Australia’s economy running hot despite rising interest rates, but experts urge caution

If the Reserve Bank's record run of interest rate rises is sapping the heat out of the economy, Shannon Battisson isn't detecting it.

Battisson is national president of the Australian Institute of Architects, representing 14,000 members across the nation, and the director of architecture firm The Mill.

It's an industry that is usually highly sensitive to the rising cost of debt, but Battisson's Canberra-based practice retains "a huge waitlist" for residential work.

"Certainly the end of last year was just crazy, crazy busy in the profession," she says.

Staff were worried clients would abandon potential projects as interest rates climbed but "we certainly haven't seen that". The firm's more nationally based commercial work, too, has "grown steadily" since the first Covid lockdown.

"There's momentum really across the board," Battisson says, according to conversations she's had with the institute's national council.

Building supply giant Boral also posted a jump of more than 50% in first-half profit in a "difficult inflationary environment".

Such buoyant sentiment is not universal. The building sector remains a hotspot of commercial failures as companies struggle to find workers and cope with soaring costs for cement, steel and other materials.

But these are examples of what RBA governor Philip Lowe referred to in Tuesday's 25 basis-point hike in the cash rate as the "strong domestic demand" stoking inflationary pressures.

Indeed such strength is why the RBA expects "further increases in interest rates will be needed over the months ahead" to quash those pressures. Underlying inflation - a gauge that strips out the more volatile changes - ran at a record annual clip of 6.9% in the December quarter, well outside the central bank's 2%-3% target range.

For experts such as Timo Henckel, a professor at the Australian National University and a member of a "shadow RBA board", a key risk is that the central bank jacks up its cash rate too high.

"They don't want to be caught out again and being overly 'dove-ish', like they were a year ago" when the RBA was slow to start lifting rates, Henckel says. Hence "the slightly more 'hawkish' stance" this past week.

Uncertainties of monetary policy - including how responsive the economy might be to higher interest rates - means the RBA could go too far. Some researchers reckon interest-rate impacts will be felt more sharply and for longer than in the past.

Australia's financial mix may also make the economy particularly twitchy. About 800,000 mortgages will soon shift from fixed rates of about 2% to more than double that this year as loan periods expire, joining the 85% or so of borrowers already on those variable and rising rates.

"Plus, you've just got a higher - a much higher - level of [household] debt compared to most other countries as well," Henckel says. "So that adds to the sensitivity."

Denita Wawn, CEO of the Master Builders Australia, says demand for builders is "showing signs of dipping [amid] the strong uplift in interest rates".

"While we are seeing a slowing in demand for new homes, we recognise the Reserve Bank has a difficult challenge to strike the right balance when curbing inflation," she says.

Master Builders forecasts new-home building activity will decline over the short-term before rebounding by 2026-27 - when inbound migration recovers, fostering more demand and helping to alleviate some of the industry's "labour challenges", Wawn says.

The MBA, much like the architects in Battisson's firm, sees government spending shoring up work in the sector. During the pandemic, state and federal authorities announced projects that are only getting started now or will do soon - the kind of work that is largely immune to higher lending rates.

"As we wait for the recovery in private sector demand to play out, the role of the government and other public sector entities will be crucial in supporting demand for building and construction," Wawn says.

Kristen Beadle, manager public practice at CPA Australia and an expert in corporate insolvencies, says she's already seeing "a significant increase in the number of companies entering some kind of external administration".

The level of such business strife is now reaching pre-Covid levels, catching up in part after a moratorium imposed during the early lockdowns to avert a cascade of corporate failures.

Still, the pickup is a lagging indicator given the often lengthy time it takes for companies to deploy various survival strategies - such as stringing out payments to creditors and suppliers - before calling in outsiders.

"We will probably see more come into play in the first half [of 2023]," Beadle says.

While much of the focus has been on the so-called "mortgage cliff" of higher repayments facing households when they refinance fixed-interest loans, a similar problem faces many businesses, she says.

And since many owners of small companies put up their homes as collateral for loans, forced home sales often follow business failures.

Andrew McKellar, CEO of the Australian Chamber of Commerce and Industry representing 160 business associations, shares the view that the RBA should be careful not to overestimate the economy's health.

A recent ACCI-Westpac Survey of Industrial Trends showed general conditions "deteriorating considerably" in the last three months of 2022. New orders were flat just as firms were battling rising energy bills, supply chain constraints and labour shortages - and now higher debt repayments.

"We have already seen that lending for new homes has plummeted, with recent ABS data showing its plunged by 62.4% since a peak in January 2021," McKellar said.

"We do want to see inflation ease, but we don't want to see the Reserve Bank squeeze the life out of the economy in the process."