By Fidelity Worldwide Investments
The last time it happened was in August 2013, and that was the eighth time in a row it occurred. Since then, 15 opportunities have come and gone to do the same, or even, the opposite thing. The amount refers to the number of policy-setting meetings since the Reserve Bank of Australia cut the cash rate to record low of 2.5% all of 17 months ago, after reducing it in seven previous steps from a high of 4.75% in 2011.
Australia’s central bank obviously saw no reason to change its policy stance throughout 2014. For most of the year, especially over the first six months, our commodity-dependent economy was chugging along, the jobs market was healthy and inflation – at 2.3% in the 12 months to September – was contained within the Reserve Bank’s 2% to 3% band.
Towards the end of the year, though, Australia’s luck ebbed. The slowdown in China dashed the prices of our biggest commodity exports. The price of iron ore, which pulls in about one quarter of our foreign earnings, halved last year to under US$70 a tonne. The decline in commodity prices overall, which plunged on average 21% in 2014 (to be down 42% from their peak in June 2011), have sapped our economic growth of late.
When commodity prices drop, mining companies reduce investment plans, for the returns from planned projects are not as lucrative as they were when prices were higher. Miners prune their staff numbers to get costs down for it’s the low-cost producer that stays in business over the long term in the commodities game. Even some high-cost producers have collapsed. The overall hit to mining profits means fewer taxes are flowing to the federal government, which puts pressure on Canberra to reduce spending to help rebalance its budget. The glum news about commodities takes a toll on the confidence of consumers, whose spending drives economic growth – about 55% of output comes from such spending. It was no surprise that consumer sentiment, as measured by the Westpac-Melbourne Institute survey, fell to a more-than-three-year low in December.
A report released in December confirmed how much the drop in commodity prices is hampering the economy. It showed economic growth slowed to 0.5% in the September quarter on a trend basis, after only expanding 0.6% in the three months to June. That’s among the slowest Australia’s economy has grown since the collapse of Lehman Brothers in September 2008.
The National Accounts, as this economic report is known, did two things. The first was it fuelled talk that Australia faces tougher times ahead; that we could even experience a recession in coming years. It’s a long time since that’s happened as our economy has expanded since it recorded zero growth in the September quarter of 1991. Darker times ahead could boost unemployment, which is already at a 12-year high of 6.2%.
The other thing it did was reinforce views that the Reserve Bank will cut the cash rate to a fresh record low sometime in 2015 or maybe early in 2016. Some commentators expect that first rate cut to take place in March this year and that the central bank to lop the cash rate by 50 basis points over 2015. Others think the next rate cut is more likely to be at the start of 2016. Lower interest rates would help revive consumer spending and encourage more investment by businesses, especially those outside the mining sector. Lower rates would undermine the Australian dollar, which is still high by historic standards, and thus make our exports more competitive. The Australian dollar has averaged 97 US cents over the past three years, according to Bloomberg data, compared with 73 US cents over the two decades prior to that.
The economy is reliant on monetary policy for more stimulus because the federal government is intent on curbing its fiscal deficit in coming years. Canberra said in December that its budget deficit for 2014-15 is expected to be $40.4 billion or 2.5% of output and that it intends to reduce this shortfall to $31.2 billion by 2015-16 or 1.9% of output. Over the next year or two then, fiscal policy will prod the economy, but not by as much. The federal government is wisely not being overzealous in bringing the budget back into surplus for that would crunch the economy. Even the IMF has conceded that ill-timed fiscal consolidation can retard recoveries and create side effects such as worsening government budgets.
Reducing the cash rate is not a simple decision for the Reserve Bank policy board for there are three dangers in cutting rates. The first is that it could fuel Australia’s housing market, which some say is already frothy. Authorities, however, can mitigate this threat by tightening the rules by which banks can lend money for housing. Another problem is that it would leave less ammunition for policymakers if times get even tougher. After all, you can only cut rates to zero and they are not too far from that now. The third issue is that rate cuts can sometimes, perversely, make consumers and businesses more nervous.
Better economic readings on China and, consequent, rebounds in commodity prices would change this analysis. Then the Reserve Bank could extend the time it has left unchanged its key policy rate.
Financial information comes from Bloomberg unless stated otherwise.
 Reserve Bank of Australia’s index of commodity prices. http://www.rba.gov.au/statistics/frequency/commodity-prices.html. The index has tumbled from 124.7 in June 2011 to 73.4 in December 2014 in SDR terms.
 Westpac Banking media release. “Consumer sentiment plunges.” 10 December 2014. https://melbourneinstitute.com/downloads/media_release/2014/CSI/PressReleaseCSI20141210.pdf
 Australian Bureau of Statistics. The economy grew at a slower pace by this measure around the December quarter of 2012 and the March and June quarters of 2013. 5206.0 – Australian National Accounts: National Income, Expenditure and Product. September quarter 2014. 3 December 2014. Time series spreadsheets. Table 2. Expenditure on gross domestic product (GDP), chain volume measure. http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/5206.0Sep%202014?OpenDocument
 ABS. Op. cit.
 Australian government. “Mid-year economic and fiscal outlook 2014-15.” 15 December 2014. http://resources.news.com.au/files/2014/12/15/1227156/680477-aus-file-myefo-.pdf