The long hoped for rebalancing in economic growth toward housing construction and non-mining business investment faces new a threat – namely emerging signs of excess capacity in these key sectors. This adds more downside risk to the economy over the coming year, and affirms our view that both interest rates and the $A have much further to fall.
AN OFFICE GLUT WILL HOLD BACK NON-MINING INVESTMENT
Although commercial property values are being pushed higher due to the global “search for yield”, the underlying drivers of new investment in the sector are not great. As noted by the Reserve Bank in its recent Financial Stability Review “commercial property conditions have softened significantly and there are now clear signs of an emerging oversupply in some markets.” In the office market in particular, vacancy rates are already high and rents are falling. The RBA noted office conditions in Perth and Brisbane are “particularly weak”. As seen in the chart above, non-residential building approvals have already turned down, which does not bode well for non-residential investment.
POCKETS OF OVER SUPPLY ALSO EVIDENT IN HOUSING
The housing sector has enjoyed a decent lift in both prices and building activity over recent years, but there’s emerging evidence to suggest the rise in supply has not been in the areas where it is needed most. As seen in the charts below, while price rises have been most acute in Sydney, the expansion in supply has been more evident in Melbourne and Brisbane – particularly high rise developments in inner-city areas. The RBA’s Report noted the “risk of oversupply appears most evident in inner-city Melbourne” while it also cited liaison reports from business expressing “concern about possible future oversupply” in Brisbane also.
More broadly, the monthly level of home building approvals is already near past cyclical peaks, suggesting the degree of further upside in housing activity may be limited. Should home building approvals peak within coming months, it would mean home building activity will also start to decline by late this year/early 2016 – undercutting what has recently been an important source of economic growth. Indeed, dwelling investment rose by 8.1% over the four quarters of 2014, contributing 0.4 percentage points to the 2.5% growth in the economy.
Should the housing sector turn down and/or the non-mining investment recovery remain stalled, the RBA will be under pressure later this year to cut interest rates further. Our call remains that the official cash rate will end the year at 1.5% p.a, with the $A sinking to US68c.