Australian Housing Bubble manageable? Maybe says one of the largest banks

On the back of currency flexibility, Australia would post 2.6% in 2017 and 3.2% in 2018, surpassing Netherlands’ 25-year modern day record of consecutive growth in a developed economy, notes BAML. Tony Morriss and colleagues at Bank of America Merrill Lynch in their November 24, 2016 research piece titled: “Australia Year Ahead – 6 Risks for 2017” anticipate AUDUSD to touch 0.70 next year, with USD appreciation dominating the ongoing strength in commodity prices.

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The six themes for Australia 2017 according to BAML:

1. There are significant limitations to policy for the year ahead. The benefits of further monetary policy easing have diminished due to financial stability risks while the high level of debt means households are vulnerable to higher rates.

2. Domestic economic conditions are likely to remain frail next year considering the state of the labour market.

3. Inflation will remain low as spare capacity and dwelling completions weigh on domestic cost pressures.

4  The threat of trade frictions is overplayed in the near-term but the risk cannot be dismissed.

5.   Lower  commodity prices next year as Chinese demand slows. Consequently, the benefit to government finances will fade.

6. The AAA rating is more a political than economic issue.

 

BAML analysts take a cautious view on Australia’s 2017 growth

As against consensus forecast of 2.8% for Australia’s 2017 growth, Morriss and team prefer to take a cautious view on the growth forecasts, as they anticipate a more modest patch of household consumption growth in light of expectations of persistently weak wages growth. They reckon GDP is expected to be dominated by external drivers, as the Australian economy enters the production phase of the mining boom. Thanks to financial stability risks, the analysts argue that the benefits of further monetary policy easing have dimmed. They anticipate a scenario where Reserve Bank of Australia would keep rates on hold and fiscal policy constrained:

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Focusing on housing sector, the BAML analysts point out that housing affordability would deteriorate in Australia should interest rates rise. By computing fair value based on household income and leverage capacity, the analysts estimate the average house price is currently around 15% higher than the fair value:

Australian Housing Bubble fair-value-estimates

Australian Housing Bubble

 

Australian Housing Bubble  – Substantial slowdown in employment growth in Australia

Morriss and colleagues point out that while around 90,000 full-time jobs have been shed in Australia so far in 2016, on an average only 4,300 jobs have been created each month. The analysts attribute the downturn in the mining investment boom as a key factor for the lack of employment growth. The analysts highlight that while firms are hesitant to employ full-time workers until they see a sustained pick-up in demand, the elevated unemployment is weighing on consumer expenditure. With around 50,000 jobs estimated to be lost in the mining sector, the analysts anticipate that the continued rotation of growth towards services will aid in employment growth. The BAML analysts reckon the unemployment rate would remain around current levels at 5.6%:

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Morriss and team attribute the recent dramatic rise in commodity prices, particularly coal, to combination of supply and demand imbalances, such as China floods, pit closures, and inventory shortages. However, with slowing Chinese demand, the analysts forecast lower commodity prices next year.

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On interest rates, the BAML analysts anticipate the RBA would be on an extended hold in 2017, limiting the scope for front end yields from rising too far relative to longer dated yields. They reckon a steeper curve as the best way to position for low cash rates in Australia, while longer-term rates head higher. The following table captures BAML’s forecasts on Australian economic and financial markets:

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