them dead, cycles live on.
- No one rings the bell at the top or bottom. And given the natural psychological tendency of individual investors to project recent market moves into the future and find safety in what the crowd of other investors is doing, the main risk is that investors, in seeking to time investment cycles, end up wrong-footed by selling after big falls & buying after big gains.
The property pessimists keep telling us real estate values are going to tank because rising interest rates will push homeowners into mortgage stress.
And they often define mortgage stress as spending more than 30% of your income on mortgage payments. However, we know that:
- about a third of Australians have no mortgage
- Around a third of property owners are investors, and their mortgage payments are tax-deductible, and they are getting higher rents
- Half of the homeowners have no mortgage, and many others are well ahead in their mortgage payments.
- While house prices are moderating, the people whose businesses are built around property are calling resilience over gloom.
- National Australia Bank says its volume of stressed loans, where payments are more than three months late, continued to push new lows in the period to the end of June.
Its latest update has this at just 0.7 percent, including small to mid-sized business loans.
- It’s a similar story at Suncorp, with its regional banking arm this week revealing that 90-day past due housing loans had fallen to just 0.43 percent of its total lending book.
- Commonwealth Bank, Australia’s biggest lender, on Wednesday, released some of the money it was holding in case of lending stress.
The RBA has two weapons to lower inflation – interest rates and media commentary to lower consumer confidence.
Despite all the headlines, the RBA’s actual cash rate increases haven’t had much impact at all on most people’s finances – remember, only about a third of us have a mortgage, many of those mortgages have been substantially paid down, and rates haven’t risen much in outright terms anyway.
- Rising interest rates are not slowing discretionary spending.
- We know the Reserve Bank is trying to slow inflation by raising interest rates.
- But will this work? For almost a decade, the RBA has been trying to increase inflation to within its preferred band of 2-3% with low-interest rates, but that didn't work.
- And now, despite rising rates and falling consumer confidence, it seems Aussies are still happy spending rather than stashing their cash.
- ANZ observed spending excluding petrol was steady in early August and seems to be following a similar seasonal pattern as in previous years.
The RBA has aggressively raised interest rates from their “Wartime” lows, but they are still at stimulatory levels, so how high are interest rates going to go, and when will they peak?
Getting inflation back under control is critical as a rerun of the 1970s experience of high inflation will be disastrous for Australians, the economy, and investment markets.
So, the RBA is right to sound tough and act aggressively now.
However, it’s likely the cash rate won’t have to go as high for the RBA to cool demand enough to take pressure off inflation and keep inflation expectations down as the futures market and some economists are expecting.
#1 Global supply bottlenecks are easing, and this will take pressure off inflation
This is evident in various global business surveys showing reduced delivery times, falling work backlogs, lower freight costs, lower metal and grain prices, and falling input and output prices.
#2 Global energy prices close to their peak
Related to this, while global energy prices (for oil, coal, and gas) are likely to remain high, they may be at or close to their peak, so their contribution to ongoing inflation may go to zero later this year.
#3 No one knows what the neutral interest rate is
The neutral rate of interest concept – which is the rate at which monetary policy is neither expansionary nor contractionary – is fine in theory but has numerous problems. We won’t know where it is until we have gone past it
# 4 It looks like the RBA is getting traction in slowing demand – far earlier than normal
- While job indicators are still strong, these are lagging indicators.
- By contrast, consumer confidence is at recessionary levels & well below where it’s been at this point in past RBA rate hiking cycles.
- Likewise, national average home prices are falling with the pace of decline accelerating in July, with the 3-month rate of decline compared to that seen in the GFC and the recessions of the early 1980s and 1990s.
- The earlier-than-normal hit to confidence and house prices reflects a combination of higher household debt levels compared to what was the case in past rate hiking cycles.
- There is tentative evidence that this is starting to show up in slowing consumer spending with credit and debit card transactions looking like they are slowing, hotel and restaurant bookings looking like they are rolling over and July retail sales implying now falling retail sales in real terms.
We know APRA increased its lending buffers to 3% in October last year, and it was right to do so, but further hikes to the cash rate by the Reserve Bank of Australia (RBA) in the coming months could potentially trigger talks on the likelihood of the Australian Prudential Regulation Authority (APRA) easing the lending buffers currently in place.
Links and Resources:
Metropole’s Strategic Property Plan – to help both beginning and experienced investors
Get a bundle of free reports and eBooks – www.PodcastBonus.com.au
Some of our favourite quotes from the show:
“I think the government’s forgotten that 90% of properties that are being let to those who have chosen not to buy or can’t afford to buy, 90% of them are owned by ordinary mums and dads who only own 1 or 2 properties.” – Michael Yardney
“So, I guess going back to what we first stated, it is just another cycle, and each downturn prepares itself for the next upturn.” – Michael Yardney
“In reality, there’s no right or wrong time to buy your new home or your next investment property.” –Michael Yardney
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