Reserve Bank governor Philip Lowe has warned of a much bigger problem for the Australian economy, and monetary policy setting, than falling property prices.
Speaking at the AFR Business Summit in Sydney on Wednesday (6 March), Mr Lowe said that while home values impact consumer spending, the more important influence is household income.
The RBA governor and his predecessor, Glen Stevens, have consistently flagged weak wages growth, often during discussions about high levels of household indebtedness.
Mr Lowe said that it is plausible that, for a time, this didn’t affect people’s expectations of their future income growth: “So they didn’t change their spending plans much, despite their current income growth being weak, and the saving rate fell,” he said.
“However, as the period of weak income growth has persisted, it has become harder to ignore it. Expectations of future income growth have been revised down and it is likely that this is affecting spending.
“My conclusion here is that wealth effects are influencing consumption decisions, but they are working mainly through expectations of future income growth. Swings in housing prices and turnover in the housing market are also having an effect, but they are not the main issue.”
This assessment is consistent with the data on housing equity injection, Mr Lowe said.
He noted that, over recent years, households have been injecting substantial equity into housing and have not been using the higher housing prices to borrow to support their other spending.
“This is in contrast to the period around the turn of the century, when households were withdrawing equity,” he said.
“Given this assessment, developments in the labour market are particularly important. A further tightening of the labour market is expected to see a gradual increase in wages growth and faster income growth. This should provide a counterweight to the effect on spending of lower housing prices.”
Taking these various considerations into account, the RBA is confident that an adjustment in the housing market is manageable for the overall economy.
“It is unlikely to derail our economic expansion. It will also have some positive side-effects by making housing more affordable for many people,” he said.
On Tuesday the Reserve Bank board agreed to leave the cash rate unchanged at 1.5 per cent, which Mr Lowe said is supporting the creation of jobs and progress towards achieving the inflation target.
“Looking forward, a key issue is the labour market. Achieving full employment is an important objective in its own right. But, in addition, a strong labour market is the central ingredient in the expected pick-up in inflation,” he said.
“We are expecting that as the labour market tightens, wages growth will increase further. In turn, this should boost household income and spending and provide a counterweight to the fall in housing prices. The pick-up in spending is, in turn, expected to put upward pressure on inflation. Of course, it is possible that inflation could move higher for other reasons, although the likelihood of this at the moment seems low. This means that a lot depends upon the labour market.”
The RBA governor noted that the latest reading of the wage price index also confirmed a welcome, but gradual, pick-up in wage growth, especially in the private sector.
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