Having recently returned from time in Sydney, the Australian economy presents as somewhat of a paradox. Prima facie, things look solid, and compared to most places elsewhere, this is certainly the case. But just like the helpless swimmer at the beach when a shadow passes in the water, it’s what lies beneath the surface that is potentially concerning. A number of examples are illustrative.
Unemployment of 5.2% is low. This has ticked up over time and has been supported by a falling participation rate, but this rate is still strong. However, impending cuts are likely to come in retail, post-Christmas as shoppers retreat again and certainly in finance, where a number of local and offshore banks have announced cuts. Not helping is the fact labour productivity has fallen to multi-decade lows at the same time that real wages have increased at close to 20-year highs. This stems, at least in part, from the government’s recent industrial relations reforms.
The RBA’s easing cycle should help consumers, and recent cuts of 50bps could be followed by 50bps more. At a cash rate of 4.25%, there exists ample room to keep reducing rates if necessary. Moreover, inflation is likely to be benign. But a counter to this will be the need of Australian banks to access off-shore funding at higher cost. Around 60% of the banks’ loan books are off-shore wholesale funded and this debt needs to be continuously rolled over. The situation in Europe is driving up the cost of funds, which means any further cuts by the RBA might not be passed on by the banks as they seek to protect lending margins. This could break the traditional transmission mechanism used to stimulate the consumer.
It is the resources sector that has seen Australia through the last 4 years. A dip in 2009 was quickly forgotten as volumes and prices moved to record levels on the back of Chinese demand. China now accounts for 20% of Australian exports. Is this likely to continue? Despite the official data, China continues to be the great unknown, and a dramatic slowdown there, particularly in property development and construction, could see demand for steel and so iron ore, fall dramatically. This is at the same time that record volumes of iron ore production are scheduled to come on in the next few years. This will need to be watched closely by anyone investing in the Australian market.
Having said all that, it is not all doom and gloom. If pressures in Europe were to ease, and China saw a soft landing, the Aussie consumer could come to the rescue. But definitely the biggest negative of the summer so far? Trying to live down losing to NZ in the cricket!