Weekly Economic Briefing: Growth peaks globally, housing slides locally

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!

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.

Growth peaks globally, housing slides locally

Australia’s economy performed relatively well through 2018 as the global economy played to our strengths. However, as our recent brief on the global outlook discussed, 2019 may not be as bright, as Brexit, the US China trade war and a decelerating Chinese economy lead to increased uncertainty, financial market volatility and reduced growth prospects. While Australia’s global backdrop may be weaker, the latest edition of our Business Outlook publication forecasts that Australia’s economy will continue to grow at an above trend pace in 2019.

Solid jobs growth and a falling unemployment rate are the main good news stories from 2018. As the chart below shows, the steady decline in the unemployment rate, seen since 2014, has continued. Strong employment growth has been the mainstay support of consumer spending, as wage growth continues its tortoise-like recovery.

Chart: Australian business investment and the unemployment rate

Source: ABS Cat No. 5206.0, 6202.0; Deloitte Access Economics

Jobs growth has been highest in the sectors of the economy which have benefited from the current drivers of growth. Construction industries have benefited from high levels of housing construction and record government infrastructure investment, health and aged care services from the NDIS and ongoing population ageing, and business services from digital disruption.

Looking ahead, the Australian economy is entering a transition period as the benefit from the current growth drivers fade. Dwelling investment is likely to detract from growth in 2019, as house prices and activity move down, while the boost from public demand will weaken as the rollout of the NDIS comes to an end. Public infrastructure spending has lifted strongly in recent years, but is also expected to peak this year.

Yet, as the chart above shows, business investment is expected to pick up some of the slack. Strong growth in profits, increased capacity utilisation, low borrowing costs for big business and the need to spend money to maintain Australia’s significantly expanded mining capital stock all point to growth in investment over 2019 and 2020.
A smooth transition to increased private investment, LNG exports and continued spending by households is expected to keep Australia’s economy growing at an above trend rate.
This doesn’t mean, however, that there aren’t some domestic risks in addition to any potential fallout from the global landscape.

The largest of these is the current downturn in housing markets, particularly in Sydney and Melbourne. Housing price falls are occurring after a stunning phase of increases. Rapid asset price gains and falls can create windfalls for some and terrible losses for others, based largely on luck over timing. What would be worrying is if the current conditions leading to the decline in prices – tighter lending standards, reduced demand from overseas, highly indebted households and a large increase in supply – were coupled with an increase in the unemployment rate.
Although housing construction would fall away under such a scenario, the bigger risk to the outlook would come from lower consumer spending and lower business investment. As the Reserve Bank is doing, keeping a watchful eye on Australian housing prices is recommended.

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

UK economic briefing by Ian Stewart

A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. Subscribe to & view previous editions at: https://blogs.deloitte.co.uk/mondaybriefing/

  • A boom in low quality mortgage lending in America triggered the Global Financial Crisis. It was a crisis of indebtedness which, courtesy of low interest rates, quantitative easing, government spending and bank bailouts, was resolved by the accumulation of even more debt.
  • As a result the world economy is more indebted today, in absolute terms and relative to GDP, than it was on the eve of the financial crisis. The stock of global debt has risen by 60% in the last ten years, far faster than global growth.
  • Yet debt levels vary too widely by country and sector to enable us to talk of a global debt bubble. Debt has risen in some countries, such as China, and fallen in others, including the US. Within countries some sectors, notably US banks, have shed debt or deleveraged and others, mainly Western governments, have raised borrowing.
  • Most Western governments are running much higher levels of debt than ten years ago. Relative to GDP, levels of UK government debt has more than doubled in the last ten years; the stock of US government debt has risen by 60%. Chinese government debt has also surged, albeit from lower levels. (The conspicuous exceptions, where government debt is falling, are Scandinavia and Germany).
  • The financial crisis triggered a massive clean-up of banks’ balance sheets, especially in the US and UK, where debt levels have fallen sharply. It’s a different story in Europe. There the process of deleveraging was stalled by the euro crisis. The European Central Bank stepped in to provide banks, especially in Italy and Spain, with cheap credit. As a result euro area financial institutions are more heavily indebted now than in 2007.
  • The cheap-money policies of recent years have lowered the return on safe assets, such as bank deposits. This has encouraged investors to move into riskier areas, including corporate debt, in search of higher returns. Non-financial corporates have taken advantage of this demand to restructure their balance sheet away from equity and towards cheaper debt finance. In the US, the euro area and China non-financial businesses are running higher levels of debt today than they were ten years ago. The UK is the exception. Its corporate sector has deleveraged and is now less indebted than those in the euro area and, indeed, China.
  • The debt burden for Western consumers has come down in the last ten years. This is especially true in the UK where tougher regulation and greater caution on the part of lenders has slowed annual growth in mortgage lending to low single digits. Together with consumers paying down debts the result has been a decline in UK consumer indebtedness to well below 2007 levels. The UK is roughly in the middle of the global league for consumer debt; above the US and Germany but below Australia, the Netherlands, Sweden and Denmark.
  • So while some sectors and countries have piled up debts, others have shed them. Asking whether global debt levels are too high is the wrong question. The right one is to ask which sectors and countries are most at risks.
  • Anyone who knows the source of the next financial crisis could become fabulously rich. Nobody has that prescience. But we’ll be keeping an eye on three areas this year: Chinese corporates, Italian banks and the use of leveraged corporate finance across the world. We look at each briefly below.
  • China’s overall debt-to-GDP ratio – for government, banks, consumers and corporates – has nearly doubled in the last ten years. At around 300% of GDP it is not far off US levels. The bulk of the growth has come from companies and consumers taking on debt, though government and banks have too. Much of the increase in borrowing has come from state-owned banks providing loans to state owned enterprises. China’s private sector has relied more on credit from the less well documented shadow banking sector.
  • Burgeoning debt has brought with it a misallocation of capital and created a lot of underused assets. Softening Chinese growth could hit asset prices and increase banks’ bad debts, reinforcing the slowdown. In these circumstances the authorities might balk at further monetary stimulus for fear of boosting already elevated levels of debt and bad loans.
  • The risks of a debt blow up in China are mitigated by three factors. Chinese corporate debt is mainly owed to state-owned banks which could be fairly readily bailed out. Capital controls reduce the risk of capital flight. And with most Chinese debt denominated in renminbi there’s less risk of a sharp devaluation sending financing costs through the roof, as has happened to many countries with high levels of foreign currency debt.
  • The second area of risk, and it’s hardly new, relates to Italy. Lacklustre growth in recent years has made it hard for Italy to shrink its mountain of government debt, which stands at 113% of GDP, well above the EU average. The cost of servicing that debt rose sharply last year as the country elected a populist coalition government committed to boosting public spending. With domestic banks and Italian households holding most government debt, higher bond yields pose a real risk to Italy’s banks. The ending of the ECB’s quantitative easing programme in December, which was an important source of capital, has added to the banks’ woes. Italian banks also have significant exposure to the Italian housing market, where prices are still falling.
  • The third area to watch is the leveraged loan market. Since the financial crisis, many companies have sought cheap financing through ‘leveraged loans’, that typically extend credit to less creditworthy, more indebted companies, usually without the kind of investor protection traditionally sought for such loans. The lenders tend to be a diverse mix of private and institutional investors on the lookout for higher yields in a low-interest-rate environment.
  • The leveraged loan market has doubled in size over the last ten years, overshadowing high-yield bonds as a source of financing for riskier businesses. But with global growth slowing, and growth in the developed world widely acknowledged to have peaked, investors are beginning to pull back from the market. But many worry that the next recession could bring about a string of corporate defaults that hit these lenders hard.
  • The US Federal Reserve, IMF and the Bank of International Settlements have all warned against a blow-up. In 2017, former Fed Chair Janet Yellen noted – “if we have a downturn in the economy, there are a lot of firms that will go bankrupt, I think, because of this debt.” However, with a diverse group of private lenders exposed to this risk, most concede that while a correction would worsen a recession, it is unlikely to pose a systemic risk to the global financial system.
  • With luck the 2007-08 crisis will prove to be a once-in-a-lifetime event. Milder financial crises are more frequent events. The dotcom bust of the early 2000s wrought havoc in the US tech sector, hitting corporate investment and profits. But the resulting recession was shallow, short-lived and confined to the US. Unlike Lehman’s failure, in 2008, the bursting of the bubble in tech stocks did not send powerful shock waves through the world.
  • Systemic financial crises are hugely damaging. More localised financial busts, such as the dotcom collapse, could be seen as disciplining mechanisms – delivering a dose of reality to over exuberant markets, curbing the misallocation of capital and averting a bigger crisis in future. A global financial crisis, like 2007-08, is to be feared and resisted. In a dynamic economy smaller scale blow ups, where the damage is confined largely to the players, are necessary correctives to excess.

 

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 2.3% at 6,809 as UK blue-chip stocks moved lower on a stronger pound, which makes their goods more expensive to foreign buyers.

Economics and business

  • UK real average earnings rose by 1.1% in the three months to November on an annual basis, the biggest rise since 2016
  • The UK employment rate rose to 75.8% – the highest number since records began in 1971
  • The pace of new UK mortgage lending slowed to a four-year low in December
  • The political crisis in Venezuela has escalated after the US, Canada and several Latin American countries recognised opposition leader Juan Guaidó as the interim president
  • US President Donald Trump backed a deal to temporarily reopen the government after the longest shut down in history, the deal agreed to fund federal agencies for three weeks but contains none of the money the President has demanded for the US-Mexico border wall
  • The number of US jobless claimants fell to its lowest level since 1969
  • In a sign of a cooling in the US housing market, new home sales fell to their lowest level in more than three years in December
  • European Central Bank president Mario Draghi warned the risks to euro area growth had risen and near-term growth is likely to be weaker than previously anticipated
  • Euro area activity slowed to its lowest level for 66 months in January, according to PMI numbers from IHS Markit
  • Germany’s Ifo business climate index fell to a near three-year low in January
  • UK restaurant chain Patisserie Valerie closed 71 branches and cut 900 jobs after it fell into administration, the remaining 122 outlets will remain open while a buyer for the business is sought
  • Facebook have settled a legal case with Money Saving Expert founder Martin Lewis who was seeking damages after ads falsely claiming his endorsement appeared on the platform
  • Billionaire investor and philanthropist George Soros criticised China’s president Xi Jinping as “the most dangerous opponent of open societies”
  • UK mobile provider Vodafone paused the installation of Huawei equipment in its networks across the world due to the security concerns that have been raised by several governments
  • British tech company Dyson will move its headquarters from Wiltshire to Singapore to take advantage of growing demand in Asia but will keep existing R&D and technology operations in the UK
  • Spanish bank Santander is to close almost 25% of its UK branches as customers are increasingly banking with their phones or computers

 

Brexit and European politics

  • MPs Yvette Cooper and Nick Boles tabled an amendment to delay Brexit if no deal is reached by the end of February
  • UK prime minister Theresa May have warned parliament that an extension of Article 50 will “not solve the issue” or rule out a no-deal Brexit in the future
  • Chancellor of the Exchequer Philip Hammond said the EU could be ready to drop some of its ‘red lines’ from the Brexit deal in order to help save it
  • Ireland’s deputy prime minister Simon Coveney said “The European Parliament will not ratify a withdrawal agreement that doesn’t have a backstop in it. It’s as simple as that”.
  • Airbus, the European aerospace manufacturer which employs 14,000 people in the UK said the UK government’s handling of Brexit is a “disgrace” and warned the firm could pull out of the UK in the event of a no-deal Brexit
  • France’s finance minister Bruno Le Maire warned that the EU will not renegotiate Brexit and that a no-deal Brexit would be a “catastrophe” for the UK and the EU
  • The FT reports that the Conservative Party has found it very difficult to attract funding since December due to donors’ frustrations with the party’s leadership and direction over Brexit
  • Great Portland Estates, the London commercial property leaser said it continues to raise rents for office tenants as demand for space in the capital remains robust despite concerns over Brexit
  • Dutch prime minister Mark Rutte criticised the European Commission for “not acting on Italy and not fining them for the fact that they are not implementing the stability and growth pact”, adding that the compromise is “creating distrust between the north and south of Europe”.

And finally… Afghan singer Abdul Salam Maftoon’s resemblance to Canadian prime minister Justin Trudeau has turned him into an unlikely celebrity in his home country. The 28-year old appeared on “Afghan Star”, a televised musical talent show and he is now being tipped to win the competition due to the exposure he has had for his uncanny likeness to the Canadian premier – facial recognition


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