Loose monetary policy is rebalancing growth: HSBC's Paul Bloxham
GUEST OBSERVER
Last week's GDP print was a strong result, considering the global backdrop.
Australia's economy grew at an above-trend pace of 3.0% y-o-y over 2015, despite falling commodity prices and China's slowdown.
Monetary policy deserves much of the credit. Cuts to interest rates over the past four years and a significant fall in the AUD have been the key supports for growth.
Low rates have lifted housing prices and construction, which is feeding through to a positive wealth effect on consumer spending.
The lower AUD is supporting strong export growth, particularly of tourism and education services to Asia. At the same time, inflation is low and set to remain so. Despite these positive growth stories, the RBA may still need to cut further to keep inflation on target.
We have long been optimists on the Australian growth outlook. A key part of this story has been our belief that monetary policy is powerful and has been well managed.
In short, when the mining boom was at its peak, in 2011, monetary policy settings were very tight, which held back the non- mining sectors and kept inflation contained. This meant that there was then significant scope to loosen settings when the mining boom ended, thereby rebalancing and lifting growth. The RBA cut its cash rate from a peak of 4.75% in 2011 to 2.00% and the AUD has fallen from US105 cents to under US75 cents.
The cut in interest rates supported a 30% rise in housing prices since mid-2012.
The combination of rising housing prices and low interest rates drove new building approvals to record highs in H2 2015. Last week's GDP numbers provided evidence that rising housing prices are also delivering a positive wealth effect, with the household saving rate falling from 9.1% to 7.6% over the past year. Although income growth has slowed, due to slower wages growth, rising housing prices and greater certainty about employment prospects are seeing households choose to spend more of their disposable income, particularly on services. The pick-up in the service sector is, in turn, driving a pick-up in employment.
The lower AUD has also supported growth by improving Australia's competitiveness. In particular, and perhaps surprisingly to some observers, this is supporting a strong rise in net services exports. Inbound tourism and international student enrolments have picked up strongly, particularly from Asia. At the same time, Australians are also choosing to take fewer international trips.
Net services exports have gone from being a drag on the economy of around 0.75ppts of GDP, four years ago, when the currency was high, to contributing around 0.5ppts to GDP growth over the past year. Without this swing, GDP growth of 3.0% in Q4 would be under 2.0%. Importantly, the lift in net services exports has nothing to do with the housing boom. So the rebalancing of growth is not just a shift from mining to housing. Services exports are being driven by Asia's increasing demand for tourism and international education services, helped along by the lower AUD.
This great rebalancing act provides strong evidence that Australian monetary policy works.
However, the rebalancing story is not over yet and nor is the role of monetary policy. Although local growth has been solid in recent years, it has not been rapid enough to absorb all of the available spare capacity. The transition from mining- to non-mining-led growth has left GDP growth at a below-trend average of 2.4% over the past three years (even with the 3.0% y-o-y print in Q4).
Although the unemployment rate has fallen from 6.3% to 6.0% over the past year, it is still well above its full employment level of 5.25-5.5% and has been for four years. As a result, wages growth is weak. Indeed, even the state with the strongest economic conditions, New South Wales, is yet to see a pick-up in wage growth. Combined with low global inflation, this has meant that underlying inflation is now at the bottom edge of the RBA's 2-3% target band.
A number of near term challenges to growth also remain. Mining investment still has further to fall. Global commodity prices also have declined further since last year and over-supply in many markets is set to keep them low. Global growth is below trend and the Asian economies are being held back by weak global trade.
Australia's housing boom is also cooling, much as it should, given the already substantial run-up in housing prices and residential construction. However, the end of the housing boom means it is unlikely that household consumption will continue at the same strong pace observed late last year.
The other challenge is the AUD. As we described above, the AUD has been a key driver of the rebalancing act and a key support for growth recently. But low global inflation, further expected rate cuts from the ECB and Bank of Japan and the markets’ doubts about whether the US Federal Reserve will hike again this year, have meant that speculative positions have turned long on the Australian dollar.
The currency has climbed from its low point of US69 cents in January to now trading around US74 cents. A higher Australian dollar is unhelpful for the rebalancing story and likely to put further downward pressure on already low underlying inflation.
So although the growth performance is impressive, given the global backdrop, the question is: will there be enough growth to keep inflation on target? At the same time, local financial conditions have been tightening, not loosening, as the AUD has moved higher and the cash rate has been steady while inflation has fallen (meaning real interest rates have increased). Effective mortgage and business lending rates have also been lifted in recent months, despite a steady RBA cash rate, as a result of regulatory changes and higher global funding costs.
Just to keep the same effective financial conditions settings as delivered the strong H2 GDP growth performance the RBA may have to cut further. Thankfully, with a cash rate at 2.00% and inflation low the RBA has scope to cut further to keep Australia's great rebalancing act underway. Our central case sees another 25bp cut from the RBA around mid-year (Q2).
