While the Reserve Bank of Australia (RBA) is expected to keep rates on hold at its December meeting, leading industry analyst and economic forecaster BIS Shrapnel says its November hike may have been premature.
Though RBA may have had concerns about the upcoming mining boom and current strong employment growth leading to serious capacity constraints and inflationary pressures, BIS Shrapnel’s latest Economic Outlook Bulletin reports that the economy has hit a soft patch since mid-year with the recovery still looking shaky.
Report author and BIS Shrapnel senior economist Richard Robinson says that the RBA should have waited since he believes the effects of the mining boom will be different to the pre-GFC resources boom.
- With government stimulus receding and public investment set to decline, the economy will lose one of the key drivers that assisted with the recovery over the past year
- Only the mining sector shows recovery
- Rising interest rates are acting as deterrents to upgraders and investors considering a home investment
- Overseas economic conditions, especially in Europe, US and China are particularly fragile
- Retail spending has been weak despite strong employment growth thanks to cautious customers
- Business investment outside of mining is plagued by high costs and unavailability of finance
Effects of the mining boom
The RBA is concerned about the effects on the wider economy from the large increase in terms of trade due to significant rises in commodity prices, which in turn boosts national income.
However, this time around the increased national income is being saved, and will also leak into more imports of capital goods including steel fabrication.
During the last decade higher mining revenues and company taxes were recycled by the previous government into income tax cuts, which fuelled consumer spending and demand inflation.
The collateral effect was the stronger growth in industry sectors supplying these household goods and services, which drove strong employment growth, further adding to the strains on capacity and the labour market.
Robinson says that the RBA responded to these pressures by hiking interest rates 75 basis points in 2006 and then a full one per cent over 2007/08.
He comments that the RBA probably thought the 2006-2008 rate hikes were too late and didn’t want to repeat its mistake this time around. But this mining boom will be different, according to Robinson.
He says that a large part of the increased tax revenues from miners will be used to bring the budget back to surplus and reduce public debt.
A significant part of the current increase in commodity revenues will be used to finance resources investment.
While the investment last time boosted the businesses of local suppliers of mining equipment, structural steel producers and fabricators, Robinson feels that a much higher proportion of construction and capital equipment for the forthcoming ‘mega’ projects will be imported.
Housing and tradeables sectors: Collateral damage of the mining boom?
According to Robinson’s report, the RBA believes there is not enough capacity to cater for both a mining boom and housing investment.
Robinson says that higher interest rates have a disproportionately greater impact on the tradeables sectors via a higher Australian dollar, lowering growth in output and employment in the manufacturing, education services as well as tourism sectors while helping the RBA achieve its goal of slower employment growth.
RBA intends to keep consumer inflation in a 2-3 per cent band over the medium term. As it has no control over a rampant mining boom, the RBA effectively acts to curtail other sectors to make room for mining, causing the housing and tradeables sectors to become the collateral damage of the mining boom.
BIS Shrapnel says it is not sensible to derail the housing recovery with a serious deficiency of dwelling stock.
Robinson says the demand-supply gap in the housing sector could potentially lead to major problems down the road including higher rental and housing inflation, which could push up the CPI, and the potential for overpriced real estate and boom-bust residential cycles.
RBA is worried about strong employment growth
The remarkable growth in the employment sector over the past year, bouncing back so quickly after the downturn is also cause for concern for the RBA.
Further strong employment will worry the RBA: Robinson says most economists believe an unemployment rate below five per cent leads to rising inflationary pressures.
The only way RBA can slow employment growth to be in line with civilian population and labour force growth is by raising rates to slow the economy.
Mining boom, high Australian dollar, stimulus wind-back and housing
BIS Shrapnel is forecasting employment growth to ease over the next two years from around 3.5 per cent to 2.5 per cent.
Primary drivers of economic growth and industry employment over the next two years include the mining boom, high Australian dollar, stimulus wind-back and housing.
- Mining investment will ramp up to boost:
- Sectors that supply materials, expertise and labour including construction
- Manufacturing sectors supplying construction materials, steel, chemicals and explosives
- Business services sectors providing leased equipment, consulting services and contract labour
- The high Australian dollar will impact non-commodity tradeables sectors such as tourism, manufacturing and education services, given the +10% appreciation since August of 2010
- Winding back government stimulus spending should lead to slower growth in public sector employment and also impact construction-related sectors such as schools
- Recovery in housing construction will boost those sectors supplying materials and labour, real estate and other related services such as legal and accounting, finance and downstream retailers of household goods
- A broader recovery in business investment from 2011/12 including private non-residential building is likely to widen and strengthen overall economic and employment growth
While BIS Shrapnel remains confident the housing sector and business investment will continue to add to the economy, their contributions remain under threat if the RBA raises interest rates too quickly.
Robinson concludes by saying that the November rise was a pre-emptive move and there may be a longer delay before the next interest hike with commercial banks effectively doing some of RBA’s future work.
Additionally, there is less urgency currently to raise rates as underlying inflation is expected to remain around 2.5 per cent over the rest of 2010/11, but is forecast to rise to three per cent over 2011/12.
BIS Shrapnel is Australia's leading provider of industry research, analysis and forecasting services.