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Question 1. What will the RBA’s next move be? Rate cuts. rate hikes or on hold?
Australia’s goldilocks economic performance – one that is not too hot, not too cold – will give the RBA little reason to cut interest rates in the near term. Elevated inflation will likely prevent the RBA from cutting rates over 2024. It is not until 2025 that inflation will move comfortably within the RBA’s target band and the cash rate can be moved back toward its neutral level.
A key driver of our on-hold view is the expectation that the labour market will not deteriorate sharply. The August employment release gave us comfort that the labour market is indeed slowing but not collapsing. Employment grew by a robust +65K for the month but comprised largely of part-time employment. Importantly, after running red hot earlier in the year, average hours worked per week shrunk to a more sustainable level. With the unemployment rate expected to lift only gradually going forward, inflationary pressures will be slow to abate.
Question 2. Should we be worried about an increase in inflation?
Rising fuel prices and a weak Australian dollar will temporarily increase headline inflation in the near term, leading to a rise in the monthly inflation print. When it is released next week, we expect the monthly CPI to increase by 5.2% over the year to August, up from 4.9% in July.
But we should start to see a downward trend in core inflation emerge, even if at a snail’s pace, given the impact of electricity subsidies, fall in food prices and the peak in rental growth.
Question 3. Is the recovery in property prices is a false rally?
Since their trough in February this year, house prices have risen by 6.2% led by a strong 8.8% increase in prices in Sydney. Despite the 4 percentage points of cash rate increases from the RBA, house prices are now only 4% below their peaks when the cash rate was at 0.1% and mortgage rates around 2%. Over this time, household disposable incomes have been going backwards in real terms and mortgage rates are now closer to 6%. On most sensible metrics, such as house price-to-income ratios and rental yield-to-mortgage rate ratios, house prices are way overvalued across Australia.
But this does not mean that we expect a correction in the near term. A mismatch between demand and supply mean that prices are likely to keep rising over the remainder of the year. The increase in demand is being driven by the record increase in net overseas migration that is driving population growth to new heights. In the year to MQ’23, Australia’s population expanded by 563K people, of which net overseas migration was 433K. While almost 300K of this represents the return of foreign students, who are predominantly renters, there has also been a sharp increase in permanent and temporary skilled migration, which is contributing to the demand for housing and pushing up prices.
Supply constraints, for both labour and materials, have delayed the construction of new homes and led to an increase in the pipeline of homes outstanding. However, once this pipeline has been completed, new additions to supply are insufficient to support the underlying demand. Estimates from the National Housing Finance and Investment Corporation (NHFIC) made in February this year estimated the excess demand gap could persist for the next five years. Our assessment is that the step higher in population combined with constraints to new supply means that it is unlikely that we will see a sharp correction in house prices over 2024.
Question 4. How big a threat is a slowdown in China’s economy to Australia?
The Chinese economy is precariously perched with authorities juggling the competing priorities of faltering short-term activity with the need to implement structural reforms. A disorderly restructuring of the property sector would weigh heavily on the Australian economy at a time when the household sector is already struggling under the burden of higher interest rates.
After stalling for some months, Chinese policy makers have begun rolling out their standard playbook of fiscal stimulus based on infrastructure spending and support to the property market. A 15% rise in iron ore prices over the last month suggests that markets have become less concerned over the threat to Australia’s economy from a slowdown in China.
In our view, as long as Chinese authorities are prepared to rely on their traditional recession-busting playbook of infrastructure spending and property market support, China will act as a ballast against Australia’s own cyclical slowdown. But the level of support to Australia is limited compared to historical experience as Chinese policy makers back away from traditional big-bang stimulus measures due to the deleterious impact on debt, overinvestment in infrastructure and exacerbation of housing market imbalances.