Australian Markets Weekly

Australian markets weekly starting 24th November 2014

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Firms adding to Capex plans? A little.

An interesting few weeks ahead with key Q3 GDP data to be released in Australia while early this week markets will be digesting Friday evening’s news where 1) ECB President Draghi said the ECB would “do what we must” to head off deflation risks and 2) the PBOC cut China’s benchmark lending rate by 0.4% bringing it to 5.6% – the first rate change since mid-2012.

Markets initially welcomed the willingness of ECB and PBOC – AUD jumped 1 US cent on the news before settling near 0.8670 this morning. The China rate cut probably more relevant for Australia and comes in response to the cooling in growth during Q3 which our China Economist Gerard Burg reckons could continue into Q4 and 2015. Don’t get too excited though because the rate cut is generally seen as a modest move – it will cheapen the loans for some Chinese firms but it’s not clear it will lead to an increase in fresh lending. So perhaps not a game changer for China, commodity prices, or the $A.

$A still high for the RBA Governor

Iron ore was still hovering at its cycle low near US$70 a ton on Friday. $A hasn’t reacted much at all to the most recent fall in the price of iron ore and through most of November. This is still too high for the RBA Governor’s liking and he noted in a speech last week that “the currency remains above most estimates of its fundamental value, particularly given the further declines in key commodity prices in recent months.”

Q3 GDP – Capex will have most focus this week

Australia’s Q3 GDP result is due next Wednesday where we estimate the economy expanded 0.7% in the quarter and 3.1% for year. This would be a slight improvement on the 0.5% pace of Q2 mostly due to a bounce back in net exports.

This week we begin to get the various GDP “partials” which form the overall GDP result. Real Construction Work Done is first up on Wednesday, which we expect to print -2.5% (Consensus -1.8%) as the plunge in engineering construction related to the mining sector more than offsets the very robust recovery in residential construction.

Most market focus will be on Thursday’s Private Capital Expenditure report. Amidst a lot of numbers that get released, focus will be on the Q3 equipment investment, which feeds directly into Q3 GDP, but more importantly we get firms’ plans for their Capex in the years ahead.

Land of Opportunity – Australian Capex normally substantial.

As a bit of context, more than most other rich countries capital expenditure is a huge part of the Australian economy. As panel 1 shows, for the past fifty years new capital expenditure has run at around 25-30% of GDP in Australia compared to around 20-25% of GDP in the United States. The historically large amount of Capex in Australia reflects the abundant economic opportunities in this country which in turn are the result of a rapidly growing population (the population grew 1.7% in 2013) and a vast geography with under-developed resources.

The most recent peak for Capex was near 29% of GDP in Q4 2012, as investment in the mining/resource sector peaked above 8% of GDP – panel 1. Since then, mining investment has slumped and total capital expenditures have been falling in real terms.

The well-publicised challenge for the Australian economy is for something to fill the gap left by the downturn in the resource sector Capex. Residential construction is helping, as is public sector infrastructure. But we and the RBA have been hopeful of a recovery in Capex by non-mining firms.

In his speech last week Governor Stevens was a bit more hopeful saying “After several years of quite subdued growth, we estimate that non-mining activity has picked up some speed over the
past year.”

Some Capex improvement but could do with some more

Forward indicators do suggest a modest recovery in non-mining Capex will continue.

This is why the Governor added in his speech last week that “it would be good to see some further strength here, as the decline in mining investment activity continues. There are sufficient spare labour resources such that we could probably enjoy a couple of years of non-mining sector growth somewhat above its trend rate before we needed to worry too much about serious inflation pressure”.

It’s fair to read this as implying: 1) overall growth remains subdued; 2) there are few/no inflation pressures to be concerned about over the next “couple of years”; and 3) accordingly there are few upside pressures on interest rates in the near term.

RBA – Market still pricing next move as a cut.

The interest rate curve continues to price the RBA on hold at 2½% for a long time – quite fair in my view. A small rally through the forward rate curve last week with OIS pricing now putting the RBA’s cash rate 9bps lower a year from now and the first full 25bps rate hike now not priced until mid-2017 – a fortnight ago this was Dec 2016.

NAB’s interest rate forecast unchanged. We continue to emphasise that the RBA could be sitting at 2½% for a long time as they wait for a more meaningful shift in fundamentals. Our forecast does pencil in modest rate hikes from Q4 2015 although the risk is this timing slips into the first half 2016. The hurdle to cut again remains high and the economy would need to be weaker than we or the RBA presently expect.

Week Ahead – OPEC

As well as our data this week, RBA Deputy Governor Lowe speaks Tuesday evening which is unlikely to be market moving because all should have a very good sense of where the RBA is at – on hold! Usual run of data globally and there will also be focus on Thursday’s OPEC meeting where they are expected to discuss supply cuts in order to arrest the decline in the crude oil price – WTI currently $76.50 having been above $105 in June.

‘For further FX, Interest rate and Commodities information visit nab.com.au/nabfinancialmarkets

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