Friday, August 15, 2014

Aussie monetary policy statement | Many imponderables ahead

The Reserve Bank of Australia (RBA) released its Statement on Monetary Policy on August 8th.

Australia is still tackling the forced transition from a mining based economy to one that is supported by domestic consumption due to the downturn in demand for Iron Ore, particularly from China, and a consequent collapse of commodity prices.

The key factors in whether or not this transition will be relatively seamless, or traumatic, are discussed in the monetary policy statement. GDP growth is expected to be a little below average in 2014/15; a pick-up in dwelling investment is already underway (fears of a property bubble are not mentioned); consumption appears to have grown at only a moderate rate over the year to date but the historically low (by Aussie standards) interest rate and some improvement in labour market conditions is expected to help here; the unemployment rate is expected to remain elevated and there is slack in the labour market, so wage growth is anticipated to remain low; and inflation pressures are likely to remain subdued.

And, once again, mining investment is expected to fall sharply from its current levels and is expected to be replaced by growth in non-mining investment.

Many imponderables ahead

It is obvious that while the Australian authorities have a clear plan for dealing with the mining downturn and enjoy significant credibility in their ability to manage the economy, there is still much that is dependent on certain things happening on schedule. The one ace they have in the hole, so to speak, is the exchange rate, and this is the subject that concerns us most. While a base rate of 2.5% might be extremely low by Australian historical standards, it is still very far above the almost zero rate that has been brought into play in most other major global economies. This means that a rate reduction is something the RBA has to fall back on if the stated scenarios do not pan out as hoped.

And any expectation by the market that this is about to become a probability will be bad for the value of the Aussie dollar.

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