Outlook: Shane Oliver

House price falls are a drag but other parts of the economy will power on

Trees don’t grow to the sky endlessly and house prices don’t go up forever but some people seemed to think they would. And now that it’s clear they won’t, the fallout will drag on the economy.

Ever since the mining investment boom ended, an upswing in the housing cycle has helped keep the Australian economy moving forward. The housing cycle has now turned down though, as record supply hits the market, lending conditions have tightened, foreign demand has retreated and there is uncertainty about negative gearing and capital gains taxes.

This is naturally causing angst about the outlook for the Australian economy and sharemarket, particularly against the backdrop of various global threats. And after 2018’s dismal sharemarket performances, it’s natural that investors feel a bit wary.

First the bad news. The housing downturn will be a big drag on the economy via slowing construction and the negative wealth effects on consumer spending, and if rising mortgage defaults drive a further slowing in bank lend- ing. The first two will detract 1% to 1.5% from economic growth. At the same time, global growth has been slowing and this risks weaker growth and prices for our exports.

But it’s not all doom and gloom for several reasons:

• The huge growth drag on the Australian economy from falling mining investment has faded.

• Non-mining investment and infrastructure spending are rising.

• Increased tax cuts are likely from July for low to middle income earners regardless of who wins the likely May election.

• Interest rates can still fall further, and the Reserve Bank is expected to cut the cash rate to 1% this year.

• The $A will likely fall further as the RBA cuts, providing a support to growth.

• And policymakers globally have moved to support growth, with policy easing in China, the Fed pausing in the US and the European Central Bank likely to announce more stimulus.

Against this background, the Australian economy is likely to avoid a slide into a severe slowdown or recession. That said, growth will likely be constrained to around 2.5%. Which in turn will mean that inflation and wages growth will remain low. Which is why we see the RBA cutting rates again.

The main risks to watch out for are: whether the US and China resolve their trade dispute, which we expect, as neither wants to see a further slowing in their economies; whether the US is able to avoid another political battle over raising its debt ceiling this year; whether policy stimulus measures in China and elsewhere are able to get the upper hand, causing growth and profits to improve; what the Mueller inquiry into President Trump’s campaign finds; how far Sydney and Melbourne property prices fall; and the Australian election.

Globally, we think things will turn out OK – much as occurred in 2016 when shares bottomed after sharp falls only to head higher again. In terms of Australian house prices, we see around 15% more downside in Sydney and Melbourne but in the absence of much higher interest rates or unemployment, both of which are unlikely, we don’t see a crash in property prices.

For the month ahead the key to watch globally will be progress in resolving the US-China trade dispute. Locally, expect March quarter GDP growth to show subdued growth, house price data is likely to remain weak and retail sales growth is likely to be subdued as falls in house prices impact consumer spending.

Overall, 2019 is likely to remain volatile as we are later in the global economic cycle. But it should be a better year for the sharemarket. While growth will be constrained by the housing downturn, other parts of the economy should keep growth going, which will help earnings, and monetary policy is still easy.

The Australian economy is likely to avoid a slide into a severe slowdown or recession