Mining cliff to keep interest rates low

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By Leith van Onselen

The AFR’s David Bassanese has this afternoon doubled-down on his view that the anticipated pick-up in residential building activity won’t be anywhere near enough to offset the hit to growth and employment as the once-in-a-century mining investment boom unwinds, noting that the ensuing economic weakness will keep interest rates low in 2014:

 …the Australian economy is likely to face another struggle in 2014, which will keep interest rates low. Indeed, I maintain there’s a good chance of at least one further official interest rate cut by early next year.

…while we can remain confident of a decent downturn in mining investment over the next few years, we can be less confident of a decent upturn in non-mining activity.

According to analysis by the Reserve Bank of Australia, mining investment will fall by about 1 per cent of national output in each of the next two to three years.

Housing investment, meanwhile, accounts for just less than 5 per cent of national output, implying we’d need unrealistically large annual gains of 20 per cent to make up for the direct loss of mining investment – before considering, of course, the relative economic multiplier effects of each…

With government spending constrained, that leaves non-mining business investment and consumer spending. As for the former, a glut of office accommodation and competitive pressures from the still high dollar won’t help.

And given already high household leverage and rising unemployment, a sudden sustained burst of consumer spending binge seems unlikely.

This is obviously similar to the view expressed on MacroBusiness. As noted yesterday, the prospect of rising housing construction offsetting declining mining investment seems highly improbable. Mining investment (represented below as engineering construction) is roughly 2.5 times as large as residential building construction, meaning that for every 10% decline in mining investment, dwelling investment would need to increase by around 25% for growth to remain unchanged (other things equal).

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Australia would need to experience an epic dwelling investment boom the likes of which we have never before seen, and even then it may still not be enough to fill the mining void. Hence, interest rates are likely to remain low (and probably fall further) for an extended period of time.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.