Building approvals fell sharply in June, albeit from an elevated level, and now appear to be well past their peak. Residential construction activity will continue to support the economy over the remainder of this year but could potentially become a drag on growth as soon as the beginning of next year.
Building approvals fell by 8.2 per cent in June, missing market expectations, to be 1.2 per cent lower over the year. The monthly figures are often extremely volatile owing to the higher density segment but, at face value, the past three months point to a significant shift in trend. On a trend basis, approvals have fallen almost 3 per cent from their peak earlier this year.
Approvals for private units fell by around 20 per cent in June -- though monthly shifts of this nature are not without precedent -- to be 16.2 per cent higher over the year. Growth over the past few years has been remarkable, which has left some analysts concerned that property developers are building too many high-rise buildings near the CBD in Sydney and Melbourne.
Property developers are making a sizeable bet that the property market remains healthy over the next couple of years. From their perspective, the following graph would give them cause for concern. The population-to-construction ratio is already at its lowest level in a decade and poised to fall further over the remainder of the year.
With the property sector already operating in uncharted waters and APRA ramping up efforts to reduce investor demand, it wouldn’t surprise me if property developers were getting more nervous by the day.
The good news, for now at least, is that residential construction will continue to support economic growth over the remainder of the year. This means an increase in high-quality construction jobs.
Based on the relationship between building approvals and completions, I anticipate that completions should rise another 10 per cent from their level in the March quarter. That’s a solid stimulus by any measure.
However, by virtue of peaking later this year, it appears increasingly likely that the residential construction sector will be a drag on economic growth next year. Construction will still be elevated in an absolute sense but even in the best case scenario the sector’s contribution to growth will diminish significantly.
Suddenly, the major bright spot for the Australian economy is not looking quite so bright. It begs the question: what will drive economic growth next year?
I can’t address this comprehensively in this column but it’s safe to say we can put a line through mining and manufacturing investment, as both are set to collapse over the next couple of years. Meanwhile, the latest estimates from the ABS suggest that non-mining investment will subtract from growth in the 2015-16 financial year.
That leaves us with household consumption, government spending and net exports.
Household consumption continues to grow at a modest pace but a weaker dollar and poor wage growth points to a fairly lacklustre spending outlook. As it stands, many households are already dipping into their savings to maintain their standard of living and that simply isn’t sustainable in the medium term. Rising asset prices have offset this to some extent -- particularly in Sydney and Melbourne -- but price growth is set to moderate significantly over the next couple of years.
The public sector may contribute modestly to economic growth but could just as easily subtract from growth depending on a combination of the public sector’s commitment to reducing government debt and the impact of automatic stabilisers. Either way, the effect is unlikely to be significant.
That leaves us with net exports. New production continues to come online in the iron ore and LNG sectors, which should support export volumes. But China is in the midst of its own economic transition -- not to mention the problems with its stock market -- which appear likely to weigh on demand across key commodities, including iron ore.
A weaker terms of trade will spill over into other sectors of the economy, putting further pressure on household spending and business investment. A weaker Australian dollar though offers some upside risk for net exports and domestic production.
Either way, it is becoming increasingly clear that Australia’s economic prospects will be almost entirely determined by demand in China over the next couple of years. Other sectors of the economy are likely to grow but are set to offer less support than has been the case over the past year.
A recession is not yet the base case for the Australian economy but it’s been a long time since one has been this likely. In response I expect the Reserve Bank to cut rates again before the end of the year -- with another cut early next year -- to push the dollar lower, improve household and business balance sheets, and hopefully reduce our reliance on China.