By BOQ Chief Economist, Peter Munckton.
- Despite the noise, the global economy is in reasonable shape;
- And this is one factor behind the decent domestic economic performance;
- On its current trajectory the next move in the cash rate is up;
- But current expectations are that move is at least one year away.
“There’s no news like bad news”
Elliot Carver, fictional character in James Bond movie, ‘Tomorrow Never Dies’
There is no doubt that Pierce Brosnan looked the part as James Bond. Suave, sophisticated, always in control. Personally though I think Daniel Craig was the better Bond, although a recent IMDB poll had Sean Connery as the fan favourite (he was good). The film ‘Tomorrow Never Dies’ while a box office success, was the only Pierce Brosnan Bond film not to open at number one. That is what happens when you open the same day as ‘Titanic’.
The villain in Tomorrow Never Dies was Elliot Carver, a media mogul creating events for the benefit of his news media empire. Probably one of his intended audiences would have been financial markets, a mob who are always reacting to the latest bit of noise. In the real world this year that has meant worrying about the Trump trade tiff or the series of Emerging Market wobbles.
But in the midst of all the noise the global economy has done pretty well. And this has led to perhaps the biggest financial development in 2018; the move of US ten-year yields to their highest level in 7 years. It is a positive development, a sign that investors’ are confident about the global economy. But it could have negative consequences. The extended period of very low interest rates led to a substantial jump in global debt and underpinned high asset prices. The worry is then what happens as rates rise.
But while global investors’ have been jumpy about the global outlook, at least for now Australians appear unconcerned. There has been no GFC’s or European debt crisis to clog up the airwaves. The result has been that Australians’ recollection of global economic developments is now at its lowest level in 17 years. Domestic political developments have been more than enough to attract attention and would have been more than enough to keep Elliot Carver in business!
The positive global backdrop is helping the domestic economy. The RBA recently gave the domestic economy a thumbs up and it is easy to see why. The Q2 GDP numbers showed an economy purring along in fourth gear. Firms agree, with surveys indicating they business conditions are well and truly above average. Consumers also see an economy that is doing well. Although when they think of their own budget they are not sure they are getting their fair share of the spoils. Workers are no longer concerned about unemployment but about the size of their pay packet. Even here though there is better news. Indicators of wages growth have bottomed and are starting to turn north.
The improvement in consumer finances is helping retailors (although more improvement is needed). The strong global economy is boosting exporters, whether that be iron ore miners or tourism operators. Interestingly, firms optimism about exports has declined over recent months perhaps reflecting concerns about the global tariff battle. But if the global economy remains strong and the $A low, exporters should do well.
According to a recent Reuters poll, economists expect a modest rise in the $A over the next year. The $A is probably a little undervalued (particularly relative to the USD) given the high level of iron ore and coal prices. Tariff concerns may again be the answer. But rising US interest rates because of a rampant US economy is likely a bigger driver. A substantial rise in the $A will probably require either signs that the Federal Reserve is nearing an end to its tightening cycle, or that the RBA is about to raise interest rates.
Despite the improvement of the Australian economy, the news flow has typically focussed on the downside risks. The tightening of bank credit has been one topic, something also recently noted by the RBA. While credit growth has slowed much of the decline can be explained by a substantial reduction in the amount borrowed by investors. Credit to owner occupiers has grown at around the same pace for the past couple of years (and above the pace of household income growth). One reason is that first-home buyers are making a comeback, helped by the improvement in housing affordability (and the absence of investors’). Meanwhile, firms indicate that finance remains reasonably easy to access. So it appears that the modest growth in business credit is more a reflection of low credit demand by firms.
Another highlighted concern has been the decline in building approvals, and what this will mean for the future of residential construction. At least some part of the large run-up of house prices in Sydney and Melbourne reflected that not enough residencies had been built to meet the large rise in population. Builders have been busy over recent years and so the housing supply-demand balance in Sydney and Melbourne is in better shape. This has played a key role in the weakening of house prices. As a result some slowing in residential construction is both inevitable and desirable. It is therefore unsurprising to see that one industry that has seen a decline in business confidence has been construction. And given all of the activity over recent years, confidence in the apartment market has taken the biggest hit.
But it is not all doom and gloom for the construction industry. There still will be plenty of demand for cranes. The amount of infrastructure work still to be done in NSW and Victoria is it at a very high level. And there also remains a large amount of other construction work in the pipeline, whether that be finishing units or houses already approved or putting up new Office buildings.
Overall, it is understandable as to why the RBA thinks that economic growth will be humming along for at least the next couple of years. Sure the likelihood of a weaker residential construction sector will mean that growth is unlikely to be gangbuster strong. But other parts of the economy are now shifting up a gear. The past speed of the economy has meant that inflation and wages is still too low for an imminent rate change. But momentum is building, and both financial markets and economists think this will mean that the next move in the cash rate is up (albeit not for some time). The latest poll has economists evenly split as to the first quarter percentage point rate hike will be in Q4 2019. By the following quarter a clear majority expect a higher cash rate.
All up, the economy is doing well. If that remains the case higher interest rates are on the way. But this does not mean that there will not be news (both real and imagined) that might challenge economist and financial market views. Hopefully Elliot Carver is wrong, and it is the good news that will matter.
We live in interesting times.