This article was written for The Wire, a publication produced by FIIG. The link is here https://thewire.fiig.com.au/article/commentary/opinion/2018/02/13/australia-has-three-problems-chronic-inflation-low-gdp-and-falling-house-prices
Australia has three problems – chronically low inflation, low GDP and falling house prices
If the latest forecasts from the RBA’s February Statement on monetary policy prove to be correct, underlying inflation will not hit the mid point of the RBA target for at least the next two years, which is as far as the current RBA forecasts extend. The RBA inflation forecasts are predicated on annual real GDP growth registering what seem at face value, decent levels around 3.25 per cent. If this figure comes to fruition, inflation will still remain low, as the RBA notes. Implicitly, GDP growth needs to be materially faster – say 3.75 per cent per annum – for inflation to accelerate to the middle of the target band.
Conversely and obviously, if there is any slight disappointment on the growth outlook – perhaps with housing being weaker than anticipated, or global conditions undershooting the current rosy outlook that results in annual GDP hovering around 2.75 per cent rather than at 3.25 per cent – the risk on those already weak inflation forecasts from the RBA will be squarely to the downside.
The December quarter CPI figure confirmed inflation was running dead. Underlying inflation is actually decelerating with an annualised increase of just 1.6 per cent in the second half of 2017, down from 2.1 per cent in the first half of the year.
While there is considerable debate why this inflation undershoot has been occurring, one simple point is that economic growth in Australia has been too low for many years. Since the start of 2013, the average annual rate of real GDP growth has been a tepid 2.4 per cent. This is a stunning 0.75 per cent per annum below what was considered the long term trend, which means that a large output gap has been accumulated over the time.
The hangover of the global financial crisis is still with us
With the economy underperforming over all those years, it is little wonder that over 13.5 per cent of the labour force is ‘underutilised’ – either unemployed or underemployed.
The following is s series of tweets I recently posted and given the feedback, I thought there were worthy of a blog post.
The RBA is finally coming around to the fact that the economy is not strong and there is oodles of spare capacity that will not be mopped up for possibly several years.
The RBA were shattered, almost personally, with the low CPI result for Q4 and the jump in unemployment in December. Of vital importance, it has come to the view that the good employment data are not representative of labour force health - unemployment and underemployment are they key.
Wages growth and hence inflation will not pick up while the economy muddles along and the slack in the labour market remains.
Indeed, some basic modelling suggest inflation is more likely to fall below 1% than reach 3% in the next 2 years, even if GDP only marginally undershoots the RBA's very upbeat outlook.
House price are falling: This is good news, for sure, but careful what you wish for. The first few months of 2018 could spell some risks if house price falls accelerate and widen geographically.
Deputy Prime Minister and former Shadow Minister for Finance and Debt Reduction came up with an economic doozie when he recommended that people “cash out your house in Sydney, Melbourne or Brisbane, and buy a house in Armidale and you put money in the bank”.
It is a quaint idea until you look at a few basic facts.
The combined population of Sydney, Melbourne and Brisbane is around 13 million.
According to the website realestate.com.au, there are 477 properties for sale in Armidale. There are a further 160 available for rent. If 0.004 per cent of the population of Sydney, Melbourne and Brisbane took up the challenge and bought and rented in Armidale, all properties would be sold and rented. There would be a crazed bidding for housing and prices would go crazy and indeed, there would be a serious dwelling shortage.
Local renters would be crunched when rents were renegotiated and propbably have to leave.
Interestingly, the population of Armidale is 23,000. It would rise 3 fold if just 0.5 per cent of the people of Sydney, Melbourne and Brisbane took up Mr Joyce’s challenge to move. Imagine the stress on the schools, hospitals and roads.
Mr Joyce’s idea is a good one as long as no one takes it up.
This article first appeared on the Yahoo 7 Finance website at this link: https://au.finance.yahoo.com/news/negative-gearing-change-221202487.html
Is negative gearing about to change?
If the polls and betting markets are correct, there is a good chance that Labor will win the next election and the negative gearing rules that have driven personal investment in housing for many decades will change.
With the Federal election set to be held late this year or early next, Labor are committing to change the policies regarding negative gearing which will radically change the way future investment in the housing market will be allocated.
It is important to emphasise that Labor is not planning to get rid of negative gearing. Far from it. Labor’s policy change boils down to keeping the existing rules for negative gearing for investors buying newly built dwellings, but ending the eligibility of negative gearing for established dwellings. For those investors wanting to negative gear, and there is no doubt there will still be many, it will still be available for new properties. Fill your boots, as they say!
It has been obvious for many years, perhaps decades, that one of the critical issues driving the extreme price rises in the Australian housing market is a lack of supply, relative to demand which has been driven by rampant population growth. In other words, there has not been enough new construction to adequately house the extra population and this shortage has seen prices rise.
The Labor policy change will encourage investment flows to new construction and over time this will help to address the supply / demand imbalance.
What the change to negative gearing will also mean is that demand from investors for established dwellings will fall away markedly. To be sure, people will still be able to buy multiple investment properties if they so desire, but they wont be able to use the tax laws to get other tax payers to subsidise the interest on the debt used to purchase those dwellings.
US bond yields are rising more quickly than the equivalent Australian yields.
The 10 year government bond in the US is now yiedling 2.71 per cent, just 14 basis points below the Australian 10 year bond and if the recent trends in the relative economic fundamentals of the two countries is sustained, Australian 10 year yields will fall below those in the US.
It is possible, and indeed my base case that over the next few months, Australian 10 year yields will be 50 basis points below those of the US. US Fed rate hikes, the RBA on hold and soon to change its rhetoric on its wishes for monetary policy will be the triggers for this move.
It is also likely to mean that the Australian dollar, which is currently sniffing the ozone around 0.8100, will fall back, perhaps sharply. The looming election, an uncertain outlook for China and commodity prices and the deterioration in the trade position are also set to undermine AUD strength.
It is not often Australian interest rates are lower than in the US, but with its economy strong and Australia still somewhat problematic, we are about to see this rare event unfold.
Podcast on the economy: This link is to my chat with Philip Clark on Nightline, ABC radio about the year ahead in 2018:
I must say the caller’s questions were a highlight.
This article first appeared on the Yahoo 7 Finance website at this link: https://au.finance.yahoo.com/news/2332204-002854969.html
'Disconcerting': 5 reasons why interest rates wont rise
Interest rates are about to rise.
So say a growing number of economists and the money market futures which are now pricing in a 25 basis point interest rate rise in the final quarter of 2018 and a further 25 basis point rise in the second quarter of 2019.
The market and many economists are increasingly optimistic that economic growth, wages and inflation will all of a sudden lift back to levels consistent with a healthy economy. The theory is that as a result of this good economic news, the hand of the RBA will be forced to hike rates from what are currently record lows. To be sure, these interest rate rises could happen over that time frame. It would be a most welcome development to see interest rates move higher as it would be a sign of a return to favourable economic conditions for the first time in many years.
But just how reliable are the forecasts and the market pricing?
This article first appeared on the Yahoo7 Finance website at this link: https://au.finance.yahoo.com/news/2307140-040859645.html
Get ready for election economics
Let’s get a bit of basic economics and budget analysis sorted out as 2018, a likely year for the next Federal election, starts to unfold.
Tax cuts do stimulate economic growth.
Be it company or income taxes that are cut, the impact on economic growth will be positive, at least in the short run. When the government decides to cut taxes by, say, $1 billion a year, there is a simple transfer of $1 billion cash from the government sector with its saving level reduced by that amount, to the private sector. That $1 billion will be available to be spent, invested or even saved by the private sector. Whatever the end mix, there is a boost to the economy.
And yes, it is as simple as that.
But what if the government decides to spend $1 billion extra on educational, roads, consultants, health care, or any other purpose for that matter?
Well, that would stimulate the economy too. The effect would be different to a tax cut because the money would be directed to a specific area (consultants for example) and not as broadly based as a tax cut. But in the end, $1 billion of cash is simply transferred from the government into the bank accounts of those receiving the money via the extra spending.
Again, it is that simple.
The recent house price data from Corelogic are showing further falls in house prices.
The falls are, disconcertingly, most evident in Sydney where prices have dropped 0.5 per cent so far in January, which brings the aggregate fall since the September 2017 peak to a chunky 2.9 per cent. This means that for a $1 million property in September, the value has fallen $29,000 in just 4 months.
The house price weakness is not confined to Sydney.
In Melbourne, the Corelogic data shows house prices topping-out. Prices are down 0.3 per cent from the December 2017 peak which, to be sure, is not a large decline after the stunning increases of previous years, but a fall it is.
There was another round of euphoria as the monthly labour force data hit the screens. The data showed a nice 34,700 rise in employment in December which brought the total rise in jobs in 2017 to 403,100.
This is good news, to be sure, but how good is it really? What is the context for this increase in employment and how is Australia going in an ever vibrant and dynamic global economy?
Of some concern, Australia’s unemployment rate remains at 5.5 per cent – it actually ticked up from 5.4 per cent the prior month. Interestingly, and something less favourable, is the fact that the unemployment rate has been below 5.5 per cent for just two months (October and November 2017) in the last four and half years. Where is that 5 per cent or lower full-employment target everyone reckons we are near?
What’s more interesting, and a sign of the policy sloth that Australia is enduring at the moment, is that around the world, unemployment rates are falling and are impressively low.
Sure each country will have its quirks but have a look at our 5.5 per cent against these countries.