Australian Markets Weekly

Most of us like matters to be resolved quickly and with clarity. This is especially true of financial market folk: Is the economic outlook good or bad? If the RBA isn’t cutting they must be hiking?

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Early Days

Speeches last week from RBA Governor Stevens and Dr David Gruen, Chief Economist at the Australian Treasury, both implied that clarity around the outlook for the Australia economy will remain elusive for a long while yet.

Investment in the resource sector was the dominant driver of growth through 2005 to 2013 and it has only just started to fall. It will fall a lot further. Governor Stevens reckons that mining investment as a share of GDP “has probably already declined by about 1 percentage point, and is expected to fall by another 3 or 4 percentage points over the next few years”. This sounds a little more than NAB’s forecast for a 3½% decline through 2014 and 2015.

So it’s early days in the transition away from mining investment-led growth.

Dr Gruen’s speech poses the question of whether the Australian economy will now go through the deep recession that has typified post mining boom experiences and has been predicted by Professor Ross Garnaut in his book “Dog Days: Australia after the boom”.

On the transition, Governor Stevens said “We have seen some encouraging early signs of the ‘rebalancing’ taking place.” They are mostly in consumer demand and residential housing. He added though, “these signs remain early ones. There is quite some way to go yet before the episode is completed”. Dr Gruen called it “so far so good”. He’s not saying the economy is all of a sudden good but more that we have so far avoided Garnaut’s “Dog Days”.

These speeches have re-emphasised a few key points. First, the Australian economy faces some large cyclical challenges. As well as the mining investment slowdown, fiscal policy is restraining and the $A is still high. Offsetting these have been better activity in the interest rate sensitive sectors but even here the news is now mixed. Last week, retail sales plunged 0.5% in May but we did see rebounds in May building approvals and June and early July house prices.

Two, don’t make the mistake of thinking that because the United States economic recovery is broadening – very solid payroll numbers in 2014 indicates it is – then so must Australia’s. In contrast to Australia, US fiscal policy is now less of headwind and after years of wage restraint the economy is competitive – even more so given the low $US. Australia has been out of phase with the US for the past decade of the mining boom and will continue to be so ahead.

Three, the $A will be lower – eventually anyway.

The Governor thinks it should be lower “and not by just a few cents”. He added that investors have “under-estimated the likelihood of a significant fall in the Australian dollar at some point”. Dr Gruen says a successful transition of growth will require “a further significant depreciation of the currency”.

Fourth and finally, the RBA are playing a long game and last week the Governor hosed down those looking for early hikes. The most probable outcome remains that they will be on hold for a long time. They’d clearly prefer not to have to cut the cash rate again but tellingly the Governor did remind all that “we still have ‘ammunition’ on interest rates”. There’s no intent here. But it’s a reminder the RBA are not dogmatic and will cut again if needed.

Week ahead: Labour force soft in June?

Another big week for data in Australia, with the June NAB Business Survey tomorrow, consumer confidence Wednesday and the June labour force report on Thursday. While labour demand measures have stabilised, they remain at moderate levels and our forecasts are more bearish than most, as we expect zero jobs and the unemployment rate rising to 5.9-6.0% – consensus is +12K and 5.9%.