The latest OECD world outlook released on Tuesday highlights that while the world economy is beholden to the risks of Donald Trump’s presidency and Brexit; the concern in Australia is housing prices and the need to ready ourselves once again for a time when the Reserve Bank increases interest rates.
Risk is a big issue for the OECD. The latest update of its outlook has thrown off somewhat the gloomy tone of the financial crisis years, but it has hardly adopted a giddy disposition. The headline is one of concern overshadowing (limited) joy: “Will risks derail the modest recovery?”
Across the OECD, 2017 and 2018 look to be better than the post-GFC years of 2011 to 2015. The big exception is the UK, which the OECD sees achieving GDP growth of just 1.0% next year due to Brexit uncertainty and the impact of rising inflation.
For Australia, the OECD’s outlook is similar to that of the Reserve Bank’s, with GDP growth improving in 2018 to 3.1%:
But the risks to this growth remain prominent in the minds of the OECD boffins. The subtitle of the update is “Financial vulnerabilities and policy risks”. The policy risks most acute are those of the Brexit and the Trump administration.
While the report does not name Trump, there is little doubt who is at the forefront of their minds when it notes that “there is significant uncertainty about the future direction of trade policy globally, in part because of falling public support for trade in advanced countries connected to disparities in outcomes across industries, workers and regions.”
It also notes that “falling trust in national governments and lower confidence by voters in the political systems of many countries can make it more difficult for governments to pursue and sustain the policy agenda required to achieve strong and inclusive growth.”
But while these issues affect Australia as well, for the most part the risk the OECD applies to Australia relates not so much to policy but to financial vulnerabilities.
Last week, the OECD’s report on Australia highlighted the concern over a housing price crash, and again in this OECD-wide report, the issue is given specific attention.
Generally Australia doesn’t feature much in such reports, and so it is significant that the only mention made of our economy is when it notes that “some countries have experienced rapid house price increases in recent years, including Australia, Canada, Sweden and the United Kingdom.” Rather pointedly it notes that “past experience has shown, a rapid rise of house prices can be a precursor of an economic downturn”.
But the issue is not just that house prices may fall and with it people’s incomes, it is that people in Australia are much more in debt than they once were – and thus moves to dampen house prices through increased interest rates will have a sharp impact on consumer spending and people’s likeliness to default.
Across the OECD, the report notes that “although there has been a slower accumulation of household debt in recent years, mortgage-debt-to-income ratios remain high in many countries”.
In Australia it is not just high but record high. Housing debt is now equivalent to 132.2% of household annual disposable income – well above the pre-GFC peak of 113.1% in September 2008.
And that point is important because that was when Australian households were paying a record amount of their disposable income on mortgage interest repayments. At 11% of quarterly disposable income it remains well above the current level of 6.8%:
The reason that we are currently paying less in interest despite having higher levels of debt is, of course, because interest rates are much lower now. And that is where the big risk from both the policy uncertainty and financial vulnerabilities nicely merge.
Since the election of Donald Trump the general view has been that inflation across the world is set to increase. This mostly comes from a belief that Trump is more likely to provide stimulus to the US economy than would have Hillary Clinton – first, because Trump promised such policies and, second, because the Republican party in Congress, which could limit such spending, only cares about the budget deficit when the president is a Democrat.
As a result, the interest rate (or yield) for government bonds both in the USA and in Australia has risen:
This matters not just because of the increased costs to our government to borrow money, but because the rates of government bonds do not stray too far away from the level of the cash rate:
The increase of the rate of two-year Australian government bonds from a low of 1.41% in August to now 33 basis points above the cash rate at 1.83% suggests the market is anticipating a rise in the cash rate over that time.
Indeed, the market is now fully pricing in a rise to 1.75% by June next year:
Some banks are already predicting a rate rise to occur this year. The RBA in its statement on Tuesday certainly gave no indication that this will occur.
Mostly its language was the same as in February. Certainly the bank was no more bullish about the economy than it was with its rather optimistic outlook in February.
In February, it said that “growth in full-time employment turned positive late in 2016.” On Tuesday, the language had been changed to strike a slightly more cautious note: “the unemployment rate has been steady at around 5¾ per cent over the past year, with employment growth concentrated in part-time jobs”.
But the OECD certainly is sounding the warning that the RBA needs to act. As I noted in January, the latest housing finance data suggests prices will continue to pick up over the next six months.
It has now been a record 76 months since the RBA last increased interest rates. And with our current record levels of debt, any rise going to have a much greater impact than in the past. But while the bank will be concerned about the impact of a rate rise of consumer spending, the signs are that this period of no rate rises will end sooner rather than later.
