One of the biggest risks facing the New Zealand economy is our closest neighbour, Australia.
A deepening correction in house prices risks engulfing the broader Australian economy and proliferating over here.
Australia has normally acted as a crutch to New Zealand when we've had problems. This time the Australian economy is teetering at a time New Zealand is looking better.
That crutch is looking splintered, and normal adjustment variables such as the NZD/AUD risk heading further north as opposed to south.
When New Zealand has been the weakest leg, the NZD/AUD has typically fallen and helped the New Zealand economy out by boosting tourism and exports.
It's now around 0.97. A test of parity is on the cards if Australia keeps faltering.
That wont be good for in-bound tourism, which is already showing signs of softening, though good for out-bound. Gold Coast properties will look cheaper too.
Australia is in trouble for numerous reasons.
House prices accross the country are down 6 per cent in the past year, with Sydney down more than 10 per cent and Melbourne just under 10 per cent.
Cities are getting hit harder than regions. Affordability and stretched valuations are biting.
An excess supply of apartments has hit.
Tighter credit (or should we say a more normal credit environment) and regulatory conditions are exacerbating the correction.
That correction follows a material boom so needs to be put in perspective but double-digit falls risk becoming problematic.
The housing stock was valued around $7 trillion. It's estimated to have lost around $130 billion in the December quarter.
Australia's gross domestic product (GDP) is just under $2 trillion. Start shaving 5, 10 or 15 per cent off the value of the housing stock, and you have big hits to wealth, potentially spending and the economy.
Normally a turn in the property cycle is induced by rising interest rates. This one is not.
When house prices were rising it boosted wealth, spending and growth, lowered unemployment, encouraged looser lending standards, more debt which boosted asset values and wealth … and the spiral was in motion.
You don't have to draw a long bow to assess that falling house prices lower wealth and will crimp spending and growth.
A credit accelerator can quickly turn into a decelerator. Tighter credit conditions in response exacerbate the adjustment on the other side.
Small to medium sized firms find it tougher to get credit in a weaker asset price environment.
Interest rate cuts coming
Australia is also showing weakness in vehicle sales, building consents and retailing.
Gross domestic product (GDP) slowed to 0.2 per cent in the December 2018 quarter and 0.3 per cent the quarter prior. That's one per cent annualised.
Income growth is subdued. Consumers' are becoming more cautious.
Employment growth has held up remarkably well, but one wonders for how long.
Construction is a big employer, but one suspects employment growth in that sector will be reversing strongly.
Most, including the central bank, seem to be assuming the Australian economy can absorb lower property prices following a large boom, pointing to other areas including employment and business investment.
That assessment is looking increasingly tenuous.
Financial markets are pricing in one interest rate cut for Australia, and the chance of another. SEEK reported job ads falling in February compared with last year, with big falls in construction, real estate and property. That's a lead indicator of unemployment.
Policymakers are facing a tough balancing act.
They've needed to rein in the property market, housing excesses and banking sector.
The problem is the economy has been used to credit supply and house prices heading north, not south.
Credit and rising house prices are akin to musical chairs; it's not until the music stops (less credit and falling prices) that you find out who doesn't have a chair.
The music is no longer playing.
Australian household debt levels are amongst the highest in the western world at around 200 per cent of disposable income or around 120 per cent of GDP. Debt serviceability metrics look reasonable, largely because interest rates are so incredibly low.
The household saving rate in Australia has been falling since 2014.
It's now barely above zero. A falling savings rate leaves little precautionary buffer to absorb tough times. On current trends households will soon be spending more than they earn.
There has been limited of progress in the political arena driving microeconomic reform.
Those are the little things that keep an economy ticking over and provide "muscle".
Australia was good on this front in the 1990's, but hasn't been of late. Revolving door politics eventually bites. Muscle withers.
Australia has seldom had to deal with tough times.
The Asian crisis and global financial crisis were felt but were reasonably well absorbed. They rolled with the punches without much change. They had good muscle. They now have less muscle and complacency.
Meanwhile, New Zealand is not wearing a clean shirt.
Property values are not as extended in Auckland as Melbourne or Sydney, but they are stretched and prices are falling as affordability, structural changes to the market, tighter lending conditions and the tail end of the cycle bite.
New Zealand has lower household debt than Australia, but high levels of aggregate private sector debt relative to the size of the economy too, largely reflecting high levels of debt in the dairy sector.
Australia might have a deteriorating household savings rate. New Zealand has a negative one.
Both countries have worked hard over post the global financial crisis to improve their financial stability and resilience of the banking sector to potential shocks. That's a plus.
But neither have really seen a material shakeout in the housing market. We've seen dips, but not many material double-digit downward adjustments.
Australia is now experiencing that scenario, and the risk is mounting that it engulfs the broader economy and we see flow-on to parts of New Zealand and especially Auckland.
- Cameron Bagrie is Managing Director and Chief Economist
Bagrie Economics. He was formerly chief economist at the ANZ