After the Federal Election delivered a surprise win and a majority government for the Liberal/National Coalition, the focus shifts now to how the returned government will respond to a weak economy. You can listen to my webinar on the post-election economic outlook here.
Interest rate cuts
After several months of keeping markets guessing, the Reserve Bank of Australia (RBA) has thrown in the towel and shifted to an easing bias. In a speech on 21 May in Brisbane, RBA Governor Philip Lowe indicated that the central bank now thinks the next move in the cash rate will be down.
Having laid out the case for using monetary policy to achieve a lower unemployment outcome, the Governor concluded his speech by saying that at the next RBA board meeting ‘we will consider the case for lower interest rates’. Last week’s news that the unemployment rate had started to edge up – hitting 5.2 per cent in April – looks to have removed the last element in what has been a steadily eroding case for leaving rates unchanged.
Markets are now confidently expecting a cut in the cash rate at the RBA’s 4 June meeting. Markets have priced in a 25 bp rate cut at that June meeting as extremely likely (more than 90 per cent probability at the time of writing). They also expect another cut to follow, taking the cash rate down to one per cent within six months.
The Australian Prudential Regulation Authority (APRA) has also proposed amending its guidance on mortgage lending in a powerful sign that its concerns have shifted from excessive borrowing to an excessive credit squeeze.
Tax cuts (or in this case, tax rebates) are an important tool right now because households are being squeezed. Australia’s high household debt burden is a key risk and – when combined with slow income growth and falling house prices - represents a critical threat to the economic outlook.
A key element here is the returning government’s pledge to deliver tax relief to low- and middle-income households through a tax rebates. Once legislated (and it now seems that the process will be delayed), the plan will deliver an injection of about $7.5 billion to the household sector, with around 10 million households likely to receive a rebate up to a maximum individual payment of $1,080. That cash payout should boost households’ spending power and deliver stimulus that is broadly equivalent to a couple of rate cuts from the RBA. But before the proposed new tax relief can be delivered, parliament needs to pass the appropriate legislation and it is very unlikely that parliament will be resume before the end of the current financial year.
Housing sector correction
We may now see a bit more stability returning to the housing market. House prices have been falling for more than a year in key Sydney and Melbourne markets, but the pace of decline has shown signs of slowing in recent months. The removal of any election-related uncertainty could help here, and proposed government assistance on mortgages for first home buyers – while small – could also provide some modest support for market sentiment.
Another potential source of support for the housing market is the news that APRA has proposed amending its guidance on mortgage lending. Under the current set-up, APRA’s guidance to Australian authorised deposit-taking institutions (ADIs) is that they should assess whether borrowers can afford their repayment obligations using a minimum interest rate of at least seven per cent. Instead, APRA now suggests letting ADIs set their own minimum interest rate floor.
APRA has also suggested a change to the way ADIs assess loan serviceability. Currently, ADIs are expected to use the higher of either (i) an interest rate floor of at least seven per cent; or (ii) a two per cent buffer over the relevant loan’s interest rate. APRA proposes to replace this with an interest rate buffer of 2.5 per cent. By relaxing serviceability guidelines, the proposed change would increase the maximum borrowing capacity for borrowers. That would ease credit conditions and so – potentially – provide some additional support for the housing market.
Slow growth outlook
Weak household consumption and falling dwelling investment have prompted the RBA to cut its forecasts for economic growth for this year. It now thinks the economy will only grow by 1.75 per cent in the year to June, down from its previous forecast of 2.5 per cent. For 2019 as a whole, the RBA reckons the economy will grow by just two per cent in real terms, instead of its earlier forecast of 2.75 per cent. And remember, those forecasts already assume that the cash rate will move in line with market expectations – which are currently for two 25 bp rate cuts.
While the short-term challenge to the growth outlook is posed by a tricky trifecta of high household debt, falling house prices and weak income growth, the medium-term challenge is to address Australia’s slowing underlying growth potential and disappointing productivity performance. Prior to the global financial crisis, the Australian economy was averaging an annual growth rate in excess of three per cent. Since the crisis – and like much of the world economy – we appear to have shifted down onto a lower growth trajectory and have seen a run of disappointing annual productivity results.
While tax rebates and rate cuts look set to provide the key impetus to the economy, other policy support for the near-term growth outlook will come from the continued rollout of infrastructure spend and measures to assist the SME sector. A weaker Australian dollar should also support exporters.
As well as providing a helpful short-term boost to the economy through the construction and delivery phase, investment in infrastructure has the potential to lift the economy’s underlying growth rate and support its productivity performance. Current plans call for a total of $100 billion of infrastructure investment over the coming decade. According to Budget 2019, this will be delivered at the same time as a shift to sustained budget surpluses.
But with growth slowing and borrowing costs at record lows – at the time of writing the yield on Australian government 10-year debt had fallen to below 1.6 per cent – the case for borrowing to invest, if needed, also looks compelling. The RBA has cited OECD estimates that an increase in public infrastructure investment in Australia is associated with a fiscal multiplier of between 1.1 and 1.3 after two years. (That is, a $1 billion increase in public infrastructure investment would increase GDP by around $1.1 billion - $1.3 billion after two years.)