When it comes to economic growth, Australia remains the outlier in the developed world, in that we have stopped quoting the economic expansion by number of months and moved to years. There have been many global shocks along the way that could have tripped the economy up, however good management, good luck and our close proximity to China have enabled Australia to enter its 28th consecutive year of expansion.
That said, growth is currently below the long run average and persistently low inflation reinforces our view that Australia is going to stay a member of the ‘low-wage party” for longer than most. This environment combined with a softening housing market, is likely to keep Dr Lowe and the other members of the Reserve Bank of Australia (RBA) Board sitting comfortably on their hands for a while longer.
Australia’s labour market, whilst unspectacular, remains robust – the unemployment rate has oscillated around 5.5% in recent months, although it is lower than this time last year. While there is still some slack in the economy as evidenced by persistent underemployment, the participation rate continues to creep up. Wage growth has been supported by the public sector, but we believe the below trend growth rate will gradually impact the consumer and their ability to spend.
Australia’s general ambivalence to the risks surrounding long-term debt serviceability and our low household savings ratio have been fundamental in supporting the economy through a period of declining mining investment and as a result, ‘la la life goes on.’
That aside, we are now enjoying the effects of increased regulation in the financial sector (prudential supervision), as the out-of-cycle increase in mortgage rates and tighter lending standards are starting to soften our lofty house prices. Auction clearance rates have declined and more sellers are taking the safer path of a private or pre-auction sale. We view this as healthy rationalisation rather than the popping of a housing bubble.
In fact, the regulator would welcome the recent softness, after all it is by design that more onerous prudential supervision should take some steam out of the housing market and improve the quality of loans, particularly when borrowing rates are at historical lows.
We believe the current less exuberant environment will continue over the short to medium-term and will likely weigh on economic data. That said, this is a better outcome than an unrelenting housing market which would necessitate a more damaging and widespread end at some point in the future.
In Western’s view, the robust labour market is the key factor negating a housing market implosion. While some borrowers will feel the pinch of higher mortgage costs, they will not sacrifice their ‘home sweet home’, but it is unlikely that ‘Desmond takes a trolley to the jewelry store’ to buy another ‘twenty carat golden ring’.
With the increase in public infrastructure spending and solid net exports, economic growth is likely to be around 3% for the year. Continued weakness in the housing market and inflation that is struggling to reach the lower band of the RBA’s target range, will likely result in the RBA being very, very patient. Accordingly we do not expect the RBA to increase official interest rates until 2019 at the earliest.
In terms of the Australian bond market outlook, we are not immune to global market pressures however, we believe domestic fundamentals still play a significant role in determining the direction of Australia’s longer dated bond yields. Absent any unexpected acceleration in growth or inflation or a global shock, 10-year bond yields should stay well contained, with a fairly low probability of a significant increase in yields in coming months.
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