Building approvals rebounded somewhat in July, partially retracing the sharp decline in June, but appear to be well past their peak. Residential construction will continue to support the economy over the remainder of the year but a construction boom will soon become a drag on growth as building activity eases next year.
Building approvals rose by 4.2 per cent in July, beating market expectations, to be 13.4 per cent higher over the year. Recent monthly data has been exceptionally volatile owing to the higher-density apartments sector, which continues to gain prominence in our two largest cities.
On a trend basis -- a more reliable indicator for future construction activity -- approvals declined by 0.7 per cent in July and are now 3.1 per cent below their peak earlier this year.
Approvals for private units rose by 6.1 per cent in July, following a steep fall last month, to be almost 32 per cent higher over the year. Approvals for detached housing fell by 3 per cent in the month and continue to trend downward.
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 in central Melbourne and Sydney. The data tends to agree with this assessment, with approvals for Victoria and New South Wales at an elevated level and the population-to-residential construction ratio at its lowest level in a decade.
Property developers are making a sizable bet that the property market remains healthy over the next couple of years. It’s a risky strategy given the strong level of supply coming on line and recent intervention by APRA into lending markets (APRA’s work is not done yet, August 31).
One of the more unusual outcomes this month was the astonishing rise in publicly financed building approvals. These rose by around 160 per cent in July to their highest level in five years and contributed 3 percentage points to monthly growth. History suggests that gains of this magnitude tend to be a one-off occurrence and could present some downside risk to estimates over the next couple of months.
But this is a mere distraction from the broader economic narrative. The Reserve Bank is relying on residential construction to be a key driver of both economic activity and employment over the next couple of years.
Based on the historical relationship between building approvals and completions, I estimate that completions should rise by a further 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 residential construction will be a drag on economic growth next year. Construction will still be elevated in an absolute sense but will no longer be contributing to economic growth.
Suddenly, the major bright spot for the Australian economy is not looking so bright. It draws us to one of the more pressing questions for the Australian economy and not one easily answered: what exactly will drive growth over the next few years?
It’s safe to say that 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, excluding manufacturing, will subtract from growth in the 2015-16 financial year (Australia’s economic transition is completely off track, August 27).
Household consumption is already being asked to do a lot -- which will become only too clear tomorrow when the national accounts are released -- while net exports continue to be weighed down by a combination of lower commodity prices and China’s economic transition. A weaker dollar should help -- particularly through tourism and non-commodity exports -- but the adjustment has not occurred as quickly as authorities had hoped.
The government sector could go either way but is unlikely to contribute to or subtract from economic growth in a meaningful sense. The Abbott government might be talking a tough game on expenditure but there is little indication that they have the capacity to cut expenditure significantly. They also cannot afford to go on a spending spree.
It’s also worth emphasising that population growth has eased and net migration points to weaker growth over the remainder of the year. This is certainly meaningful for residential construction and retail sales. It also means that we can no longer use strong migration figures to obscure our poor productivity performance.
Aspects of this narrative may change over the next couple of years. The dollar, for example, could crash towards US60c and provide a much needed stimulus to our exports sector, boosting production and employment. Lower interest rates could free up household and business balance sheets to invest more and take advantage of stronger asset prices. Regulatory shifts by APRA could direct more -- and cheaper -- capital towards the business sector.
The Chinese rebalancing could go more smoothly than expected and growth may moderate at a more gradual pace. Growth in India and other emerging economies may support the demand for commodities and offset some of the more recent losses.
But it’s worth understanding the risks facing the Australian economy and how these pieces fit together. Right now we have a residential construction boom; however, history shows that when approvals peak it is only a matter of time before construction begins to contract.
What has become increasingly obvious is that Australia may need a fair bit of luck to ride out these challenges unscathed. They aren't insurmountable but they pose a considerable threat to living standards and our economic prosperity unless policymakers wise up to these challenges.