ANALYSIS: WA could find itself in a tough spot if the Reserve Bank raises interest rates in response to economic conditions in the eastern states.
As welcome as Western Australia’s reawakening economy is for the business sector, there could be a shock in the offing from east coast policymakers if the Reserve Bank of Australia points the interest rate needle north in an effort to cool the overheated housing markets in Sydney and Melbourne.
Just as the GST distribution formula lags the real-time economy, much to the chagrin of many in WA, which will receive just 30.4 cents in GST for every dollar raised in the state in 2017-18, an increase in interest rates to benefit the economies of other states would hurt WA.
The current low rates encourage business investment in WA, helping lift the state out of the doldrums. An increase in the RBA rate can only temper than enthusiasm to invest here.
So far, most comments about the early signs of an improvement in the WA economy have focused on the pick-up in the mining sector, a modest improvement in business sales, and a fall in unemployment.
Each of those positive factors is noted in an online story on the Business News website from last Thursday, ‘Signs of growth in WA economy’, which included comments from the Commonwealth Bank of Australia and the Chamber of Commerce and Industry of WA.
So far, so good. What could possibly be wrong with the positive trends that are delivering a much-needed injection of confidence?
In two words, the answer to that question is ‘interest rates’. A more detailed explanation suggests that, just as the GST revenue-sharing formula is unfair to WA, so too will the next move in interest rates, and possibly just as harmful.
London and Hong Kong-based HSBC Bank Australia identified the interest rate threat to WA in the latest edition of its ‘Downunder Digest’, which was headed: ‘States reveal the rebalancing act is almost done’.
The key elements in the report included observations that:
• the end of the mining boom in 2012 (yes, it really did end five years ago) had led to a rebalancing of the national economy away from resource towards housing and services in NSW and Victoria;
• the shift to new sources of growth was aided substantially by ultra-low interest rates; and
• the beneficial effects of the low rates have largely ended, and it could be argued that they are already too low for NSW and Victoria.
The solution to the issue of low rates is obvious – higher rates – but that is certainly not in the best interests of WA, as HSBC explained.
“The recovery in WA is only just getting under way. Nonetheless, with conditions in the mining states improving we expect the Reserve Bank to begin to lift its policy (cash) rate from the first quarter of next year,” HSBC said.
“The challenge for the Reserve Bank is that there is only one monetary policy setting for the whole nation, however, at various times there can be significant divergence in economic performance between the states.”
Property prices provide the best measure of the divergence since the 2012 end of the mining boom that overinflated the WA economy.
“Since mid-2012, Sydney’s house prices have risen by 80 per cent, and Melbourne by 60 per cent, compared to 21 per cent in Brisbane, 6 per cent in Perth, 11 per cent in Adelaide and 24 per cent in Canberra,” HSBC said.
Much of the outperformance in the Sydney and Melbourne property market over the past five years was a result of the flip from tight monetary policy up to 2011 (to handle the resources boom in WA and Queensland) to loose monetary policy from 2012.
In theory, the next move towards higher interest rates should not have too much of an effect on WA because the resources sector ought to be expanding rapidly; but it is not.
That leads to the critical issue for WA; will the Reserve Bank lift rates too quickly to dampen the Sydney and Melbourne property markets, having a serious negative effect on the WA economy?
HSBC is concerned that the answer that question could be yes.
“With the stablisation of the mining sector starting to feed through to an improvement in the broader economic indicators in Queensland and WA, we see the Reserve Bank as unlikely to be constrained from lifting its policy rate by conditions in those states,” HSBC said.
“However, the fragility of the recovery in those mining states, particularly WA, could be a limit on how fast the Reserve Bank would consider lifting its cash rate.
“For example, the Reserve Bank would be keeping a keen eye on housing loan arrears in WA once it starts to lift its policy rates.”
The significance of that comment lies in the reference to ‘housing loan arrears’, which can be taken as a warning that the test for WA is not how quickly the economy might recover, leading to more housing loans, but how quickly people are falling behind in their repayments.
But how much weight the Reserve Bank places on WA will be interesting to watch, because traditionally the state doesn’t count for much in national policy settings – and if you doubt that, consider the GST situation.