This year commenced with a marked deterioration in economic sentiment.
The primary catalysts were the (not mutually exclusive) concerns over the outlook for the Chinese economy and a sharp decline in oil prices, together with heightened geo-political risks and tensions.
A litany of gyrations on – and concerns regarding – the international economy resulted from this poor start to 2016. Global equity markets weakened considerably. Global bond markets rallied. In mid-January, the International Monetary Fund (IMF) lowered its world economic growth forecast – as I portended at the beginning of January – largely due to perceived downside risks to the Chinese economy.
There is now an elevated focus on the amount of debt that has flowed into developing economies in recent years in search of higher returns. There is a greater concern that the debt burden has become too high. This in turn has increased the risk of another Euro-banking crisis given that much of the debt has come from the still fragile European banking system.
Within this international environment, expectations of below-average economic growth for Australia in 2016 became further entrenched, thereby increasing conjecture about further cuts to the Official Cash Rate (OCR) in Australia from its current level (held since May 2015) of two per cent. We subsequently had the first RBA Board meeting for 2016 in early February. The Bank is in wait-and-see mode. Should any deterioration in global economic and financial conditions derail an improving Australian labour market and dent economic growth prospects here at home, then we will have an OCR of 1.5 per cent by the end of the year.
Against this economic backdrop, the outlook for new home building in 2016, especially the first half of the year, remains healthy. This is primarily due to the large pipeline of work yet to be started for medium/high density dwellings. The short-term outlook is also for construction of detached and semi-detached dwellings to hold up at above average levels.
There are larger than usual geographical differences in new housing conditions when we delve below the national surface, as has been the case all cycle. While new dwelling commencements are likely to fall almost everywhere in 2016, we will still be able to characterise this year as a strong one for New South Wales and Victoria. Queensland is recovering but not to the extent of historical cycles. The Northern Territory is quite weak, South Australia is very weak. Western Australia is a declining and uncertain market, while the Australian Capital Territory should bottom out this year.
Back to a national focus, it is 2017 (and possibly fiscal year 2016/17) that we need to watch. There are risks of sharper than desirable slowdowns in new home building, exacerbated by the deterioration recently of global economic sentiment.
A large part of these external risks lie with the situation in China – although this risk actually needs to be put in perspective.
There was certainly a sharp (and rapid) economic slowdown in China early last year which prompted widespread calls of an impending ‘hard landing’. This slowdown was almost certainly sharper than official Chinese figures would have us believe, while the volatility in equity markets in China last year – which HIA Economics wrote about on a few occasions in 2015 – was extreme.
It is true that the risks of a ‘hard landing’ for the Chinese economy have increased. However, this outcome didn’t eventuate in 2015 and probably won’t in 2016. People are right to be more on guard and official GDP figures certainly do need to be taken with a grain of salt. Setting aside this question on how accurate these official figures are, the fact that the Chinese economy is growing at a significantly slower rate than a few years ago is neither surprising nor alarming in its own right. The key questions are how much slower, according to what metric, and is that slowdown accelerating? These are hard questions to answer, but a slowdown in early 2016 of a ‘hard-landing’ magnitude seem an overblown prospect, despite what some recent headlines might suggest.
China’s equity markets still appear to be in bad shape and its currency is under increasing pressures. China’s policymakers still don’t appear capable of addressing core structural problems – hardly a fresh concern, but one that first intensified my focus on the downside risks to China back in 2014. For the real economy, though, the jury is still out on whether there really was a sharp slowdown underway as we entered 2016.
China’s financial market turbulence and what impact that may have on the economy, together with its excessive debt levels, are the real focus and cause for concern.
Is it likely that the risks to China have a significant impact on new residential and commercial construction activity in Australia in 2016? No, that’s unlikely. However, if we were to experience as we progress through the year a declining conversion of medium/high density approvals into commencements, implying less of the record pipeline of apartments was going to be built, then the second half of the year could look very different than the first. Do developments in China represent a downside risk to the construction industry in 2017 and beyond? Yes, they do, but let’s keep a watching brief and not get carried away with exaggerated headlines.
Let’s also remember that 2015 marked the fourth consecutive year of growth in new dwelling commencements – only the fifth time in the last 60 years that Australia has achieved this feat. In year five – 2016 – we are likely to start the third or fourth highest level of dwellings on record, behind 2015 and 2014, but comparable to 1994.
That’s a pretty good place to begin assessing signals regarding industry conditions as we move through 2016.