UBS Outlines Worst Case Scenario For Australian Economy

RBA Maintains Optimistic Outlook

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Worst Case Scenario

 In a research note released this week, investment bank UBS outlined its “worst case” scenario for the Australian economy. The research conducted for the study consisted of creating five potential scenarios for the Australian economy, which is currently in its 27th year of expansion.

The worst of these cases includes house prices dropping by 30% with the unemployment rate soaring and the RBA cutting rates to 0% from their current level of 1.5% which is the record low.

The analyst responsible for creating the report, however, notes that he sees current conditions in Australia as being consistent with the third case, merely a housing correction. Nevertheless, he also warns that the risk of a credit crunch is “real and rising.”

In the research note, Jonathan Mott writes “The rapidly deteriorating housing market is a signal of even tougher times ahead. The housing credit squeeze experienced over the last six months is expanding”. Mott then adds that “The outlook for the banks has not been as challenged since at least 2008.”

The domestic housing market in Australia has now entered its second year of decline, fuelled by tighter restrictions on lending and reduced availability of credit. In Sydney and Melbourne, where house prices were highest, prices are now down a combined 7.4% and 4.7% respectively, leading the declines in nationwide house prices.

The RBA has maintained accommodative monetary policy, with rates at record lows of 1.5%, since 2016. However, regulators have been tough on closing down entities offering riskier loans such as interest-only mortgages often used by property investors. Regulators are now enforcing stricter verification methods as well as reducing the level of capital that individuals can borrow.

Wages Remain Key For RBA

Households indebtedness continues to be a major issue for the RBA which regularly highlights low levels of household income and high levels of household debt as the main obstacles to a rate rise. While wage growth has recently risen off the low level seen over 2016 / 2017, we are not yet seeing any encouraging upside momentum with levels stalled at 2.1% over the last few months.

However, the RBA continues to maintain an optimistic outlook in its meetings, highlighting solid momentum in labor market tightening. At its last meeting, the bank revised higher its forecasts for growth, employment, and inflation.

Growth, Unemployment, and Inflation To Improve

This update comes on the back of better growth figures recently which the bank acknowledged was down to stronger levels of household consumption, investment in housing and exports. It seems the RBA is backing growth to keep rising over the final part of the year and then to continue between 3% and 3.5% each year over the next few years.

Regarding employment, the unemployment rate recently fell to a six-year low of 5% which is the level the RBA previously regarded as signaling “full employment.” The bank now forecasts unemployment to fall further to 4.75% in 2020.

On inflation, the RBA believes that the tightening labor market and reduction of spare capacity in the economy will finally start to feed into upward price pressures and is looking for inflation to move up to 2% in the first half of next year and up to around 2.25% by late 2019 – early 2020.

Technical Perspective

audusd

AUDUSD is currently sitting in the low end of the three-year range from around .81 to .68. with prices having sold off from the high end of the range earlier in the year. Any moves higher at this stage appear corrective, and there is a lot of resistance overhead in AUDUSD with .7329 and .75 the next key levels to watch. To the downside, the rising trend line from 2015 lows is the key for now. While price remains above the .7178 level (key support over the last two years) we are likely to see a continued grind higher.

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