Terms of trade getting pounded

The RBA’s index of commodity prices is out for March and it was not a good month:

Preliminary estimates for March indicate that the index declined by 2.0 per cent (on a monthly average basis) in SDR terms, after declining by 0.9 per cent in February (revised in conjunction with new weights). The largest contributors to the fall in March were declines in the prices of iron ore, coking coal and steaming coal. The rural commodities subindex rose, led by the price of wheat, while the base metals subindex fell in the month. In Australian dollar terms, the index declined by 2.6 per cent in March.

Over the past year, the index has declined by around 13 per cent in SDR terms. The prices of many commodities in the index have fallen over this period. The index has risen by 2.3 per cent in Australian dollar terms over the past year, reflecting the depreciation of the Australian dollar over this period.

As indicated in previous releases, preliminary estimates for iron ore, coking coal and thermal coal export prices are being used for the most recent months, based on market information. Using spot prices for these commodities, the index declined by 4.6 per cent in March in SDR terms, to be around 18 per cent lower over the past year.

The SDR measure is a good proxy for the terms of trade (ToT). Remember, the terms of trade is a ratio between export and import prices so is largely unaffected by the value of the dollar. The 4.6% spot price fall recorded in the last paragraph tells you what is coming in the next few months as contract prices follow spot down.

The four largest items in the basket are iron ore 32.2%, coking coal 14.4%, thermal coal 9% and gold at 8.4% (gas is 7.1%). So it’s not hard to see why the ToT is under pressure again. All things equal this will mean considerable pressure on national income and weaker nominal growth in Q1 national accounts. The flow through to the Budget will come shortly after.