I saw a recent survey that said 83% of economists now think that the next interest rate move is likely to be up. That’s almost a dead-ringer for it going the other way.
Here’s what I think…
But first, before we get to that… Let’s look at two big issues that are giving the RBA headaches.
Let’s start with a chart that shows just how much the game has changed in Australia over the past 20 years.
This is the share of export trade going to our three biggest trading partners – the US, Japan and China.
It’s a stark reminder of just how important China has become. The share of exports to Japan and the US have been in steady decline over the past twenty years. China on the other hand has gone bang.
China’s share has gone from less than 5 percent at the turn of the millennium, to just shy of 35 percent this year. Over one third of our exports are now going to China!
This is an incredibly rapid ascendancy into an amazingly dominant position. We have become hugely reliant on the fortunes of China, and just how much of our stuff they can buy.
To a large degree this is a resources story. If you look at the breakdown of Aussie exports, there’s been a similar surge in the resources share of exports, again kicking off around the turn of the millennium.
But while resources have dominated the China story, we’re also exporting rural (=food) and services to Chinese buyers.
And this is why everyone is watching China so closely these days. China does have a big impact on how things are flowing here.
What’s interesting about the explosion in exports to China is that it’s come at a time when the Aussie dollar has remained persistently and stubbornly high. And it’s remained a thorn in the side of policy makers – especially poor ol Glenn at the RBA.
Because the high dollar – and pretty much everyone agrees it’s too high – is real headache for those Aussie businesses that have to compete with companies overseas.
When the Aussie dollar is strong, it’s not just the price of our exports goes up and foreigners don’t want to buy as much. It’s also that the price of competing imports goes down.
So if you’re an Aussie manufacturer – making cars for example – a higher AUD makes your overseas competitors’ cars cheaper.
And so you’ve either got to cut your price as well (decreasing profitability) or find ways to cut costs, or both.
But the AUD’s been high for a long time now. The low-hanging fruit of efficiency gains have been picked. And so it’s tough times for Aussie companies.
This chart here sums it up.
It compares inflation (the annual change in prices) of tradeable and non-tradeable goods and services in Australia. Tradeable goods are those goods where an import from overseas would do just as well – like cars. Non-tradeables are those things were you can’t import them from overseas – like haircuts.
What it shows is that inflation in non-tradeables has been pretty consistent – hovering around 4 percent over the past three years.
Prices of tradeable goods and services however have been falling since the beginning of 2012. Inflation has been negative from that time on, and is only now just starting to push back towards positive territory.
It’s likely that the high AUD has a lot to do with this.
But what that means is that if you’re a company producing tradeable goods and services, then you’ve had to cope with a climate of falling prices. You’ve either had to cut your own prices as well, or risk being priced out of the market.
This, of course, would eat into your profit margins and make for very lean times.
And so the high AUD is making for tougher economic times. If it’s hurting company profits, then it’s also taking a swipe at employment, which in turn means consumer confidence and retail sales.
And so everyone would like to see the dollar move lower.
But it won’t.
It’s currently stuck in a band a few cents either side of US 95c, and has been for months. And the fortunes of the dollar are largely being dictated by what’s going on overseas, and there’s very little anyone here at home can do about it.
And for the time being, the headwinds coming off the high AUD are keeping downward pressure on rates. If the AUD is slowing us down, then interest rates need to be speeding things up.
(We could be asking fiscal policy to chip in here as well, but the Abbott government went to the election with a cost-cutting agenda, so they’re on the side-lines for now.)
Glenn Stevens would like to avoid cutting rates if he can. With official rates already down to 2.5 percent, and a lot of nations already pushed to the zero-bound, he’ll be doing everything he can to avoid a similar fate.
Once rates go to zero, your options really narrow down. And you end up with crazy experiments like Quantitative Easing.
And so it would be a dream come true if the AUD fell another 10 to 15 percent. It would make Glenn’s job a whole lot easier. And it would be a big shot in the arm for the Aussie economy.
But the AUD just won’t move.
Glenn’s even got into the ‘jawboning’ game. At the beginning of the month he threw up his hands and took the unprecedented step of trying to talk the Aussie down.
He said: “these levels of the exchange rate are not supported by Australia’s relative levels of costs and productivity. Moreover, the terms of trade are likely to fall, not rise, from here. So it seems quite likely that at some point in the future the Australian dollar will be materially lower.”
It might not sound like such tough-talking to us, but for central bankers and markets, these were fighting words.
And it worked… for a bit. Glenn’s statement knocked more than a cent of the Aussie dollar that day.
But the effect was only temporary, and was unwound when another central banker – this time in Europe – said that Europe could be on the way to quantitative easing too, and the AUD jumped again.
And the net effect is that this month, the AUD has held fairly steady.
Stevens is right. In theory the dollar should be lower. And everyone would like it to be lower. But it doesn’t matter. It’s what happening overseas – particularly in the US that’s driving the dollar’s fortunes.
And this means, that for the time being, the RBA’s easing bias remains in effect.