Once again, many pundits and particularly the foreign exchange traders have got the wrong end of the stick when analysing this year’s highly significant change of direction by Reserve Bank Governor Philip Lowe.
The singular fact that many seemed to have grabbed hold of is that Dr Lowe has now conceded that the RBA might be forced to cut official interest rates.
Which is why the Australian dollar plunged just after his speech was made.
What they left out is that not only does he think that an interest rate cut scenario is unlikely, it would be a bad outcome all round if he was indeed forced to cut rates.
The entire “vibe” of Dr Lowe’s important speech this week was not that the Australian economy is going to hell in a handbasket but quite the opposite, that there is room for considerable optimism.
Many reasons for optimism
There are challenges as well of course, including slower than expected economic growth, falling house prices, high household debt and slowing world growth.
However, there is plenty of reason for cautious optimism – the jobs market is holding up well, LNG exports are rising, iron ore prices are rising sharply and the strong growth in infrastructure spending is compensating somewhat from the downturn in housing construction.
What we really don’t want – apart from an interest rate cut – is for the RBA to start reacting to gloomy headlines and to be panicked into an early rate cut when there is every chance the right course will be to hold rates steady for much longer than initially expected and to gradually raise them as activity and inflation finally turn upwards.
GDP to fall
That is exactly the most likely medium-term scenario outlined by Dr Lowe, although you would think from some of the commentary, he was predicting Armageddon.
Sure, Dr Lowe did reduce the RBA’s prediction for GDP down to around 3% over 2019 and 2.75% over 2020 and forecast a slower pick-up in inflation.
That is not stellar growth – and there is a chance the RBA are being too optimistic – but it is enough to continue the process of lowering unemployment and to provide some support for consumer spending.
The entire basis for the pessimism of most traders and commentators – particularly those who seem to relish the prospect of an interest rate cut – is that the Australian housing market is sliding.
Housing market pessimism potentially overblown
By now we are used to dramatic headlines about Australia’s plunging house prices but the reality is somewhat different.
As Dr Lowe pointed out, you can’t look at the short-term dip in Sydney and Melbourne house prices without also looking at the significant surge that happened before that.
Dr Lowe made the point well by saying: “… the recent housing price declines follow very large increases in prices. Even after the recent declines in Sydney, prices are still 75% higher over the decade. In Melbourne, they are 70% higher. While the price falls are no doubt difficult for some, including people who purchased in the past couple of years, there are many people sitting on very significant capital gains and there are others who now will find it easier to purchase a home. And of course, in a number of cities and much of regional Australia, things have been more stable.’’
Household income set to rise
He then went on to say that most households don’t change their consumption in response to short-term changes in their wealth and that household income growth is expected to pick up and feed in more strongly to consumption than changes in wealth.
“Over the next year, we are expecting a pick-up in household disposable income to provide a counterweight to the wealth effects of lower housing prices,’’ Dr Lowe said.
I think a lot of the hyperbole around property prices comes from the shock to the system that falling prices have brought.
People have simply become accustomed to property prices rising higher year after year like clockwork and can’t quite believe it when the tide starts to flow in the opposite direction, which it always does eventually.
As Dr Lowe pointed out, though, there are positives to the lull in property prices, not least the greater affordability they bring for those prepared to grab the opportunity.
Bad debts a key indicator
For a real-world example of how well Australian’s are handling the property correction though, it was hard to go past the Commonwealth Bank’s (ASX: CBA) profit result this week.
Yet again, the result showed that provision for bad and doubtful debts was steady at its current very tiny levels.
If you really want to see how the real estate market is holding up under pressure, bad and doubtful debts at the major banks are one of the better indicators.
They may well begin to trend up over the next year or so but the time to get really worried about a property crash is when they start rising quickly.