From Bloxo:
Commodity prices continue to slide. Iron ore prices have fallen to new decade-lows of under USD40 a tonne in recent days (Chart 1). Oil prices have sunk to six-year lows, following OPEC’s decision not to cut production. Brent oil is trading at USD41 a barrel while WTI is at USD38 a barrel. Base metal prices have fallen by -7% over the past three months, led by nickel and zinc. Thermal coal prices have fallen by -11% during that time. Agricultural prices have also been weaker, despite the possible effects of El Niño on future production.
The broad-based nature of the falls in commodity prices suggests a common factor is the main driver of the weakness, which appears to be China. Timely indicators continue to suggest that China’s growth is slowing. Our Chief China economist, Qu Hongbin, has recently revised down HSBC’s view of GDP growth in China from 7.2% to 6.7% in 2016. Weaker than expected infrastructure investment and trade are the key reasons for the downward revisions.
At the same time that demand has weakened, commodity supply has been ramping up. Iron ore production is rising further as new capacity continues to come on-line. Although Australia is still faring better than most, as most of its iron ore is produced at the low end of the global cost curve, some smaller producers are set to come under pressure if current prices persist. The coal sector is already facing considerable challenges, with most thermal coal mines currently running at cash losses. The lower oil price has implications for the profitability of Australia’s LNG projects, which are set to see their exports ramp up considerably over the next 12-18 months.
There is no denying that Australia’s resources sector faces tough times. Resources sector profitability is likely to weaken, despite considerable efforts to cut costs. Thankfully, low interest rates and the lower AUD are already rebalancing growth towards the non-mining sectors. It is also worth keeping in mind that mining is only 10% of Australia’s economy, while the non-mining sectors account for 90% of the economy and that the resources sector is over 80% foreign-owned, so the negative income effect largely falls on foreigners rather than locals.
The housing and services sectors are picking up strongly and creating local jobs. Net services exports have contributed around 0.5ppts to GDP over the past year, up from being a drag on growth of -0.3ppts three years ago. The lower AUD is encouraging Australians to holiday and spend locally rather than abroad. The combination of a lower currency and rising middle class incomes in Asia, particularly in China, is supporting strong Asian tourist arrivals and rising enrolments in Australia’s education facilities. Education exports are Australia’s third largest export by value. See ‘Australia’s next opportunities in China: Moving beyond resources’, 4 November 2015.
Nonetheless, as commodity prices fall further more economic stimulus may be needed. Ideally this would come from a lower AUD. However, the recent fall in commodity prices has not been matched by a falling AUD; instead the currency has risen (Chart 2). As our chart shows, this misalignment is now as big as it has been since 2014. The rise in the currency may partly reflect the RBA’s reluctance to consider further rate cuts.
However, the RBA faces an increasing challenge. To the extent that its apparent reluctance to consider rate cuts is holding up the AUD, it may also be weighing on improvements in competitiveness that a lower currency delivers. If the resources sector weakens further, more growth is likely to be needed in the non-mining sectors, which may require looser financial conditions.
Of course, low inflation means the RBA has room to move further on rates. While the central bank has doubts about its effectiveness in lifting domestic growth, given the already record low level of the cash rate, a falling cash rate path could lend strength and credibility to any attempt to jawbone the AUD lower. The recent falls in oil prices and the higher AUD also imply that the next CPI print, due in late-January, may be weaker than previously expected. This may give the RBA little excuse not to cut in early 2016, despite the on-going rebalancing of Australia’s growth and recent stability in the labour market.
They’ll be forced to cut, guaranteed. It’s to Bloxo’s credit that he’s woken up to it, despite the astounding ignorance of this statement: “It is also worth keeping in mind that mining is only 10% of Australia’s economy, while the non-mining sectors account for 90% of the economy and that the resources sector is over 80% foreign-owned, so the negative income effect largely falls on foreigners rather than locals.”
