The Australian economy grew at an annualised rate of 4 per cent in the first half of 2018, which is a fantastic result, not just in comparison to recent economic history, but also a strong result relative to pre-GFC growth levels.
Despite this, the Australian stock market has lagged, and many commentators talk negatively over the future strength of the Australian economy. Whilst it is certainly true that a sell-off in global equity markets has been a big factor in this, the magnitude of the falls, and the tone of the commentators, suggests deeper issues in the Australian economy.
Perhaps the most significant issue being declining Australian house prices.
Declining house prices are certainly related to the sell-offs being seen overseas, due to an increase in global interest rates lifting borrowing costs.
However, there are also other factors helping to force house prices lower, including persistently low wage growth, increase lending controls from our banks, and decade of house price gains (which make marginal gains increasingly difficult).
Regardless, the decades of house price outperformance will ensure that any decline will rub-off on the wider economy, and household spending will be reduced.
“House prices and consumption are clearly correlated, with a typical lag of six months plus to consumption and jobs.” According to George Tharenou, Carlos Cacho and Jim Xu, economist at UBS.
“Hence, we expect consumption to moderate from the strong 3% plus annualised pace in recent quarters to 2.3% in 2019.
Consumption is the biggest contributor to economic activity, and with house prices falling, it is unsurprising that economists are lowering their forecasts for Australian economic activity moving forward.
According to David Rumbens and Ben Guttmann, economists at Deloitte, “Households have been a key driver of the economy in recent times through increased spending, including on housing. But record-low wage growth has meant that growth has been based on a large run-up in household debt, rather than income growth. Interest rates on that debt (by far the largest share of which is devoted to housing) have already started to increase, even without the central bank moving its benchmark interest rate. That combination of rising borrowing costs and anaemic wage growth could crunch the capacity of households to further lift their rate of spending, acting as a drag on 60 percent of Australia’s economy.”
The analysis of UBS and Deloitte is supported by research from the Australian Housing and Urban Research Institute (AHURI), which suggests that as of 2009, for every $100,000 increase in Australian house prices, owner-occupiers will lift their consumption expenditure by around $1,500; with investors lifting their consumption by approximately $2,800.
The AHURI concluded that their findings were “consistent with the hypothesis that the increases in housing prices affect household consumption through the relaxation of a credit or collateral constraint that enables households to increase their borrowing in order to finance consumption”. With house prices falling, it is likely that the reverse is also true.
Given the current house prices falls and rising borrowing costs, there are undoubtedly risks to the downside for the Australian economy. However, all is not doom and gloom, with the RBA keeping their positive forecasts for Australian economic activity and their suggestion that “[recent] weak consumption growth was offset by strong growth in business investment and public demand”.