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How Far Can You Inflate A Bubble Without It Bursting
  • The Reserve Bank of Australia (RBA) is in a bind. Meagre growth, lacklustre jobs figures and almost non-existent demand cornered it into cutting the official cash rate by 25 basis points to 2.25% – a new record low. But with steaming residential property markets in Sydney and Melbourne, many are asking whether this will simply fuel the fire of further property speculation.

 

China: It All Depends on You

  • The graph below captures the quandary facing the RBA. Commodity prices have taken a nose dive over the past year. Although there has been recent spikes in the price of benchmark iron ore (which accounts for over one fifth of Australian exports) this is not expected to hold and ANZ is tipping the average price per tonne to rest at $US58 for 2015. Which is unwelcome though not unexpected news for the small and medium sized producers already travelling in or near the red.

 

 

  • This slump can be explained by easing demand in the Chinese residential property and manufacturing markets. As the graphs below shows, all indicators for these markets have been on trend decline, and are expected to keep heading south.

 

 

  • Long powered by the near insatiable demand of these Chinese markets, the Australian economy is experiencing profound shock at the end of prosperity, with growth at a meagre a 0.3% for Q4 2014. JP Morgan has gone so far as to say that the economy is ‘sliding down the precipice’ and to make matters worse, we are largely unprepared for the decline. The RBAs rate cut was evidently intended to stem this slide, but monetary policy can only do so much to fix major structural problems.

 

The Walking Dead

  • As outlined below, mining has been the greatest contributor to Australian growth for many years whilst other sectors have basically been on life support. This is of serious concern, and no doubt has been plaguing RBA Governor Glenn Steven’s sleep, because there is little push by other sectors to fill the mining void. As the picture below on the right makes clear, non- mining business investment has not been bolstered by the 15 month long and already historic low interest rates and, in fact, has largely suffered declines. Beyond the RBA’s finger crossing wishes, there are few signs that this will change from further interest rate cuts as business confidence is sitting uncomfortably and persistently low.

 

 

Hot Property, Cold Economy

  • Marry this situation with unbalanced though steaming property markets around the country and you soon discover a recipe for disaster. The total value of Australian residential properties has come to rest snuggly at $5.4 trillion, a sizeable increase of $124,445 million from the previous quarter. While this is considerable in its own right, these increases have largely been driven by investors and as outlined below, largely concentrated in the NSW market.

 

 

  • Despite this unbalanced growth respected HSBC economist Paul Bloxham has said that with the rate cut ‘the risk of a housing bubble is increasing.’ He indicated that the Sydney market is particularly vulnerable to a bubble, precisely because house prices are already far outpacing household income growth.

 

Conclusion

  • The economic outlook for the country is resting on a miracle: whether commodity prices (in effect Chinese demand) will increase and whether non-mining investment will finally take the RBA’s bait. With few outside the RBA expecting the rate cut to deliver either outcome, the real concern now is that the decision will fuel speculative activity in the property market and further inflate the bubble. The RBA has undoubtedly weighed its options long and hard and determined that this risk, though present, is not as great as the news headlines would have you believe. The best of a bad situation? Time will tell.

 

This update does not constitute financial advice and should not be relied upon as such. It is intended only to provide a summary and general overview on matters of interest and it is not intended to be comprehensive. You should seek professional advice before acting or relying on any of the content.

 

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