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Thursday, 08 August 2013 15:34

The Australian election and investors

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The Federal Election

With the much anticipated Australian Federal election now set for 7 September it is natural to wonder what impact, if any, there might be on investment markets – both in terms of the uncertainty created by the election itself and in terms of the outcome. At present while opinion polls have Labor and the Coalition running at around 50% each on a two party preferred basis, according to bets placed on online betting agency Centrebet the Coalition remains the clear favourite.

Source: Centrebet

The performance of markets around elections

Elections can potentially have a short-term impact on investment markets. This is because investors don’t like the uncertainty associated with the prospect of a change in government during the campaign and then there may be relief once the poll is out of the way and possibly optimism associated with the election of a new Government.

The next chart shows Australian share prices from one year before till six months after Federal elections since 1983. This is shown as an average for all elections (but excludes the 1987 and 2007 elections given the global share crash 3 months after the 1987 election and the start of the global financial crisis in 2007), and the periods around the 1983 and 2007 elections, which saw a change of government to Labor, and the 1996 election, which saw a change of government to the Coalition. The chart suggests some evidence of a period of flat lining in the run up to elections, possibly reflecting investor uncertainty before the poll, followed by a relief rally soon after it is over.

Source: Thomson Financial and AMP Capital

However, the elections when there has been a change of government have seen a mixed picture. Shares rose sharply after the 1983 Labor victory but fell sharply after the 2007 Labor win, with global developments playing a big roll in both. After the 1996 Coalition victory shares were flat to down. The point is that based on the historical experience it’s not obvious that a victory by any one party is best for shares in the short term and, in any case, historically the impact of swings in global share markets arguably played a much bigger role than the outcomes of Federal elections.

What is clear though is that after elections shares tend to rise more than they fall.The next table shows that 8 out of 11 elections since 1983 saw the share market up 3 months later with an average gain of 5.4%, which is above the 1.8% average 3 monthly gain over the whole period.

Source: Bloomberg, AMP Capital

The next chart shows the same analysis for the Australian dollar. In the six months or so prior to Federal elections there is some evidence the $A experiences a period of softness and choppiness which is consistent with uncertainty about the policy outlook, but the magnitude of change is small – just a few percent. On average, the $A has drifted sideways after elections. While the $A fell soon after the 1983 Labor victory this was due to a policy devaluation in the dying days of the fixed exchange rate system.

Source: Thomson Financial, AMP Capital

The next chart shows the same analysis for Australian bond yields. Interestingly, on average bond yields have drifted down over the six months prior to Federal elections since 1983. The average decline has been around 0.75% which is contrary to what one might expect if there was investor uncertainty regarding the policy outlook. However, the tendency for bond yields to decline ahead of Federal elections appears to be more related to the aftermath of recessions, growth slowdowns and/or falling inflation prior to the 1983, 1984, 1987 and 1993 elections and the secular decline in bond yields through the 1980s and 1990s in general. More broadly, it’s hard to discern any reliable affect on bond yields from Federal elections.

Source: Thomson Financial, AMP Capital

Policy change and shares

Over the post war period shares have had an average return of 12.9% pa under Liberal/National Coalition Governments compared to 9.8% pa under Labor Governments.

Source: Thomson Financial and AMP Capital

Some might argue though that the Labor Governments led by Whitlam in the 1970s and Rudd and Gillard more recently had the misfortune to be affected by severe global bear markets beyond their control and if these periods are excluded the Labor average rises to 14.6% pa. Then again that may be pushing things a bit too far. But certainly the Hawke/Keating government defied conventional perceptions that conservative governments are always better for shares. Over the Hawke/Keating period from 1983 to 1996 Australian shares returned 17.3% pa, the strongest pace for any post war Australian government.

Once in government political parties of either persuasion are usually forced to adopt sensible macro economic policies if they wish to ensure rising living standards. Both the Coalition and Labor agree on the key macro fundamentals – i.e. the need to keep inflation down, to return the budget to surplus and in the benefit of free markets.

Policy differences

The main areas of difference between the two parties of probable economic significance relate to taxation, climate change, government spending & the budget and regulation.

  • in terms of tax the Coalition has promised to cut the company tax rate (although for large companies this is partly offset by a paid parental leave scheme) and abolish the mining tax;
  • the Coalition is proposing to abolish the carbon tax/Emissions Trading Scheme and will rather pay companies to reduce emissions;
  • the Coalition is likely to take a lighter/more business friendly approach to regulation than a Labor government. This may involve some partial wind back of industry regulation; and
  • the Coalition will likely try and speed up the return to a budget surplus by cutting government spending, much as it did under John Howard following the 1996 election.

As a result, perceptions that the Coalition will be lower taxing and less focussed on regulation and hence more business friendly than a Labor government may increase the chance a Coalition victory will result in a typical post election share market bounce. However, it’s worth noting that this may be partially offset if it announces aggressive fiscal tightening after the election (given the negative impact this could have on economic growth and profits at a time when the economy is already soft). What's more if a returned Labor Government follows up on its commitment to a National Competitiveness Agenda working to seriously boost productivity growth then it could have a positive long term impact on growth, profits and ultimately share market returns.

However, it does seem that there is the potential for significant sectoral impacts with the Coalition’s policies likely to be positive for miners, heavy carbon emitters and small companies (due to the company tax rate cut).

Concluding comments

The historical record points to the strong chance of a post election share market bounce. This may also fit in as we move out of the September quarter, which is often the weakest of the year, into the normally strong December quarter, as the profits reporting season ends in Australia and as uncertainty is removed post a possible September decision by the US Federal Reserve to start tapering its monetary stimulus.

Another potential positive from the election is that it is likely to see the end of minority government in Australia as whoever wins is likely to have a clear majority in the House of Reps. This could help usher in a period of more certain and rational policy making. However, it’s not guaranteed as whoever wins may still not have control of the Senate.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.
Tuesday, 06 August 2013 16:39

RBA cuts rates to 2.50%

Written by

bank-building-icon1Surprisingly moves to neutral bias.

As widely expected the Reserve Bank Board decided to lower the cash rate by 25bps to 2.50% at its August Board meeting.

For us by far the most significant aspect of the Governor's statement was the decision to move back to a neutral bias from the consistent easing bias that we have seen in recent statements.

It does not hold that a central bank should necessarily move to a neutral bias following a rate move. An easing bias was used in the May statement despite delivering a rate cut. The words used were: "The Board has previously noted that the inflation outlook would afford scope to ease further ... at today's meeting the Board decided to use some of that scope". That is a more dovish explanation for a rate cut than that used today "The Board judged that a further decline in the cash rate was appropriate".

We were expecting that the Bank would choose to maintain downward pressure on the AUD by repeating the rhetoric from the June and July statements which said: "The Board judged that the inflation outlook ... may provide some scope for further easing should that be required to support demand". In today's statement the key final sentence was: "The Board will continue to assess the outlook and adjust policy as needed to foster sustainable growth in demand and inflation outcomes consistent with the inflation target over time" – a clear neutral bias.

Other aspects of the statement were more encouraging from the perspective of our forecast which has been and remains for another cut in November. Firstly, the statement followed the structure in July by pointing out that although the Australian dollar has depreciated 10% since early April it remains at a high level. The only change in this statement was to revise that change up to 15%.

The other really important point was that despite the 15% fall in the currency the Governor repeated his confidence that inflation pressures are expected to remain under control. Comments on the real economy did not change from the July statement with growth being described as "a bit below trend" and the unemployment rate being recognised as edging higher.

The international outlook remains unchanged with global growth being described as "running a bit below average this year". A new observation is the linking of volatility in the global financial markets with a downturn in a number of emerging market economies. That link to emerging markets was not made in July.


In choosing not to maintain a clear easing bias it seems very unlikely that the September meeting will be 'in play'. Of course, with that meeting being timed for four days before the Federal election it would have been quite surprising to see any change in monetary policy so close to an election. We are not unnerved by today's approach because it in no way implies that rates have reached some form of institutional low and that should the economy evolve in the way we expect the Bank will cut rates again.

The calling of the election, by providing some political certainty by early September, might boost confidence measures but hard decisions showing up in the data to raise employment and investment seem a lot further off. We also agree with the Reserve Bank that the fall in the currency is most likely to impact importers' margins rather than consumer prices. A much stronger demand environment would be required for importers to confidently pass on price increases. We have not doubt that the Bank expects there is more work to be done. Note that the Government raised its unemployment forecast for 2013-14 from 5.75% to 6.25% and expects it to remain there over the course of the next year. We expect that the Reserve Bank feels the same way, although Friday's Statement on Monetary Policy will only include growth and inflation forecasts.We expect the Bank would therefore have no hesitation in cutting rates again once more information is available on inflation which will print in late October and the response of business/consumers to the election result has been clearly signalled.

We also believe that these dampening forces will be sustained through into early 2014 providing scope for another cut in February.


Written by Bill Evans

Chief Economist - Westpac Banking Corporation

Monday, 05 August 2013 09:23

Yet another (big) budget downgrade...... UBS view

Written by

716719-kevin-ruddKevin Rudd last week announced the pre-election budget update.  Here is an extract from UBS economic team that provides a summary of this announcement.

Budget downgrade




Key new measures (over 4 years) are:


Tobacco tax $5.8bn

PBS price changes $2.0bn

FBT on cars $1.8bn

Other ETS saves $2.1bn

Public sector efficiency $1.8bn

Delayed Foreign aid $1.0bn

Higher tax compliance $0.8bn

Bank deposit levy $0.7bn

Superannuation changes $0.6bn



New PBSA listings $1.4bn

PNG aid and resettlement $0.5bn

Non-claw back of carbon comp $3-4bn

Deffered self-education changes $0.3bn



Tuesday, 04 June 2013 15:52

RBA holds rates steady, easing bias intact

Written by

665200-health-insurance-moneyAs expected the Reserve Bank Board decided to leave the cash rate unchanged
at 2.75% at its June meeting.

The Governor's statement accompanying the decision presented taken as a
whole leaves us comfortable with our existing position: a 2% terminal rate
with the next easing in August.

The key concluding paragraph retained a clear easing bias but also made it
clear the Bank was in assessment mode – not only on the need for further
support for demand but also the degree to which the inflation outlook
afforded scope for further measures. Monetary settings were judged to be
'easy' and sufficient to "contribute to a strengthening of growth over
time, consistent with achieving the inflation target". And settings were
seen as "appropriate for the time being", the phrasing indicating the
Bank's views may be reassessed month to month.

However, the closing sentence gave a more uncertain view on the scope for
further easing: "the inflation outlook, as currently assessed, may provide
some scope for further easing, should that be required to support demand."
That contrasts with the statement accompanying the May decision to cut
rates which had a more definitive assessment that "the inflation outlook
would afford scope to ease further ..." with the Board choosing to "use
some of that scope". The changed emphasis points to the RBA seeking more
comfort on inflation, suggesting any follow on move is more likely to occur
post CPI in August than at July's meeting.

The sharp decline in the AUD is also likely a factor in the more qualified
view on 'scope'. The Bank may be seeking not only to reassess what impact
this may have on inflation but where the current move settles. Notably, the
statement acknowledges the decline in the currency but asserts that the
exchange rate "remains high considering the decline in export prices". That
aligns with our own view that the decline has merely reduced the degree of
overvaluation rather than eliminated it altogether (in USD terms we see the
decline as having reduced a 10c overvaluation to one around 3c). The Bank
may also share our concern that the change in market expectations on Fed
policy (a 'tapering' in QE purchases), which has been a key driver of
recent currency moves is misplaced and could reverse quickly.

The rest of the Governor's statement was brief. Global growth was seen
running a bit below average with "reasonable prospects of a pick-up next
year".  =Australia's growth was seen as "a bit below trend" and inflation
consistent with the medium term target.

The description of the impact of previous policy easing was decidedly more
downbeat though. In April, the Governor's statement boldly asserted that
there were "a number of indications that the substantial easing of monetary
policy during late 2011 and 2012 is having an expansionary effect on the
economy". In May, the view was that there had been "a strengthening in
consumption and a modest firming in dwelling investment". In June though
the statement looks less convincing with simply: "The easing in monetary
policy over the past 18 months has supported interest-sensitive areas of
Also of note, the view on business investment statement is not touched on
at all. This may be due to heightened uncertainty around the timing of the
mining investment cycle but is notable given the resilience of investment
plans revealed in last week's ABS Capex report.
We saw this has a key factor in the RBA leaving rates on hold this month
and it might have been put forward as a positive sign but instead the Bank
has opted not to discuss the investment outlook directly at all.

The Reserve Bank has retained an easing bias, but it is not an urgent one.
The path of easing from here will depend on developments in demand; the
financial markets (the $A, as it jointly impacts demand and inflation) and
the inflation story itself. The most important piece of information on the
latter front will come to hand between the July and August meetings, in the
form of the second quarter CPI. We have a more downbeat view on global growth next year and our domestic forecasts are also lower than the Bank's. As such we
already see a strong case for further monetary policy easing. However, the
tone of today's statement implies that the RBA Board is looking for further
evidence before acting again, which points to rates being kept on hold in
July.  However, it is likely to signal at that meeting that the forthcoming
inflation print could provide scope for it to support demand further within
the context of its target. That intent would then be actioned at the August
meeting. Beyond that point, we see two further 0.25% rate cut moves, in the last quarter of
this year and the first quarter of next year.


Westpac Economics Team


This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.

Wednesday, 27 March 2013 10:50

China - a controlled slowdown, not a train wreck

Written by

The most important influence on the Australian economy is arguably China, given our vast exports to China.

The Chinese authorities have successfully cooled the economy down, without trashing it as can be seen by the following charts.





Tuesday, 05 March 2013 18:41

RBA keeps rates on hold in March - next move likely lower

Written by

As expected Reserve Bank Board holds rates steady at March meeting

As we expected the Board of the Reserve Bank decided to hold the cash rate
steady at 3% following today's Board meeting.

There were minimal changes in the wording of the Governor's statement from
the statement issued on February 5 following that "no change" decision.

Of most importance was retaining the term "the inflation outlook, as
assessed at present, would afford scope to ease policy further should that
be necessary to support demand". Maintaining that statement indicates that
the Board retains an easing bias and future decisions will be impacted by
the growth profile.

By far the most important data release since the last meeting was the
Capital Expenditure survey for the December quarter. This survey provided
the first estimate of investment plans for the 2013-14 fiscal year. It also
provided the fifth updated estimate for investment in 2012-13. The news on
2012-13 was quite poor with substantial downward revisions to investment
plans. However, partly because the 2012-13 number was so low it was not too
big a stretch for the 2013-14 investment plans to show a solid increase.
Indeed by our calculations those plans indicated an 11% boost in investment
in 2013-14. That evidence is likely to have been a key factor in the Bank's
decision to hold rates steady. Indeed, while investment outside mining
continued to be assessed as "relatively subdued" the Governor did qualify
that with "recent data suggest some prospect of a modest increase during
the next financial year". Hence from the Bank's perspective progress in
rebalancing growth towards the non-mining sectors appeared to be underway.

Another aspect of the Capex survey indicated that the peak in resource
investment might be further out than previously assessed. However, there is
considerable uncertainty around those estimates and the Bank, prudently,
retained its general assessment that "the peak in resource investment is

The themes that have figured consistently in previous statements were
repeated today – moderate growth in private consumption; near term outlook
for non residential building subdued; exports strengthening; public
spending constrained; inflation consistent with the medium term target; and
low demand for credit.

The wording on the housing market changed. Whereas in February it was
described as: "prospective improvement in dwelling investment", it is now
described as: "appears to be slowly increasing". This somewhat more
positive assessment is the direct result of a modest 2.1% reported increase
in housing construction for the December quarter. Higher dwelling prices
and rental yields are also noted.

The conviction that inflation will remain consistent with the medium term
target is given more support in this statement. Whereas the February
statement predicted that a soft labour market would be working to contain
pressures on labour costs this statement notes that this result has indeed
been "confirmed in the most recent data". In the February statement the
Bank raised the prospect of businesses focussing on lifting efficiency to
contain wage pressures and this sentiment is retained.

The description of the international situation is largely unchanged
although the Governor appears to be a little more confidence around
downside risks. Compare "downside risks appear to have abated, for the
moment at least" (February) with "downside risks appear to have lessened in
recent months".

The description of financial markets includes a more upbeat assessment of
the sharemarket, "share prices have risen substantially from their low
points". However, the Bank continues to point out that financial markets
remain vulnerable, adding "as seen most recently in Europe".

The key theme is repeated in this statement, "the full impact of this
[easing in monetary policy] will still take more time to become apparent,
there are signs that the easier conditions are having some of the expected

Despite the recent fall in the AUD (substantially more in USD terms than in
TWI terms) the Bank continues to point out that the exchange rate remains
higher than might have been expected.

Conclusion – expect the next rate cut by June.
This statement is clearly structured to signal that the Bank retains its
easing bias but will be patient before cutting rates further.

We believe that there will be another cut in this cycle but not until
around June. Forces that are most likely to highlight the need for lower
rates will be around: an ongoing softening in the labour market; contained
price and wage pressures; a disappointing response from business in terms
of investment; and a housing recovery that, while quite vibrant in Sydney,
will not be replicated around the country. We also expect that the
Australian dollar will be drifting higher through to mid year particularly
as foreign investors rebalance their appetite back towards high yielding
Australian assets.

Bill Evans
Chief Economist
Westpac Institutional Bank


This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.



Wednesday, 24 October 2012 10:20

Health/Reality Check on the Australian Economy

Written by

David Murray, the former CEO of the Commonwealth Bank and former head of the Future Fund spoke recently to the 7.30 Report.

He spoke about the current path of the Australian economy and whether it is sustainable.



Wednesday, 12 September 2012 16:43

Consumer Sentiment rises slightly but remains weak

Written by

•The Westpac Melbourne Institute Index of Consumer Sentiment rose by 1.6% in September from 96.6 in August to 98.2 in September

This is the seventh consecutive month that the Index has been below 100. Apart from the 2008/09 period when the Index held below 100 for 16 consecutive months this represents the longest run of consecutive ‘sub 100’ prints since the early 1990s. Furthermore, there have only been two months in the last 15 when the Index has printed above 100.

The consumer is clearly stuck in an extended ‘cautiously pessimistic’ phase. In September last year the Index printed 96.9 so it has only increased by 1.3% over the whole year. That is despite 1.25% of rate cuts from the Reserve Bank; a more or less steady unemployment rate which is close to full employment; and some recent positive news around the threatening European situation.

This does not bode well for consumer spending and is consistent with the slowdown in consumer spending indicated by the June quarter national accounts. Although this followed a strong March quarter rise, the softening has come despite major policy boosts to household incomes including $1.9bn in fiscal handouts. With a sharp fall in July retail sales confirming this boost is now reversing, underlying momentum appears to be soft, in line with the consistently downbeat signal from the Consumer Sentiment Index.

Media coverage is often a major factor shaping respondents’ confidence including how they assess their own financial position and how they evaluate macro issues.

In the September report we receive an update on the news items which are capturing the attention of consumers and whether these were favourable or unfavourable. It shows the dominant news in September was around ‘economic conditions’ with 47% recalling news on this issue. Next was ‘budget and taxation’ (39.8% recall); international conditions (25.5% recall); and employment/wages (20.6% recall). Other topics registering lower recall include covered interest rates; inflation; politics and the Australian dollar.

Since June, the overall sentiment Index has increased by a modest 2.7%. Respondents generally recalled slightly less unfavourable news on international conditions although these items were still overwhelmingly negative. Other news was viewed as even more unfavourable than in June.

Four of the five components of the Index increased with the sub- indexes tracking views on “family finances compared to a year ago” up 0.3%; “family finances over the next 12 months” up 4.8%; “economic conditions over the next 12 months” up 0.6% and “economic conditions over the next 5 years” up 3.4%. The sub- index tracking views on “whether it is a good time to buy a major household item” fell by 0.4%.

By June this year we were particularly concerned by readings on “family finances over the next 12 months” which was printing at a level around the low-point of the 2008-09 period. Since thenwe have seen an encouraging improvement in this component which has increased by 11.4%. However it is still at a historically low level. For example the average print of that component during that 2008/09 period when the Index registered 16 consecutive months below 100 was 105.2 – today’s print of 96.2 is still well below that average. We can only conclude that respondents remain concerned about their finances despite the recent rally.

This survey also provides a quarterly update on respondents’ savings preferences. There was a sharp increase in the proportion of those respondents who assess bank deposits to be the wisest place for savings, with that proportion increasing from 32.6%

in June to 39.0% in September. That proportion is the highest proportion since December 1974 and comfortably exceeds the peak proportion during the 2008/09 period of 36.9%. For this survey the 6.4ppt increase in preference for bank deposits was at the expense of real estate which fell from 25.0% in June to 19.8% in September. The proportion of respondents favouring shares stayed near record lows at 5.5%, while the proportion opting for ‘pay down debt’ was steady at 20.4%.

If we compare the total proportion of respondents who prefer conservative savings options, covered by bank and other forms of deposits in conjunction with “pay down debt” the current proportion registers 63.5% of respondents. That compares with 64.2% in December 2008 when we were at the height of risk aversion during the Global Financial Crisis. In short, respondents are exhibiting a similar level of risk aversion in terms of their savings preferences as we saw in 2008.

The Reserve Bank Board next meets on October 2. Our forecast has been and remains that the Bank will decide to cut the official cash rate by 50bps over two meetings by year’s end. The case for lower rates is strong. Inflation remains well contained and the Bank’s own forecast has inflation remaining consistent with the target over the next one to two years. Interest rates are only slightly below neutral levels. The June quarter national accounts showed that consumer spending is slowing and investment in residential construction and plant and equipment has been contracting for the last few quarters. Despite a near 10% fall in the terms of trade the Australian dollar has failed to perform its usual ‘shock absorber’ role. Fiscal policy at both Federal and

state levels is tightening. Both consumer and business confidence are soft. From a domestic perspective only the fall in the unemployment rate and the ongoing surge in mining investment counter the case for lower rates. However, the fall in the unemployment rate has been due to discouraged workers leaving the workforce while the medium term outlook for the mining investment has recently been revised down by some mining companies.

In short, we think the case for lower rates has already been made and there must be a reasonable chance that the Bank will decide to move in October. However, central banks are conservative so a November ‘call’ for the first move looks to be more prudent.

Bill Evans, Chief Economist





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Wednesday, 03 October 2012 11:00

Is the mining boom over and would it be so bad if it is?

Written by

The miners are big enough to play dirty

Key points

  • The mining investment boom still has another year or two to go but its peak is starting to come into sight and the best has probably been seen in terms of commodity prices.
  • While there is the risk of a timing mismatch around the end of the investment boom in 2014 and as other sectors take over in driving Australian economic growth, the eventual end of the mining investment boom should lead to more balanced Australian growth.
  • The eventual slowing of the mining boom should mean lower interest and term deposit rates, the best is over for the Australian dollar (A$) and a more balanced share market.


Recent weeks has seen much debate and consternation in Australia as to whether the mining boom that has supposedly propelled the economy for the last decade is over. This followed the cancellation or delay of various resource investment projects including the massive Olympic Dam expansion and a fall in commodity prices over the last year.
But is it really over? And would it really be the disaster for Australia that many fear? After all, we have had years of hearing about the two-speed economy where the less resource-rich south eastern states were being left behind and it was said that the people of western Sydney were paying the price (via higher-than-otherwise interest rates and job losses) for the boom in Western Australia, so many Australians might be forgiven for thinking good riddance.

Semantics and confusion

Much of the debate about whether the mining boom is over has been characterised by confusion as to what is being referred to with some focusing on commodity prices, others on mining investment projects and others saying that technically it hasn’t even begun until mining and energy exports pick up. In broad terms the mining boom that has gripped Australia for the last decade likely has three stages.

The first stage, or Mining Boom I (MB I), began last decade and saw surging resource commodity prices driven by industrialisation in China. This resulted in a rise in Australia’s terms of trade to near record levels (see the next chart). This phase was initially good for
Australia last decade as it seemingly benefited everyone. Resource companies got paid more for what they produced, their profits surged, they employed more people, and they paid more taxes, which led to budget surpluses and allowed annual tax cuts. They paid more dividends and their share prices went up. The A$ rose but not to levels that caused huge problems for the rest of the economy. So, not only did the resources companies benefit but there was a big trickle down effect to almost everyone else. As a result the economy performed very strongly and unemployment fell below 4%.


The second stage, or Mining Boom II (MB II), has been characterised by a surge in mining and energy investment. This has been underway for the last few years and will take mining investment from around 4% of gross domestic product (GDP) in 2010 up to around 9% in 2013, contributing around 2 percentage points to GDP growth in each of 2011-12 and 2012-13.


The third stage, or Mining Boom III (MB III), will presumably come when resource exports surge on the back of all the investment.  So where are we now? In terms of the commodity price surge that characterised MB I, it’s likely that we have either seen the peak or the best is over with more constrained gains ahead:

  • Firstly, the pattern for raw material prices over the past century or so has seen roughly a 10-year secular or long-term upswing followed by a 10- to 20-year secular bear market, which can sometimes just be a move to the side.


The upswing is normally driven by a surge in global demand for commodities after a period of mining underinvestment. The downswings come when the pace of demand slows but the supply of commodities picks up in lagged response to the price upswing. After a 12-year bull run since 2000 this pattern would suggest that the commodity price boom may be at or near its end.

  • Global growth appears to have entered a constrained patch. Excessive debt levels in the US, Europe and Japan have constrained growth, while potential growth in China, India and Brazil looks like being 1 or 2 percentage points lower than was the case before the global financial crisis. This means slower growth in commodity demand going forward.
  • The supply of raw materials is likely to surge in the decade ahead in response to increased investment.
  • Finally, the surge in commodity prices since 2000 was given a lift by a downtrend in the US dollar from 2002 as commodity prices are mostly priced in US dollars. This has now likely largely run its course.

Taken together, this would suggest that the best of the commodity price surge since 2000, or MB I, is behind us. There are two qualifi cations though. First, after the recent short-term cyclical slump there will still be a rebound, probably into next year as global growth picks up a bit. Second, it’s way too premature to say that the surge in demand in the emerging world is over - China and India are still very poor countries with per capita income of just US$8,400 and US$3,700 respectively compared to US$40,000 in Australia suggesting plenty of catch-up potential ahead and related commodity demand.

In terms of MB II, while the cancellation of Olympic Dam and other marginal projects indicates that projects under consideration have peaked, this does not mean the mining investment boom is over. In fact it probably has another one to two years to run. Based on active projects yet to be completed there is a pipeline of around A$270 billion of work yet to be completed. Iron ore related capital spending (on mines and infrastructure) are likely to peak this fi nancial year and coal and liquid natural gas related investment is likely to peak in 2014-15, suggesting a peak in aggregate around 2014.

In other words, the boom in mining investment has 18 months or so to run before it peaks and starts to subside back to more normal levels. But what can be said though, is with the cancellation of marginal projects that were in the preliminary stage, the end is coming into sight.

Finally, MB III or the pick-up in export volumes flowing from the surge in mining investment in iron ore, coal and liquefied natural gas will start to get underway around 2014-15.

Heading towards a more balanced economy

Talk of the end of the mining boom has created a bit of nervousness regarding the outlook for Australia. However, the reality is that the current stage of the mining boom focused on
mining investment has not been unambiguously good for the economy and its inevitable end should hopefully see Australia return to a more balanced economy.

It was always thought that after two or three years the surge in mining investment would settle back down as projects ran their course. Trying to do a whole lot of projects in a relatively short space of time was always fraught with the threat of excessive cost
pressures and an excessive surge in supply. We are now seeing market forces kicking in to rationalise resource projects and so the more marginal projects are being delayed. This is a good thing as it will reduce cost pressures, leave work for the future and reduce the
size of the commodity supply surge over the decade ahead thereby helping avoid a crash in commodity prices.

The cooling down of the mining investment boom should help lead to a more balanced economy. MB II has not been good for big parts of Australia. With roughly 2 percentage points of growth coming from mining investment alone it has really put a squeeze on the
rest of the economy. Housing and non-residential construction, retailing, manufacturing and tourism have all suffered under the weight of higher-than-otherwise interest rates and a surge in the A$ to 30-year highs.

What’s more the boom in mining investment has meant that the Federal Government has not seen the tax revenue surge it got last decade, so last decade’s regular tax cuts have not been possible and this has weighed on household income.
This is all evident in the Australian share market which has underperformed global shares since late 2009, with the resource sector being the worst performer over the last year as resource sector profits have fallen 15% or so.

So, the end of the mining investment boom, to the extent that it takes pressure off interest rates and the A$, should enable the parts of the economy that have been under the screw for the last few years to rebound, leading to more balanced growth. This is also likely to be augmented by a pick-up in resource export volumes equal to around 1% of GDP from around 2014-15 according to the Bureau of Resource and Energy Economics.

Of course a risk is of a timing mismatch around 2014 as investment slows down with other sectors taking a while to pick up. To guard against this the Reserve Bank will clearly need to stand ready to respond with lower interest rates.

The bottom line is that the end of the mining investment boom in a year or two won’t necessarily be bad for the Australian economy and will likely see a return to more balanced growth.

Concluding comments
It’s premature to call the end of the mining boom just yet. The peak in mining investment probably won’t be seen until 2014 and thereafter actual mining production and hence exports will start to pick up. However, the best has probably been seen in terms of commodity price gains and the end of the investment boom is starting to come into sight.
While there may be the risk of slower growth as the Australian economy shifts gears away from mining investment in 2014 to mining exports, construction and other parts of the economy that have been subdued, the end of the investment boom should lead to a more balanced economy reflecting less pressure on the interest rates and the A$.
For investors there are several implications including:

  • Ongoing pressure for lower interest rates as the risk of an overheating economy subsides. This means that term deposit rates are likely to fall further in the years ahead.
  • The best has likely been seen for the A$, implying less need to hedge global shares back to Australian dollars.
  • Resources shares are currently cheap and should experience a cyclical rebound when confidence in global growth improves.
  • However, beyond a short-term bounce it’s likely that the cooling of the mining boom will allow a return to a more balanced share market with domestic cyclicals likely to perform better.

This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.

Thursday, 26 July 2012 11:31

Australian Official Interest Rates - Further to fall

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Westpac Consumer Confidence index was released in July showing an improvement in Consumer Sentiment.

Finally we have some evidence that the Reserve Bank’s policy of cutting the official cash rate by 1.25% between November last year and June this year is starting to gain more positive traction with households.

However, this result is far from convincing and should not be interpreted that we can expect confidence to steadily return to more normal levels over the months ahead.

The Index is now 2% above its level in October last year prior to the beginning of the rate cut cycle. However it is still 4.1% below the reading in November last year when households responded positively to the first rate cut in November. Following that initial
positive response in November concerns around the international and domestic economic outlooks offset any positive impact of the rate cut in December. These ongoing concerns, particularly around the international economic outlook, continued to mute the impact of subsequent rate cuts in May and June. In fact, despite the cumulative cuts of 125bps we still have the situation that pessimists slightly outnumber optimists.

Over the month, households were probably buoyed considerably by the result from the Greek elections and the positive reception to the latest European leaders’ summit , averting, at least for the time being, a new crisis in Europe.

While the Reserve Bank did not cut interest rates further there was a strong 5.5% jump in the confidence of those respondents who hold a mortgage.

There was also some positive news around the domestic economy.Petrol prices are down by 7% since the last survey and have now fallen 13% since May. The Australian dollar rallied from 98¢ to 102¢ versus the US dollar, and the share market rose 2.7%.

All components of the Index increased in July. The sub-indexes tracking consumer expectations for economic conditions over the next 12 months and five years increased by 5.8% and 5.2% respectively. The sub-index tracking responses on ‘whether now is a good time to purchase a major household item’ rose by 1.1%.

Respondents were also more positive around their own finances. The sub-indexes tracking assessments of finances relative to a year ago improved by 4.6%; and the outlook for finances over the next 12 months improved by 3%.

However, disturbingly, the sub-index tracking respondents’ outlook for their finances over the next 12 months is still 9.4% below the level in October last year prior to the beginning of the Reserve Bank’s rate cut cycle.

The Board of the Reserve Bank next meets on August 7. It is our view that interest rates in Australia are still too high. In his Statement following the interest rate decision on July 3 the Governor described interest rates as “a little below medium term averages”. With the Australian dollar back above parity, despite lower commodity prices, and fiscal policy being quoted by the RBA to be contradictionary in the order of 0.75% – 1.5% of GDP financial conditions in Australia are mildly stimulatory at best. Although there are tentative signs of improvement emerging in some interest rate sensitive parts of the economy, these have yet to show a convincing recovery and remain vulnerable to renewed weakness. Mean while the threat from a deteriorating global economic outlook continues to build.

Not with standing these issues the recent rhetoric from the Bank indicates that it is in a ‘wait and see’ mind set. Accordingly, whilst we think it is likely that, as we saw in the first half of 2012, the Bank’s ‘wait and see’ approach will eventually evolve into further
rate cuts totaling 0.75%, our call that the next cut will come in August could prove to be too early. However, because we believe that Australia needs lower rates and much can happen, particularly in the international economy, we are comfortable
maintaining that view.

Sourced from Bill Evans -Chief Economist Westpac

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