Growth Surprise Flattens Australia’s Big Shorters

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Despite claims Australia’s property market is a “Big Short”-style bubble about to burst, the latest growth numbers revealed the Lucky Country’s 25-year economic dream run is far from finished.

On Wednesday, national accounts data showed the world’s 12th largest economy picked up speed in the fourth quarter, despite weaker prices for its key commodity exports. GDP expanded by a solid 0.6 percent compared to the previous quarter, when it rose by an upwardly revised 1.1 percent.

Annualized growth of 3 percent was the economy’s fastest pace in almost two years, exceeding forecasts for a 2.5 percent rise, on the back of strong household spending, particularly in the “bubble” cities of Sydney and Melbourne.

Australia’s ABC News touted the “world beating” growth rate, pointing to the slower GDP readings by other developed economies including the United States (up 1 percent), the Eurozone’s 1.1 percent gain and Britain’s 1.9 percent.

“The service sector is very strong,” National Australia Bank chief economist Alan Oster told Bloomberg News. “What you’ve got is a restructure in the domestic economy that is showing greater flexibility and adjusting from the mining-led part of the economy.”

The news helped the Australian dollar climb to a near seven-month high of US$0.73, posting its best week against a basket of foreign currencies since October, also aided by positive retail sales data and higher iron ore prices. Australian stocks also gained, with the benchmark S&P/ASX200 index enjoying its best week in five months as it regained the psychological 5,000-point line.

Australian Treasurer Scott Morrison hailed the GDP data as showing a continued “transition from the largest resources investment boom in our history to broader-based growth.”

“We are growing faster than every economy in the G7, and growing well above the OECD average. We are growing faster than the United States and the United Kingdom, more than twice the pace of Canada – a comparable resource-rich advanced economy – and we’re matching growth rates in economies like South Korea,” Morrison said in a statement.

Household consumption and construction grew strongly in the December quarter, with household spending rising by 0.8 percent compared to the previous quarter and dwelling investment by 2.2 percent. Government spending also climbed by 1.6 percent, but business investment dropped by 3.3 percent and engineering construction by 12.3 percent, reflecting the unwinding of the mining boom.

However, the higher household spending was driven by a fall in household savings, which at 7.6 percent dropped to its lowest level since 2008. Income growth remained weak, with average wages falling by a sharp 0.6 percent and real household disposable income by 0.3 percent compared to the previous quarter.

Yet the cooling of a property boom in the southern capitals, as shown by falling dwelling approvals, may crimp household spending, ANZ Research warned.

“The fall in the saving rate points to a significant wealth effect from the strength in house prices last year. However, given the impetus from the housing market is set to fade in 2016, households are likely to feel less comfortable reducing their saving rate going forward,” the bank said.

“Further, as the boost to growth from the lower [Australian dollar] fades and employment growth moderates, it will be difficult for household spending to accelerate further.”

Meanwhile, ANZ said sluggish business investment would likely continue, as construction of the remaining major liquefied natural gas (LNG) projects winds down and low commodity prices restrict new projects. Recent capital spending data showed “a bleak picture of non-mining firms’ investment plans” through to fiscal 2017, it said.

Overall though, the banks’ economists said the data showed the much touted transition to non-mining activity was occurring, driven by the housing sector, which was offsetting weakness in non-mining business investment. Growth in non-mining industries such as housing, information technology and finance rose by 0.6 percent compared to the previous quarter, “suggesting that activity continues to broaden beyond the mining sector.”

“The economy continues to face a number of headwinds, but those headwinds are fading. Sharply falling mining investment and commodity prices will continue to be a drag on GDP growth for some time, but the drag from mining investment will peak in the current financial year and commodity prices look to have bottomed,” the bank said.

ANZ said the data would comfort the Reserve Bank of Australia (RBA), which on March 1 kept official interest rates steady at 2 percent for the 10th consecutive month, citing continued low inflation and a projected rise in consumer spending.

Nevertheless, the bank said: “The economy clearly finished 2015 on a strong note, but we are not out of the woods yet. The unemployment rate remains elevated and further inroads are necessary before the RBA can sit back and feel as though its job is done.”

Other analysts have cited the looming end of an “income recession,” suggesting that the worst may be over following four years of tumbling commodity prices.

“Until the middle of last year we were pretty downbeat because of this whole income squeeze story, and the terms-of-trade decline, which was manifesting itself in various ways,” JPMorgan’s senior economist Ben Jarman told the Australian Financial Review.

“We now get a sense with the way the economy has behaved, thanks to the lower dollar over the last six months, that some of those effects look to be getting quite long in the tooth.”

Jarman said falling oil prices had helped compensate consumers for a weaker currency, while steady employment growth – the jobless rate has hovered around 6 percent – had mitigated softer wages.

Commenting on the latest GDP data, Australian Prime Minister Malcolm Turnbull said the nation “has already passed most of the way through the greatest terms of trade shock in our history.”

For Morrison though, his first budget due in May will face the challenge of slower wages, profits and government revenue. Nominal GDP expanded by only 0.4 percent in the December quarter and 1.9 percent over the year, compared to an average of 5.7 percent in the 1990s and 11.4 percent in the 1980s.

“It is one of the major challenges of achieving our medium-term fiscal consolidation strategy,” the Treasurer said Wednesday.

‘The Big Short’

Despite the apparently sunny economic outlook, surging property prices in Australia’s two biggest cities of Sydney and Melbourne and the associated debt build-up have sparked renewed warnings of a housing crash.

In scenes similar to Hollywood’s financial crisis film The Big Short, a hedge fund manager and an economist reported “irrational” exuberance in western Sydney’s housing market following a recent tour of the city.

“The further west I went, the more irrational it felt. Lots and lots of supply and prices that bore no resemblance to construction cost and income of people around there,” John Hempton, Bronte Capital’s chief investment officer, told the Australian Financial Review.

Hempton and his fellow investigator, Variant Perception economist Jonathan Tepper, warned of mortgage brokers helping circumvent bank guidelines on loans, claiming an oversupply in apartments despite prices comparable to Hong Kong.

“Australia now has one of the biggest housing bubbles in history,” Tepper said, pointing to Australia’s real estate to GDP value of 3.8 times, a level comparable to the 3.5 times seen in Ireland and Japan before their housing crashes.

He said the nation had one of the highest levels of housing debt to GDP in the world, at around 120 percent. With around 40 percent of new mortgages in recent years being interest-only loans, he warned of a “Ponzi scheme” which could reverse viciously if prices started falling.

Tepper has warned of prices dropping by up to 50 percent in Sydney and Melbourne and by 80 percent in mining towns, should the bubble be pricked, with the fallout hitting the nation’s big banks as well as government revenue.

The latest housing figures by CoreLogic RP Data showed an 11.1 percent annual gain for Melbourne and 9.5 percent for Sydney in the year to February 29, although the rises were more modest for Brisbane (up 5.5 percent) and Canberra (up 4.5 percent), while the mining capital of Perth contracted by 3.1 percent.

But with Sydney prices dropping by 0.2 percent compared to the previous quarter, CoreLogic RP Data’s Lawless said national house price growth should moderate in the year ahead.

While Tepper’s report initially caused bank shares to slide, they rebounded after the stronger than expected GDP reading. Other analysts have previously forecast a crash in Australia’s housing sector, including Jeremy Grantham, founder of investment house GMO, who said in 2010 the sector was a “time bomb,” yet prices kept rising.

“Generally our banks are very cautious with their lending. We cannot compare ourselves to other countries where people can buy without a deposit. [A crash] has never happened,” property developer billionaire Harry Triguboff said.

“The only way house prices crash is if rates go up suddenly and/or unemployment increases materially. Either of these two scenarios will take years,” JPMorgan’s Sujit Dey said in a report.

Australia’s central bank still has some interest rate ammunition too, with official rates at 2 percent and consumer inflation rising by 1.7 percent.

While talk of a housing crash may have made Canberra sweat, the latest growth numbers point to a happier ending than the U.S. story, particularly for a government facing re-election later this year.

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