Weekly economic briefing: Australia’s housing boom – a prudential perspective

The Weekly Economic Briefing is written by two senior Deloitte Economists, David Rumbens from Deloitte Access Economics in Australia and Ian Stewart Deloitte’s Chief Economist in the UK. They provide a personal view on topical financial and economic issues. Subscribe to receive the Weekly Economic Briefing in your inbox!

In this week’s blog:

Australian economic briefing
UK economic briefing
International economic briefing

Australian economic briefing by David Rumbens

This section of the briefing provides a snapshot of key economic data and issues of relevance to Australia.

Australia’s housing boom – a prudential perspective

Last week the Australian Prudential Regulatory Authority (APRA) announced further measures to make our banks more secure, increasing minimum capital requirements for authorised deposit-taking institutions (ADIs). This announcement continues a busy three years for the regulator, where prudential measures have gradually been ramped up.

Following the 2014 Financial System Inquiry (FSI), APRA outlined a range of measures aimed at reinforcing sound residential mortgage lending practices. In order to improve assessments of whether potential borrowers can afford their mortgages, APRA introduced an interest rate serviceability buffer whereby the minimum expected interest rate buffer must be the higher of either at least 2% above the loan product rate or a minimum assessment rate of at least 7%.

In addition, APRA acted against the risks posed by significant growth in interest-only and investor lending by setting the expectation that institutions limit the flow of new interest-only lending to 30% of new residential mortgage lending, and manage investor lending growth to not exceed 10%.

Banks are required to keep a certain proportion of capital on their balance sheets to cover any potential losses that may ensue from borrowers defaulting on their loans or depositors withdrawing excessive amounts of funds. This capital is calculated as a share of risk-weighted assets. In July 2016, APRA increased the floor on average residential mortgage risk weightings from 16% to at least 25% for larger banks authorised to use an internal approach for calculating their regulatory capital requirements. This meant that more reserves were required to be held to cover potential losses on residential mortgages.

Hence, APRA’s decision last week to increase minimum capital requirements by 150-basis-points for the major banks and a lower 50-basis-points for smaller banks was not unexpected. However, given that the major banks generally hold a surplus of capital on their balance sheets, the impact is expected to be minimal.

While the strong house price growth seen in Sydney and Melbourne has focused attention on the residential mortgage sector, APRA has not set targets in relation to house price movements. APRA’s intention has not been to manage house prices, but to mitigate credit risk and ensure that bank lending standards remain sound. The importance of sound lending standards cannot be underplayed, especially when considering some overseas experiences during the 2008 Financial Crisis.

In the United States prior to 2008, mortgage originators were unchecked, granting loans on low introductory interest rates to borrowers who were unable to afford these loans once this introductory period ended. Whereas in Ireland, housing credit growth almost tripled between 2002 and 2008 with little interference by the prudential regulator. Although housing credit growth was relatively healthy in Australia during this period, Australian banks were well capitalised, had tighter lending standards and were more closely monitored by APRA. Unsurprisingly, the US and Irish banking systems were hit hard by the financial downturn.

APRA remains ahead of current international standards set out under the Basel III Accord and appears to have equipped the banking sector to cope with a potential shock. APRA’s most recent stress tests in 2014 illustrated a relatively resilient banking system, concluding that banks had enough capital to absorb losses from a fall in house prices of almost 40%. The introduction of tighter restrictions since then suggests that the banking system is well placed to address potential future economic adversity.

That is not to say there still might not be a significant fall-out for Australian house prices – valuations are indeed very stretched.  But it gives some reassurance that the Australian banking system (despite its significant weighting towards residential mortgages) is not likely to be collateral damage should that occur.

For more information on the Australian brief, please contact the co-authors, David Rumbens and Tom Heagney.

 

UK economic briefing by Ian Stewart

A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. Subscribe to and view previous Monday Briefings at: http://blogs.deloitte.co.uk/mondaybriefing/

Global growth and trade are looking up

  • Growth in world trade has been pretty lacklustre in recent years. Much of this weakness has been due to the hangover from global financial crisis. Political hostility to trade liberalisation, shortages of finance and sluggish growth rates have all weighed on exports.
  • When we last wrote about this, in late 2015, global trade volumes were growing at the slowest pace ever seen outside a recession.
  • Since then things have started to look up. Data from the Netherlands Bureau of Economic Analysis, released last week, shows that global trade volumes are rising at an annual rate of 5.1%, the fastest rate in six years. This is still way below pre-crisis rates, but it means that growth in global trade is, once again, outpacing, and reinforcing, global GDP growth which is also on an upswing.
  • Last week the International Monetary Fund raised its forecasts for the growth of the world economy to 3.5% this year and 3.6% in 2018.  The improved global outlook has been driven by better prospects in Japan, a number of emerging market economies and, in particular, the euro area.
  • The turnaround in the fortunes of the euro area is especially pronounced. The Germany Ifo survey, the bellwether of business sentiment for the whole of Europe, is running at the highest level in its 25 year history. Investors have been flocking to buy euro area assets. Euro area equities have returned 23% so far this year and the euro has risen by 10% against the dollar.
  • While activity is accelerating across much of the world the UK is heading in the opposite direction. UK growth is slowing as higher inflation takes a toll on consumer spending power. You get some sense of the change in fortunes that UK house prices have scarcely changed in the last year while in the once-moribund German housing market prices have risen 11%.
  • The silver lining from sterling’s devaluation is the boost it lends UK exports. Add in the fact that growth in the UK’s core markets of the euro area and the US is recovering and the stage looks set for a rebound in export growth. As Ben Broadbent, a member of the Bank of England’s Monetary Policy Committee has said, a weak pound, a global recovery and, as yet unchanged rules and tariffs with the EU, puts UK business is in the “sweet spot” of the export cycle.
  • This is starting to be reflected in the economic data. After contracting through much of 2016 UK goods exports are growing at an annual rate of over 6%. Confidence in UK manufacturing, a sector which exports roughly half of what it produces, is running at the highest level in 30 years. It is indicative of a sector that is gearing up for growth that manufacturers are buying raw materials at the fastest pace since 1977.
  • Exports account for around 30% of UK GDP and stronger exports should help partially offset the effects of the consumer slowdown. Overall the UK economy is likely to post GDP growth of around the 1.5% mark this year, down from 1.8% in 2016. The composition of growth is likely to change more than the rate of growth – a weak pound is reallocating growth away from the consumer towards exports, manufacturing and capital spending.
  • So where does this leave UK interest rates? Our guess is that a slowing economy, Brexit uncertainties and subdued wage growth will keep UK rates on hold until next year, even as the Federal Reserve continues to raise US interest rates.
  • The good news is that global growth and global trade are heading up. For a UK economy facing Brexit uncertainties and a squeeze on the consumer, exports offer the best hope for growth over the next year or so.

PS – One of the articles on our summer reading list argued that the lures of computer gaming could explain why so many young American men are forsaking work:

https://www.1843magazine.com/features/escape-to-another-world

A bleaker explanation was advanced in yesterday’s Sunday Times by the veteran US economist and commentator Irwin Stelzer. Mr Stelzer linked declining male workforce participation to opioid, heroin and marijuana addiction. Millions of Americans are unemployed or have given up looking for a job despite their being almost six million job openings. Drugs do seem to be playing a role. Mr Stelzer says that 25% to 50% of qualified job candidates fail routine drug tests.

OUR REVIEW OF LAST WEEK’S NEWS

The FTSE 100 ended the week down 1.2% at 7,368. Global growth prospects continued to improve, with strengthening activity in China, the euro area and Japan offsetting weaker data from the US and the UK.

International economic briefing by Ian Stewart

Economics and business

  • The UK economy grew at a quarterly rate of 0.3% in Q2. Growth of 0.7% in 2017H1 was the slowest since 2012
  • UK consumer confidence fell in July to its lowest level since the aftermath of the Brexit vote last summer
  • Euro area economic confidence rose in July to its highest level since 2007
  • Ireland’s central bank sharply upgraded its 2017 growth forecast to 4.5%, with an improved euro area outlook outweighing expected negative Brexit-effects
  • The IMF warned there needs to be more sustained growth and inflation before the European Central Bank (ECB) should end to its aggressive monetary stimulus
  • Low interest rates maintained by the ECB have saved German taxpayers almost €250bn in debt repayments over the past decade, according to the German Bundesbank
  • The Federal Reserve signalled that it is ready to begin unwinding its monetary stimulus “relatively soon” if the US recovery remains on track
  • The IMF revised down its US growth forecast for this year from 2.3% to 2.1%
  • Greece returned to international debt markets for the first time in three years, marking in a milestone in the country’s economic recovery
  • The Spanish economy grew by a strong 0.9% in the second quarter, taking Spanish GDP back to levels last seen before the credit crunch of 2008
  • Japan’s labour market continued to tighten, with more permanent vacancies than job applicants recorded for the first time on record in June
  • The UK announced plans to ban all petrol and diesel car sales by 2040, matching pledges made by President Emmanuel Macron in France
  • China launched a military agency to develop state-of-the-art weaponry, in Beijing’s latest move to modernise and expand the Chinese military
  • Sri Lanka is selling a remote port to a Chinese state-owned company to raise funds to pay its estimated $65bn of debt, which includes $8bn owed to China
  • Broadcaster ITV Plc announced an 8% fall in net advertising revenues, citing continuing “political and economic uncertainty”
  • The UK’s first labour enforcement tsar suggested that large retailers and construction firms may soon be held responsible for labour infringements, such as minimum wage violations, by companies in their supply chain
  • The UK government plans to introduce drone registration and safety awareness courses for owners of the small unmanned aircraft weighing more than 250 grams (8oz)
  • The US Food and Drug Administration is seeking to limit nicotine content in tobacco products, for the first time in its history
  • London’s iconic ‘Walkie Talkie’ skyscraper was sold to Hong Kong investors to £1.28bn in the UK’s largest ever office deal, highlighting the continued appeal of London’s commercial real estate to Asian investors

Brexit and European politics

  • German carmaker BMW announced that a fully-electric version of the Mini is to be built at BMW’s UK plant at Cowley, safeguarding around 4,500 jobs
  • Donald Trump tweeted that the US and UK are working on a “major trade deal” that would come in to effect as soon as the UK exits the EU in early 2019
  • Chancellor Phillip Hammond confirmed the UK would seek a simple “off-the-shelf” Brexit transition deal with the EU, to maintain current trading relations for at least two years after Brexit. The transition period would end by 2022 at the latest.
  • Home Secretary Amber Rudd sought to reassure UK-based businesses there will not be a “cliff edge” in terms of employing foreign workers after Brexit, although free movement of people will end
  • Labour leader Jeremy Corbyn used an interview with the BBC to rule out the UK’s continued membership of the Single Market under a post-Brexit Labour government
  • Former UKIP-leader Nigel Farage criticised the Conservative government’s Brexit position, claiming that “even Jeremy Corbyn is now offering a tougher line” on post-Brexit immigration
  • Italian authorities said they are in talks with a number of UK asset managers about shifting their operations to Milan
  • French President Emmanuel Macron’s approval rating dropped by 10 percentage points to 54% in July, the second-biggest drop in popularity for a French president so soon after an election
  • President Macron made his first major intervention in the corporate sector by nationalising the STX France shipyard, with the “single objective” of protecting French jobs by preventing the shipyard falling into Italian hands
  • The FT reports that a number of recruitment consultancies have described a sharp drop in numbers of EU nationals applying to work in Britain’s technology industry
  • Amazon announced that it is to double the number of research and development staff it employs in London, as part of a drive to expand its UK workforce to 24,000 by the end of 2017

And finally…

  • The price of tomatoes has risen so much in India that armed guards have been deployed to protect shipments of them in the state of Madhya Pradesh – Tomato force

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