UBS just cut its growth outlook for the most important part of the Australian economy

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UBS has cut its forecasts for domestic consumption, outlining three key threats which will continue to weigh on household spending in the new year.

UBS economists George Tharenou and Carlos Cacho said the combination of weak wages, flat house price growth and a low household savings rate “just doesn’t add up to anything but a weaker consumer outlook”.

“We are cutting our outlook for real consumption to only 2.0% annual growth in 2018 & 2019 (was 2.2%), further below consensus of 2.4%/2.5%”, the pair said.

While consumption is expected to slow, the net effect on GDP is likely to be offset by increased business investment, the analysts said.

So in effect, their forecast is for an extension of the results seen in last week’s Q3 GDP report which was propped up by increased investment amid the slowest growth in consumption since the 2008 financial crisis.

Despite bumper jobs growth in recent months — which continued this morning as November jobs data smashed expectations — the analysts said there’s no evidence that it will translate into higher wages.

Their position is that the Philips Curve — which plots the correlation between low unemployment and higher wages — is “largely broken, given the strength of jobs growth in recent years has structurally failed to translate to any recovery in wages”.

But perhaps in a glimmer of hope for Australian workers, quarterly data in today’s employment report showed underemployment — a measure of those employed who want to work more hours — continued to fall, which suggests the labour market is tightening.

In addition to slow wage growth, Australian household cash flow also fell to a record low in 2017, the analysts said.

“There have been significant drags on household cash flow from the combination of higher taxes (i.e. mainly via ‘bracket creep’ of higher average tax rates), as well as a surge in both utilities and petrol (almost entirely driven by higher prices rather than volumes),” they said.

On the outlook for house prices, the analysts highlighted the lagged impact of macroprudential regulations by APRA, with activity slowing as lending standards tighten.

They also expect further restrcitions from APRA will be forthcoming — with a specific focus on the living expenses component of mortgage applications.

That echos the view of JP Morgan analysts earlier this month, who said additional macroprudential measures may be forthcoming.

“We think that APRA is flagging ‘Phase 3’ of macroprudential policy tightening in 2018,” they said.

“We think that APRA’s new focus on raising the floor of assumed minimum living expenses is likely to see lenders reduce the maximum borrowing capacity of some borrowers, relative to the last few years.”

They added that households also face the prospect of higher mortgage costs stemming from the lending restrictions, as more borrowers are forced to switch into principal & interest repayments.

The net effect is that the UBS forecast for 2018 house price growth has been reduced to flat, with falls of between 0-3% predicted for 2019.

In view of that, UBS maintained its forecast that interest rates will be on hold for the duration of 2018.

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