Don't Expect A Rate Reduction From The Reserve Bank Of Australia

 |  Includes: EWA, FXA
by: Hale Stewart

Australia's economy is in a very interesting place. Thanks to China's rapid growth - which has provided a vast and growing market for Australia's natural resources - the Aussies have experienced a very long period of solid economic growth. But the Australian economy has been feeling the negative impact of China's slow move towards a more consumer-led economy in the form of decreased natural resource investment and overall activity. As a result, parts of the Australian economy are now slowing, while others are picking up. Caught in the middle is the RBA. While they currently have the highest interest rates in the developed world, the slowdown in investment and uptick in unemployment would surely lead them to consider lowering rates. But an uptick in inflation and an already strong Australian dollar are forcing the RBA to keep rates at higher levels

Let's start by looking at the basic problem faced by the Australian economy.

Above is a graph from the RBA's "chart pack" that shows mining and non-mining investment. Since the end of the recession, overall investment in mining has increased, while that in non-mining has decreased. This highlights the central problem faced by the Australian economy.

And at the same time, unemployment has been ticking up:

The unemployment rate has been slowly increasing, now standing at a little over 6%.

To encourage investment in non-mining activities (which would then lead to an increase in jobs, lowering unemployment), the RBA should lower rates from their current level of 2.5%. However, there are other problems that this move lower would exacerbate, starting with the Aussie dollar:

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The chart above is from the Bank of International Settlements, showing the overall level of the Australian dollar. While it is at lower overall levels, it is still high enough to be a bit concerning to the central bank, who recently said the following about the Aussie's level: "The Australian dollar is still 7 per cent higher than its low in late January, but around 11 per cent below its recent peak in April 2013." Lowering rates would send the Aussie higher, hampering exports.

In addition, the Australian housing market is heating up:

The prices in major markets are clearly accelerating. This has been encouraged by the increase in mortgage underwriting:

And finally, inflation is increasing, further hampering the RBA:

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Australia could use lower rates to encourage the non-mining investment and, in more general terms, help to speed up the change from a raw materials economy to a more diverse production base. However, the current housing market and inflation picture are hemming the bank in, preventing it from lowering rates. In short, unless we see a drastic deterioration of the Australian situation, don't expect rate reduction from the RBA anytime soon.

Hale Stewart,