Australian economic outlook: patience is needed

How to

Martin Lakos, Division Director
Saturday 15 August 2015

I wrote in July about the importance and influence that business and consumer confidence has on economic activity, and that there was good reason for Australians to be more confident than the various sentiment surveys have reported we are feeling.

The most recent NAB Business Survey shows confidence was down in September but still considerably up from averages this time last year.

The survey said: “Confidence varies significantly across industries, with services firms the most optimistic, and transport and utilities surprisingly strong (falling oil prices and removal of the carbon tax?).”

Continued overseas momentum, particularly the US and China

However, global markets have turned down recently, reflecting a 180-degree shift from concern around when the US will raise interest rates due to consistent and improving growth, to the slowing growth and weak inflation outlook for Europe. As a result, we have seen a tug of war between the US Dollar and other currencies around the world.

Macquarie remains positive on the momentum the US economy is demonstrating. Europe will need additional stimulation from both the European Central Bank and each Government to support growth.

China is also favoured as recent data on trade saw exports up 15%, signalling not all is down and out with China’s trading partners. Additionally, imports were most encouraging being up 7%, indicating that Chinese domestic demand is improving. Both numbers were well above analyst expectations.

So, the global adjustment towards ‘normal’ economic activity continues.

Talking of adjustments, where does this leave Australia?

Australian business investment

As I noted in July, the Australian economy is experiencing a transition from a reliance on the mining sector to a broader spread of sectors, as has been the case previously.

To offset the decline in mining investment over the next few years, Macquarie estimates that the level of non-mining investment needs to lift by around 20-25%. This is not an especially ambitious target. Indeed, following the commencement of the Reserve Bank of Australia (RBA) rate cut cycles in 1996 and 2000, non-mining business investment rose by around 30-40% over the following three years.

Currency readjustment for the Australian Dollar

A notable recent adjustment has been the weakening exchange rate which could deliver growth benefits for our economy. The Australian Dollar averaged US 94 cents in July but has since fallen to a recent low of US 86.4 cents. That is a devaluation of 8%, although the Australian Dollar has in fact devalued by 21% from a 10-year high of $US1.10 in August 2011.
Why has it taken so long for this weakening to occur? There are four key factors that influence a currency’s value.

  1. The country’s sovereign credibility: Australia’s AAA rating is the highest in the world. As a result, it attracts funds and foreign investment due to this ‘safe haven’ status.
  2. Interest rates: For some time, Australia has had the highest official interest rates of any developed economy (the US, Europe and Japan are virtually at zero). Hence, this attracts buying of Australia’s currency to take advantage of this differential.
  3. Commodity prices: Up until recently, energy and iron ore prices have been high which have also supported Australia’s currency.
  4. The Australian Dollar is priced against the US Dollar: So, if the US economy is doing well, demand for US Dollars goes up and that is reflected in a weaker Australian Dollar.

The benefits of a sustainably weaker currency to business are clear and though patience is required, businesses can be more confident of these benefits coming through.

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