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What's happening to the economy – The RBA's take

Australia’s central bank reveals its latest thoughts on what’s going on in and around the country.

In their Statement on Monetary Policy for February 2016, the Reserve Bank of Australia (RBA) has provided a cautiously optimistic outlook on how Australia will fare over the next two years.

The Australian economy

In spite of global financial turbulence and the continued slowdown in the domestic mining sector, the RBA continues to hold the same forecast that they held in the previous Statement back in November – that economic growth in Australia will increase to be slightly above the decade average.

In addition, they anticipate further growth increases in household demand and incomes – boosted by rising employment, low interest rates and cheaper petrol prices.

Whilst the RBA expects further large falls mining investment, they’re forecasting non-mining investment to pick up some of the slack as a result of the improved local demand. With regards to housing investment growth, they predict a gradual moderation from the explosive pace of last year.

The RBA was surprised, though, about the fact that labour market conditions improved notably since their last statement – something they had not anticipated.

Against the backdrop of below-average GDP growth, the unemployment rate fell to 5.8 per cent in December, leaving it at a 26-month low! Job ads and vacancies were up, whilst employment grew at an above-average rate and the participation rate continued its upward trend.

The RBA offered a few possible reasons for these unexpected and unusual labour market results:

  • “The labour market data contains information not apparent in the national accounts data.”
  • “Strong growth in employment of late will be followed by a period of weaker employment growth.”
  • “Low growth of wages is likely to have encouraged businesses to employ more people than otherwise.”
  • “The strength in labour market conditions relative to output growth may reflect a rebalancing of the pattern of growth towards labour intensive sectors and away from capital intensive sectors.”

Take your pick, but all of their suggested reasons are likely to have played a part in the surprising labour performance.

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RBA Concerns

The RBA’s main concerns for Australia’s economy centred around the performance of China.

Since August 2015, carrying through to early 2016, wavering Chinese growth expectations have been sending shivers throughout financial markets all over the world. With China as its biggest trading partner, Australia has been far from immune to this market uncertainty. On the 31st of July 2015 the ASX 200 index sat pretty at 5,699.20 points before someone hit the panic button and it spiralled down to as low as 4,841.50 points on the 20th of January 2016 – about a 15 per cent fall from grace.

The RBA addressed why the concerns in China are fuelling so much of this uncertainty in Australia.

“While growth in China has been expected to slow gradually for some time, the recent bout of global financial market volatility has been characterised, in part, by concerns about the evolving balance of risks in China and the ability of the Chinese authorities to manage a challenging economic transition,” the RBA said.

“The authorities still have scope to respond if the economy turns out to be much weaker than expected, but any sharp slowing in economic activity or increase in financial stresses in China could spill over to other economies in the region and adversely affect commodity prices, including those that are important for Australia.”

 

Around the world

Looking at other countries and global markets, these are some of the general observations the RBA made:

  • Current monetary policy around the world is “very accommodative” and is “supporting economic activity”, despite lacklustre inflation by most central bank’s standards.
  • On China, the RBA said their slowing growth can be put down to “a decline in investment growth associated with excess capacity in heavy industry and the large stock of unsold housing.” Other factors such as declining growth in both productivity and the urban labour force have also had an influence. Meanwhile, their service sector has been resilient.
  • Other commodity exporters around the world have also been severely affected by weaker conditions in the Chinese industrial and construction sectors.
  • Whilst falling oil prices have dragged down global share markets, it’s actually been supporting the growth of Australia’s main trading partners who are net importers of oil. The RBA forecasts these trading partners to continue to grow at their current rates over the next couple of years.
  • The expenditure growth in the US has been driven by increased private consumption as a result of lower oil prices and continued employment growth. The RBA also expects the US to increase their interest rates “very gradually.”
  • Faster growth in India is a result of “stronger private consumption and public investment.”

What this means for interest rates

With the fairly positive economic data coming out of Australia over the past few months despite financial market volatility, the RBA felt justified in leaving the cash rate on hold at two per cent. They believe that the earlier moves to reduce the cash rate by 50 basis points in the first half of 2015 were successful in supporting growth and assisting in the rebalancing of activity towards the non-mining sectors.

Whether or not there will be another interest rate cut in the coming months will depend on inflation and labour market figures. Should inflation remain weak and jobs figures turn negative, a rate cut would look increasingly likely. We’ll have to see what happens.

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