26 May Rate cuts, tax cuts and easy credit, but is the cavalry too…
Australia’s mortgage belt is about to be given a helping hand with tax and interest rate cuts. (Mick Tsikas, file photo: Reuters)
Australian households are under siege and running low on ammunition.
Spending is running ahead of income growth and all of a sudden jobs are looking less secure.
The financial fortifications of rising house prices are looking less secure, particularly as many are built on a powder-keg of debt — household debt is at record 190 per cent of household income and rising.
At last it appears the cavalry is on its way, cobbling together an array of monetary, macro-prudential and fiscal weapons hopefully to boost confidence and liberate spending.
Two rate cuts should deliver the average mortgage holder (with a $350,000 debt) around $100 a month soon — that’s assuming the Reserve Bank delivers and the banks pass on 80 per cent of those cuts.
APRA’s de facto stimulus measure of easing borrowing restrictions should buttress crumbling house prices.
The promised tax cuts will shovel back up to $1,080 a year to middle-income taxpayers. It will be less for lower-income brackets.
The tax cuts will be a bit slower in arriving given the offset will only be paid once tax returns are filed.
Based on taxpayers’ past behaviour, around two thirds — or $4 billion — of this year’s cuts will be delivered in the third quarter and another $1.7 billion in the fourth.
Wealth effect of falling house prices
The question remains, is it all a bit last-minute to stave off the economy beating retreat?
Minack Advisors principal Gerard Minack says while the measures are helpful, they are probably too late to prevent a downturn in residential construction.
Last week’s construction data shows an industry on the slide, while forward-looking measures such as building approvals, loan applications and industry surveys indicate things will get worse before they get better.
“But the big question is whether wealth effects from already-seen house price declines bite the consumer. If they do bite, these measures will be too little, too late, ” Mr Minack said.
Just how effective the multi-pronged intervention will be in re-booting the economy depends on how much households spend and how much they save.
Incentive to pocket the tax cuts
Citi’s Josh Williamson says the tax offsets will boost disposable incomes and should be worth around 0.75 percentage points of GDP in the 2020 financial year.
“That said, we don’t know how much of the tax cuts will be saved,” Mr Williamson said.
“Our working assumption is that up to half of the tax cuts will be siphoned into precautionary savings balances given high household debt and expectations of on-going low wage growth.”
Squirrelling the money away is just what the economy doesn’t need right now.
Despite insipid wage growth, households have been able to keep spending thanks to rising house prices allowing savings to be used to fund consumption.
It has allowed household spending growth to outpace disposable income growth over the past four years. Noticeably, savings started picking up late last year as house price falls accelerated.
Spending savings helped dodge recession
The opportunity to re-stock savings rather than keep spending may be too hard to pass up for increasingly anxious households.
“The simple point is that Australia may already have been flirting with recession if not for this saving decline,” Mr Minack said.
“Nominal household disposable income growth is running at only 2 per cent — near zero in real terms. If the saving rate had flat-lined, real consumer spending — accounting for 55 per cent of GDP — would have shown no growth.”
Mr Minack says while the rate and tax cuts are handy, and could lift household disposable income by 1 percentage point, it needs to be seen against the adverse effects of the “wealth effect” of falling house prices.
Saving rates jumped significantly across a number of developed economies in the wake of post-GFC property correction.
Mr Minack said if that were to be replicated in Australia it would completely swamp the modest policy boost in the pipeline.
Minack Advisors principal Gerard Minack has warned increased saving levels in households increases the risk of recession. (ABC News)
“Of course, the GFC is a harsh comparison. On the other hand, wealth effects are likely to be more powerful in Australia than elsewhere because house wealth is larger relative to income.”
To get some idea of what might happen, it is instructive to have a look at Western Australia.
“House prices have fallen for longer in WA than elsewhere and per capita consumer spending is now falling,” Mr Minack said.
“If the same thing happens in New South Wales and Victoria by the end of the year, we’re toast.”
Consumer spending per capita is now falling in WA after a protracted period of falling house prices (Supplied: Minack Advisors)
Mr Minack says this is all circumstantial evidence that saving does rise, after a lag, as house prices fall.
“In this context, even if lower mortgage rates and relaxed macroprudential put a floor under house prices, it’s not clear that a turn in house prices will come soon enough to forestall a broad rise in saving.
“If saving does start to rise, recession will remain a risk,” Mr Minack warned.
Does more need to be done?
The Reserve Bank’s recent downgrading of GDP and inflation forecasts were framed with the expectation of two rate cuts.
Already a number of economists, including Westpac veteran Bill Evans, are saying it won’t be enough, and three cuts, taking the official cash rate below 1 per cent, is the bare minimum.
“Our forecasts for employment, wages growth, economic growth, inflation and conditions in the housing market are consistent with the need for policy to ease through the full course of 2019,” Mr Evans said.
Mr Evans said there has been a fundamental change in the RBA’s approach where the biggest perceived risk to the economy is unemployment and low wages, rather than, “excessive household debt and frothy housing markets”.
“The risk of overstimulating the housing market seems low, ” Mr Evans said.
If all else fails, Mr Evans argues the RBA may have to look at more unorthodox approaches such as quantitative easing, or money printing, to get things going, but that is more likely to be an issue for next year.
After week on the skids, global market largely steadied on Friday.
The S&P500 edged up a tad, but was still down more than 1 per cent over the week.
The ASX went the other way, falling on Friday but was up more than 1 per cent for the week.
Futures trading points to a flat opening to the week.
Markets on Friday’s close:
- ASX SPI 200 futures flat at 6,462, ASX 200 (Friday’s close) -0.6pc at 6,456
- AUD: 69.2 US cents, 61.7euro cents, 54.4 British pence, 75.7 Japanese yen, $NZ1.06
- US: Dow Jones +0.4pc at 25,586 S&P500 +0.1pc at 2,826 NASDAQ +0.1pc at 7,937
- Europe: FTSE +0.6pc at 7,278 DAX +0.5pc at 12,011 EuroStoxx50 +0.7pc at 3,351
- Commodities: Brent oil +0.4pc at $US68.69/barrel, Gold +0.1pc at $US1,285/ounce, Iron ore -0.1pc $US105.32/tonne
Over the medium term, the bigger question is who will wrest controls on the ASX; the bulls or the bears.
UBS economist George Tharenou said local markets took unusually divergent approaches to the news of the week.
The Australian dollar dropped to a post-GFC low, 10-year bond yields slumped to a record low while the market priced in around 60 basis points of rate cuts.
“In contrast however — and clearly supported by the lower Australian dollar and the expected lower interest rates — the Australian equity market surged towards a record high,” Mr Tharenou noted.
Mr Tharenou said at the moment economic data keeps keeping worse; unemployment is trending up and the global risk of a trade war is escalating.
“A surprise slump of first quarter construction means GDP is likely to post a third consecutive quarter of per capita recession … the worst since the GFC,” he said.
“It’s likely the bears will be fed weak data for months, but the bulls will ignore it as ‘pre-stimulus’; with winners unclear till year end.”
Soft business investment
This week’s key numbers should be tasty fare for the bears.
Business investment, or capex, (Thursday) is likely to be fairly flat with growth in equipment purchases slightly outweighing declining building investment.
The continuing strength in equipment investment — which accounts for around 4 per cent of GDP — largely depends on consumer spending. If that sags, so will investment.
The forward-looking estimate of business investment is also expected to be a little softer, although the miners may be a little more encouraged to open their wallets thanks to the higher prices they are currently receiving.
Housing approvals (Thursday) have been volatile for months. April’s figures shouldn’t be as dire as the 15 per cent slump in March, but still down around 20 per cent on a year ago.
Private sector credit (Friday) has been sluggish for a fair while, dragged down by weak home lending.
Housing credit growth is at a historic low of just 4 per cent over the year and another weak figure is likely. Post rate cut and credit easing readings in coming months will be more significant.
One developing worry is softening business lending, although it is hardly surprising given sliding business conditions and confidence.
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