Macro 8 minutes to read

What fading global growth means for RBA policy

Eleanor Creagh

Australian markets strategist, Saxo Bank

Summary:  The latest macroeconomic projections from economists at the IMF make for bleak reading. Australians, who are among the world's most heavily-indebted householders, face a particularly difficult situation and this will likely force the country's central bank into a significant policy shift.


The International Monetary Fund is downgrading its outlook for the world economy to the lowest level since the financial crisis, and Australia is no exception. According to the IMF, Australia's economic growth will slow at almost twice the speed of other advanced economies this year. The fund forecasts GDP growth will wane from 2.8% last year to 2.1% in 2019, which represents a 0.7% downgrade to its October 2018 forecast. With growth slowing to 2.1%, hiring momentum would abate, prompting unemployment to rise which could spark a downturn in already sluggish wage growth and inflationary pressures.

This bleak prognosis comes just two days after the IMF's lead economist for Australia, Thomas Helbling, warned that Australia's housing market slump is worse than previously forecast, rendering the local economy in what he determined as a "delicate situation". Helbling also spoke about the need for increased infrastructure spending and potential rate cuts from the Reserve Bank of Australia. 

So, what is going on in the Australian economy?

The debt-fuelled surge in Aussie house prices has led to one the biggest house price booms in modern times, outpacing most major home price expansions in the western world. The “Australian Dream” has been financed through an epic accumulation of debt as interest rates collapsed, and credit availability surged, with household debt standing at a record high of 189% of disposable income. But now the tables are turning, something we have discussed at length, as home prices have become unaffordable for the average person, supply is rife, foreign demand is dwindling and perhaps most importantly, banks have tightened the screws on lending standards, cutting off the supply of credit to a nation who have gorged themselves on debt with Australian households being some of the most leveraged in the world.

The readiness of credit which formerly pushed residential house prices to record highs is now working in reverse as lending standards have been tightened making it much harder to get a mortgage. As home prices have come off the boil, the demand for credit has also turned down, as people are less inclined to buy into a falling market. Where credit growth goes, house prices tend to follow. And this is exactly what we have seen, house price falls have continued to gather steam this year, outpacing the declines seen in the late 1980s during the last recession.

Looking forward into 2019 it is likely that the East Coast housing market will continue to slide as credit conditions remain restrictive with the banks self-regulating, and demand falters, thus weighing on the growth outlook for the year ahead. In January we forecast the East Coast market could see a further 15% of declines throughout 2019.

Source: Core Logic
Source: Core Logic

The economy has also lost momentum in the back half of last year, the Q3 and Q4 2018 GDP readings confirmed that the domestic economy recorded the two weakest quarters of growth since the financial crisis as weak household spending weighs on growth.

In the midst of this downturn the labour market has held up, unemployment is now sitting at an 8-year low of 4.9%. This divergence between the labour market and the economy is something that is puzzling even the RBA, the central bank has stated that it is devoting significant resources to understanding this dichotomy.

But pervasive stagnant wage growth means income growth for the average person is not enough to offset the negative wealth effect felt as house prices continue to deteriorate. For most people, their home is their biggest asset and a significant store of wealth for the average Australian household, so continued house prices declines weigh on household consumption.

Private consumption is a big driver behind the Australian economy and historically represents around 60% of GDP. This means the outlook for household spending is very important in determining the future path of the Australian economy. As we have previously highlighted, the outlook surrounding the consumer in Australia remains fragile, which will see the RBA forced into a corner where there is no option but to cut rates, despite its reluctance.

So, what’s next for monetary policy? The RBA has shifted to a more neutral bias and is being a lot more realistic, shifting away from the characteristic stubborn optimism which has long prevailed. 

Last week the RBA took a small but significant step towards adopting a formal easing bias when it altered the last sentence in the final paragraph of the April monetary policy decision statement for the first time since March 2017. The last sentence now reads, “The Board will continue to monitor developments and set monetary policy to support sustainable growth in the economy and achieve the inflation target over time”. The RBA does not change the statement on a whim, so the shift signals an intention to alert the market that its view on monetary policy is changing. This signals a more fluid approach to setting monetary policy than has previously been seen, something we flagged last week, and implies that the RBA will shift course on monetary policy should growth continue to deteriorate and inflation continue to remain persistently below target.

Looking at the bigger picture, including Governor Lowe’s speech in February, the signals collectively indicate that the policy bias is creeping slowly from neutral towards adopting an easing bias before cutting rates in the second half of this year. These signals are consistent with our view that the RBA will downgrade growth forecasts in the May Statement on Monetary Policy. And it is likely it will adopt an easing bias at that point as well, making policy meetings more “live” than they have been for the entirety of Governor Lowe’s tenure. 
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