After 27 years, the Australian economy is finally facing a recession. Neither monetary nor fiscal policy look set to save it and yet again we appear highly dependent on a Chinese surprise.
The outlook for the Australian economy is bleak. Gross domestic product and consumption growth are expected to fall. The recent decline in house prices will almost certainly continue alongside the six year-long stagnation in real wage growth.
Against this backdrop, the bond market’s expectations of more than one interest rate cut in 2019 are now echoed by economists, corporates and equity investors, while the Reserve Bank of Australia (RBA) has remained tellingly silent until last month, when it opened the door to speculation.
If the RBA lowered the cash rate below 1.5 per cent, it would be the first cut since August 2016 and the lowest ever since it began targeting the cash rate. Economic conditions have deteriorated significantly since that last stimulatory measure.
Criticism of RBA governor Philip Lowe’s strategy has shifted from a focus on this latent conservatism to a broad assessment that if he were to change tack now it would be a case of too little, too late.
Lowe’s stewardship can only be judged with the aid of hindsight and these criticisms may be too simplistic. The complexity of the Australian housing market in a record-low interest rate environment – asset inflation, high household debt, poor credit quality and bank reregulation – has inhibited RBA decision making.
The RBA has juggled “popping” the asset bubble by raising rates with “blowing it up” with further cuts, ultimately choosing to do neither.
Meanwhile the broader economy has deteriorated and macroprudential reform, the banking royal commission and the exit of international property investors have burst the property bubble where the RBA would or could not.
The recent fall in housing prices, particularly in the east-coast market, was a necessary correction given the frenzied price growth in recent years. Consumer sentiment has suffered greatly from this negative wealth effect and it is likely to struggle as property cycles are long and slow.
The outlook for consumer sentiment is crucial given the astounding levels of household debt, which is now 127 per cent of GDP.
Coupled with the increase in interest-only loans and credit availability, low interest rates since the global financial crisis have led to households’ debt-to-income ratio reaching a record high of 189 per cent. It is widely thought that the responsible lending obligations, outlined in the National Consumer Credit Protection Act 2009, were too loose and ambiguous, resulting in poor loan quality. This has changed at breakneck pace and the big banks are now assuring investors that credit conservatism is here to stay.
In another blow to household wealth, when interest-only loans become mature they will no longer be offered, resulting in mortgage repayment increases of 30 per cent on average. The Australian Prudential Regulation Authority has vowed to expediently implement the royal commission’s recommendations, which also see it strengthening its prudential and supervisory framework and broadening its power.
Following these tectonic shifts in the economy since the last rate cut, the RBA is now on shakier ground than ever.
With the cash rate sitting at 1.5 per cent, the predicted cuts will not materially stimulate the economy, let alone stave off a recession. This means that Australia is dependent on the short-term benefits of fiscal stimulus. With a federal election looming, it is expected that both parties will compete to outspend each other on infrastructure and other programs. However, this injection is likely to fall short.
If China fails to stimulate its economy to sufficiently drive global growth, an Australian recession is almost certain.
Matthew Haupt is a Lead Portfolio Manager at Wilson Asset Management.