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    Strong Australian economy casts doubt over further RBA easing

    Australia’s economy continued to power ahead in the first quarter of the year as GDP expanded by 1.1% over the quarter – the highest in four years. The figure beat expectations of 0.8% quarter-on-quarter growth and is up from 0.7% in the previous quarter, which itself was revised up from an earlier estimate of 0.6%. On a year-on-year basis, growth stood 3.1% higher than the first quarter in 2015.

    The main drivers of growth in the first three months of 2016 were exports and household consumption. Exports contributed 1% to the quarterly growth figure, while consumption added 0.4%. The strong exports performance comes amid a sustained healthy demand from Australia’s biggest trading partner, China, despite the ongoing economic slowdown there. An unexpected rebound in iron ore prices since January has also helped boost revenue for Australia’s large mining sector.

    Other indicators in recent weeks have also been pointing to robust demand in the economy. Building approvals rose sharply in April, underpinned by strong demand for residential apartments. Employment has been growing steadily since 2015 (although it has slowed in recent months) and retail sales continue to expand at a solid rate.

    However, the rosy economic picture hasn’t deterred the country’s central bank, the Reserve Bank of Australia, from loosening monetary policy. The RBA remains concerned about the very low inflation rate, which, at 1.3% in Q1, is higher than in other advanced economies but below the Bank’s 2-3% target band. This prompted the RBA to cut its cash rate by 0.25% to 1.75% in May, the first cut in 12 months. The move surprised the markets and analysts expect at least one more cut later this year.

    The RBA is also worried about the currency appreciating too much. The Australian dollar rallied by almost 15% against the US dollar between January and April, threatening to derail the central bank’s attempts to rebalance the economy away from mining exports. It has since eased from above 0.78 to around 0.72 currently against the greenback.

    Today’s strong GDP figures would make it more difficult for the RBA to justify another rate cut, especially as ultra-low rates could further inflate an overheating housing market. However, recently introduced measures to better regulate mortgage lending may support the case for more rate cuts if inflation continues to undershoot the target band.

    Also worrying for the outlook ahead is a fall in business spending. Capital expenditure declined by 5.2% in the first quarter, deducting 1.7% from GDP growth. Lower investment is regarded as having a negative impact on future growth.

    Another uncertainty is whether the recent rebound in commodity prices will hold and whether China’s economy will be able to avoid a deeper slowdown. These factors may yet give the RBA further ammunition to cut rates.

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