Australia's transition

24 May 2016

By Shadforth Financial Group

The Australian economy is showing signs of responding to commodity price weakness by rebalancing to the services sector and to activities that are driven by
domestic demand. The commodity price appreciation over the quarter has cushioned this transition, but we expect further commodity price weakness in 2016. If significant falls in coal and iron ore prices were to materialise we anticipate that there would be a further decrease in the ability to predict commodity company earnings.

It is vital that capital expenditure in the non-mining sectors that support activity and jobs counterbalances the sharp decline in mining investment. The latest capital expenditure survey highlighted mixed data, although total year-on-year new capital expenditure improved slightly to -16 per cent from -20 per cent, which indicates signs of stabilisation. Looking to the future, we expect an increase in capital expenditure during 2017 as business lending increases and the Australian dollar weakens.

Australian dollar strength remains a concern for the RBA

Australian companies reported their half-year financial results during the quarter, exceeding expectations despite global economic headwinds. Companies leveraged to housing and the consumer market fared best, reinforcing the moderating concerns associated with the property market and the view that share market weakness can be mainly attributed to global macro-economic concerns.

Graph

The Reserve Bank of Australia (RBA) kept the main interest rate unchanged throughout the quarter at a historical low of 2 per cent, but in early May, they reduced the rate to 1.75 per cent. The RBA’s themes remain unchanged with a focus on the relatively strong Australian dollar, weak business investment and poor business conditions. The RBA noted that improved labour market conditions were as a result of the expansion in the non- mining parts of the economy, however, monetary policy would need to be accommodative to support the economy that was experiencing weaker growth.

The global economy continues to muddle through soft growth

Heightened concerns over emerging markets continued to weigh on share markets during the March quarter despite a recovery in oil and other commodity prices. The backdrop of slower global economic growth continued to hamper investor sentiment. Most notably, China continued its extraordinary monetary easing and expansionary fiscal policies to bolster growth. The improvement in market sentiment towards riskier assets is likely to be short-lived as recessionary pressures and macro-economic headwinds generate volatility in shares and bonds in China. Economic fundamentals are not helping reduce investor concerns because China’s growth is continuing to slow while at the same time is over-reliant on credit. Standard and Poor’s cut its credit rating outlook for China to negative in response to rising debt levels and its reliance on credit growth to meet economic targets.

Divergence between Federal Reserve and European Central Bank policy

The Federal Reserve is currently poised to continue increasing interest rates while in Europe further easing is generally expected. Janet Yellen, the Chairwoman
of the Federal Reserve, signalled that the Federal Reserve would be cautious in raising interest rates owing to the headwinds facing the global economy. Expectations regarding the number of interest rate increases for the year dropped to two as Yellen said that the Federal Reserve’s employment and inflation targets “…will likely require a somewhat lower path for the federal funds rate than was anticipated in December.” The European Central Bank (ECB) increased monthly asset purchases by ¤20 billion to ¤80 billion and reduced the deposit rate by 10bps to -0.4 per cent. The aim is to boost growth and painfully low headline inflation which fell to -0.2 per cent in February against a backdrop of lower oil prices and the weaker economic outlook. We believe that monetary stimulus is justified whilst Europe faces  the risk of deflation, deteriorating business and consumer confidence and uncertainty surrounding external conditions, particularly the spill-over effects from China and emerging markets.

Educational guides