Westpac’s Bill Evans ‘gobsmacked’ by lending drop

The Australian 12:00am February 23, 2019

David Rogers

As chief economist of Westpac, Bill Evans has a pretty good bead on the economy.

But when he looked at the ­December housing finance data this month, he was shocked.

New lending for housing had fallen almost 15 per cent since mid-year, confirming his growing sense of unease about a rapid slowdown in the economy after the end of a record housing boom that was spiked by slowing Chinese demand and a crackdown on risky lending.

“I’ve been gobsmacked by the rate at which new lending has ­collapsed,” Mr Evans told The Weekend Australian. “That fall, coming on top of earlier falls, was very surprising.”

The Australian dollar dived, bond yields fell and the sharemarket soared this week after the veteran economic forecaster said the Reserve Bank would be forced to cut interest rates in August and November this year as economic growth would be much weaker than it expected.

On top of disappointing economic growth data for the September quarter and sharp falls in business conditions, building ­approvals, retail sales and house prices at the end of 2018, the collapse in home lending was the final piece of evidence Mr Evans needed to slash his economic growth forecasts and abandon his long-held prediction of no change in official interest rates — a view unmatched by peers since the RBA’s most recent rate cut to 1.5 per cent in August 2016.

Mr Evans now predicts economic growth of just 2.2 per cent in 2019 and 2020 — well below the trend or “potential” rate of 2.75 per cent needed to stop ­unemployment rising and well short of the RBA’s ­recently downgraded forecasts of 3 per cent and 2.75 per cent.

It comes after RBA governor Philip Lowe said the interest rate outlook was “more evenly balanced” and “in the event of a sustained rise in unemployment and a lack of further progress on lifting the inflation objective, lower interest rates might be appropriate at some point”.

RBA minutes this week said that if house prices were to fall much further, consumption could be weaker than forecast, resulting in lower GDP growth, higher ­unemployment and lower inflation than forecast. But given that further progress in reducing ­unemployment and lifting inflation was still a “reasonable expectation”, there was “not a strong case” for interest rate cuts.

However, Mr Evans said the economy slowed dramatically last year. The annualised growth rate in the first half of 2018 was a robust 4 per cent. But in the second half the partial data suggests it slowed to just 1.5 per cent. For the economy to then ­rebound to a 3 per cent pace in 2019 — as the RBA is now expecting despite the sharpest housing downturn in decades — “seems to be a very large stretch”.

While the RBA said a positive “income effect” from rising jobs and wages would outweigh a negative “wealth effect” from falling house prices, it could already be hitting consumption — about 60 per cent of the economy — which has been supported by a rundown in savings since the ­global financial crisis.

Mr Evans predicted house prices in Melbourne and Sydney would fall 5-10 per cent this year and more next year, based on his estimates of the need to ­restore affordability and the impact of tighter lending standards.

The negative wealth effect from falling house prices would push the household savings rate up to 3.5 per cent this year and 5 per cent in 2020, from 2.4 per cent last year, Mr Evans said.

“Those savings rates imply consumer spending growth around 2 per cent,” he said.

He also expected home lending to continue falling also due to a lack of demand. “We expect these falls, albeit at a much slower pace, to continue through 2019, representing a negative feedback loop to prices. That negative wealth effect is therefore likely to persist through 2020 with a further extension of the soft profile for consumer spending.”

The sharp downturn in residential housing construction would also play a part. Westpac sees residential housing construction falling 10 per cent this year and 5 per cent next year. And businesses are likely to lower their investment plans due to a softening environment.

Capital expenditure data next Thursday and economic growth data on March 6 will be critical.

Mr Evans was wary of a slowdown in capex plans and a further slowing of consumption.

But he did not see much risk of a credit crunch that could cause a recession. “I wouldn’t call what we have seen so far a credit crunch, but it was a big slowdown,” he said. “It’s very much been a demand thing that’s been important (for credit). So if you’re an investor faced with rental yields below even these funding costs, and you think prices are going to keep falling, you’re certainly not going to want to get back into the market.

“We’ve heard bits and pieces from certain banks that the supply story is a factor, and there is an element of that, but I think the main factor is demand. People aren’t walking in the door.”

Mr Evans has little doubt that the RBA will cut rates if the economy weakens as much as he ­expects — thereby avoiding the sort of “policy mistake” that could tip the economy into recession.

And he acknowledged the housing market could hold up better than expected so that an extended negative wealth effect did not materialise, and incomes could be supported by a stronger than expected labour market.