“Australia has a lot of go”, was how the old tourism campaign used to go. But more recently Australia’s get up and go seems to have got up and gone.
The country is suffering a hangover from the mining boom and worries about the outlook for Chinese economic growth. In common with many other developed economies, Australia is hoping that other sectors of the economy will pick up the slack and that it can rebalance its economy.
The country is unique in managing to avoid a recession for more than 20 years, with the last one occurring in 1991. Even at the height of the global financial crisis, the economy only recorded one quarter of negative growth before quickly rebounding. However, now there are questions over demand for the raw commodities that Australia exports – mainly to China – such as iron ore and coal. So how will the country cope with lower growth from the rest of the world?
The price of a tonne of iron ore dipped below US$80 per tonne in early October and has declined by 40 per cent this year. However, the fall in price has been driven not just by concerns over lower future demand, but also by oversupply. Many iron ore producers have kept up supply in the face of lower demand, preferring instead to pursue high-volume, low-cost strategies to gain market share.
The big uncertainty in the economy right now is the extent of the investment decline in the mining industry and how that can be offset by non-mining activity. The prognosis does not look good. The Reserve Bank of Australia recently cut its expectations for growth this year by 25 basis points to 2.5 per cent, and for 2015 growth by the same amount to 3.25 per cent. While these are downgraded figures, they are the thing of dreams for many eurozone politicians and the European Central Bank.
The downgrades themselves are not so problematic given the slowing in global economic growth that has occurred over the summer and into the autumn of this year. The troubling part is that they come at a time when the RBA has already cut the interest rate to its historic low of 2.5 per cent more than a year ago as it attempts to stimulate economic growth. Moreover, the country faces two challenges in the near future.
First, the government is pursuing fiscal consolidation and its 2014/15 budget included policies of higher taxes and spending cuts which will create a drag on economic growth. Second, the currency has been persistently strong even as the price of iron ore has fallen. Granted, the Aussie dollar has fallen recently versus the US dollar, but not as much as the RBA would like. However, this resilience acts a de facto tightening of policy offsetting the RBA’s actions. The stronger currency also makes it difficult for the economy to rebalance and the non-mining sector to deliver the much-needed growth. Exports look expensive and foreign earnings are being eroded.
At the same time, the RBA is concerned with investors’ enthusiasm for the housing market and would be loath to cut rates further for fear of stoking an already inflated housing market. Officials have stated that an announcement on macroprudential policies could be expected before year end. It is likely the usual tool kit of measures will be adopted, including changes in bank capital requirements, interest rate buffers and stricter lending standards. These policies have been used in neighbouring New Zealand, as well as here in the UK, and are becoming the norm – and a much welcome measure – for maintaining financial stability.
So it is unlikely that the RBA will move on rates in the near term as the outlook weakens and disinflationary pressures come into play. This may be unwelcome news to many Australians, but for international investors who have floundered in the doldrums of ultra-low interest rates, they may be pretty happy to pick up a relatively higher bit of yield on Aussie bonds.
Kerry Craig is global market strategist of JP Morgan Asset Management
