Wednesday, April 9, 2008

Interest Rates Have Already Stung The Economy

There seems to be quite a wide range of views about where the economy is heading, and just what the impact will be on you and me. When the United States sub-prime crisis began to hit last year only the very pessimistic predicted that the effects would flow on to Australia in any meaningful way. The majority of opinion seemed to be that a combination of a supposed “disconnect” between the United States and the rest of the world, along with a booming Australian economy driven by resource sales into China meant that we could quite safely ignore the whole thing.

Tell that to investors in Centro or MFS.

Even now, the conventional wisdom is that Australia can still be shielded from the worst of the fallout by a combination of the resources bonanza and the massive Federal Budget surplus. It’s true that those factors are providing considerable comfort, but at the same time the evidence is suddenly piling up that the rapid succession of interest rate increases has triggered an abrupt slowdown. The number of observers now prepared to contemplate the idea that we have thrown the brakes on too hard is growing daily.

Equally, the doomsayers are still telling us that our housing prices continue to be massively over-inflated, which combined with high debt levels is a recipe for a market correction of United States proportions. In my view, the only thing preventing that is the massive undersupply of new housing, which has been artificially constrained to ensure continued price growth, and returns for developers. While availability remains a problem, so will affordability. But as soon as availability is addressed, and it has to be, then all bets are off.

It has reached the stage where the International Monetary Fund is warning that the Australian property market is ripe for a correction of the order of 25%. Despite this, most mainstream economists are still suggesting we are somehow immune from such a prospect. The fact is that we are not. With a slowing economy it is likely that we will see profits fall, unemployment rise and mortgage defaults increase. If the downturn is severe enough it will trigger a slide in property values.

That’s why even the optimists are starting to feel nervous.

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