The quarterly Statement on Monetary Policy (SMoP) released by the Reserve Bank last Friday gave more explanation of why it decided to cut the cash rate to 2.25%, and also examined the falling iron ore and oil prices. In doing so it noted that while the impact on economic growth of such falls was mixed, the impact on the budget from falling commodity prices was overwhelmingly negative.
The big-picture numbers in the February SMoP are not good. For most of 2013, the RBA was predicting Australia’s economy this year would grow by between 2.5% and 3.5%. Such a growth (with the mid-point of 3%) is largely on trend as the average annual growth for the past 25 years is 3.1%.
But in 2014 as the economy here and abroad weakened more than expected, the RBA began predicting growth of between 2% and 3%.
Reserve Bank cuts rates to 2.25% as economic outlook worsens
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This time round they have revised it down further to between 1.75% and 2.75%.
The main reason given for the gloomier prediction was “that consumption will continue to grow at a below-average pace for a time and non-mining investment will remain subdued until at least mid 2015”.
This in itself is enough reason for the RBA to have cut rates last week. It would be inconceivable for them to downgrade growth to well below trend levels while also suggesting that interest rates did not need to be cut.
Interestingly the RBA downgraded the economic growth for 2015 despite also assuming a “lower level of interest rates” than was assumed in its November SMoP.
This by itself would be excepted to see economic growth improve. But it is tempered by the fact that the RBA also predicts “somewhat lower growth of labour incomes than had been expected”.
It suggests this will occur because the employment situation remains weak, such that they believe the unemployment rate will “likely to rise a bit further and peak a bit later than earlier expected”. The bank also suggests that unions and businesses now expect wages growth to be weaker due to lower inflationary expectations.
Union officials expect inflation over the next two years to be less than 2% annual growth. This would suggest the wages price index – and thus labour incomes – will stay at levels well below average.
Each SMoP as well as containing the standard snapshots of the international and domestic economies provides a bit of an insight into the areas the RBA thinks are most crucial. For example last November the SMoP contained extra sections looking at the housing market.
This time, the focus was on falling commodity prices.
The impact of oil prices is perhaps most clearly demonstrated in the changing assumptions made by the RBA in determining its growth forecasts.
Throughout 2013 and 2014, the RBA assumed oil prices around US$103 to $104 a barrel. In November’s SMoP, the RBA dropped its assumption by 19% to US$86/barrel.
The bank has also dropped its expectations for the value of the Australian dollar. In November it was assuming the dollar to be worth US$0.86, now it assumes a price of US$0.78.
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The RBA suggests the falling oil prices have boosted consumers’ disposable income. In the last six months of 2014, the RBA estimated the drop in petrol prices alone increased real household disposable income by 0.25%, and that it will boost it by another 0.5% in the first three months of this year.
So this is good news, but the bank suggests the impact on the budget will be minimal. There will be little change to petrol excise revenue. And while there will be companies whose profits (and thus tax) will be higher due to paying less for oil, this will be offset somewhat by the lower revenue from companies who produce oil and LNG (the price of LNG is linked to oil).
It also notes that as production of LNG ramps up over the coming years, rises and falls in the oil prices will begin to have a greater impact upon both the economy and the budget.
The impact of the falling iron ore prices on the budget, however, is expected to be much more of a concern.
The RBA notes that in the past year the spot price for iron ore has fallen by 50%.
Fortunately the falling value of the Australian dollar has lessened the fall in Australian dollar terms.
Since November 2013 the price of iron ore has fallen by 55%, but because the value of our dollar has fallen as well in that time by 14%, the decline of iron ore prices in Australian dollars terms is just 47%.
That is still a horrendous fall, but at least the falling dollar also “offsets some of the economic effects” by “stimulating demand” in other industries such as manufacturing, tourism and education.
The RBA also suggests that while falling iron ore prices would usually lead to falling household income and in-turn household expenditure, because of the “high level of foreign ownership of iron ore companies” this impact is less than would be expected.
But the hit on the budget of various governments is severe.
In December, the Australian government revised down its estimates of the iron prices in it mid-year economic and fiscal outlook. It suggested an average price of $60 per tonne (minus freight).
Treasury at the time estimated that “a US$10/tonne reduction in the forecast iron ore spot price” resulted in a “decline in tax receipts of $0.8bn in 2014-15 and $2.8bn in 2015-16”.
So it would cause Joe Hockey (and any other person who may at this point wish to be treasurer) conniptions that some analysts now tip iron ore prices to fall below $US40 a tonne.
Rather nicely and subtly, the RBA in noting the declining iron ore prices pauses to give a bit of a slap to state and federal governments over the past decade.
It concluded that “during the mining boom, governments responded to the increase in the tax base by lowering the average tax rate for households, and increasing expenditure and transfer payments” – ie it cut taxes and increased family payments.
But the RBA notes: “As the iron ore price has fallen from its peak, governments have chosen to offset lower tax and royalty receipts partly through fiscal restraint on current expenditures, such as transfer payments to households, and partly by increasing borrowing over the next few years.”
The suggestion that governments may have been too hasty to both cut taxes and also increase payments when the goings were good is left unsaid, but is certainly implied.
With Hockey last week leaking to the Australian Financial Review that the budget surplus will be pushed back in the wake of further write-downs in revenue, and the political difficulty he has had with cutting family payments, he may well be one who rather ruefully thinks that the RBA is on the money.
Source: The Guardian
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