- Australia’s key commodity prices could tumble in first half of the year if the signals from Chinese M1 monetary growth are any guide.
- Weaker commodity prices, should such a scenario eventuate, will weigh on Australia’s terms of trade, nominal GDP growth and budget revenues.
- Along with other downside risks, ANZ Bank says this will likely ensure the RBA will strike a more cautious tone on the outlook for the Australian economy ahead.
If the chart below from ANZ Bank is any indication, the risks for Australia’s key commodity prices, and hence terms of trade, nominal GDP growth and budget revenues in the first half of the year, are firmly to the downside.
It shows the relationship between M1 money growth in China overlaid against the Reserve Bank of Australia’s (RBA) commodity price index priced in US dollar terms. M1 growth, that of physical currency and other monetary assets that can be quickly converted into cash, has been advanced by six months by ANZ to show the relationship between the two.
Over the past year, growth in Chinese M1 money supply eased to the second-lowest level on record, surpassing the lows seen in 2015 and 2016, another period when concerns about the trajectory for the Chinese economy were acute.
Should the relationship between it and Australia’s key commodity prices hold true, it points to big downside risks, perhaps as much as 40%, for Australia’s key commodity prices ahead.
But will a steep fall in commodity prices, as suggested by the sharp deceleration in Chinese M1 growth, actually occur on this occasion?
ANZ is sceptical at this point.
“Is this time different? Possibly,” the bank says.
“Iron ore prices have held up surprisingly well over recent months, helped by China’s supply-side reform measures that favour higher grade ore, as well as stimulus measures favouring construction. This strength in demand coincides with low supply growth.
“Our forecasts already incorporate some fall in commodity prices, but nothing like the roughly 40% decline suggested by the current growth in China’s money supply.”
However, ANZ warns that any steeper decline in commodity prices will have “important implications for the economic outlook,” something the bank says will likely ensure the RBA will strike a more cautious tone on the outlook for the Australian economy in upcoming policy statements and speeches.
“Alongside the downside risks to commodity prices, uncertainty about the global economic outlook and the trajectory of the domestic economy in the face of house price falls will almost certainly see a change from the RBA’s upbeat tone of last November,” ANZ says.
“Its forecasts are set to be downgraded, and the extent of those downgrades will have policy implications.
“On balance, we think the Bank will retain an expectation that growth will be at or a bit firmer than trend over the next few years, which would imply modest downward pressure on the unemployment rate and a very gradual lift in inflation.”
The RBA will announce it’s first monetary policy decision for 2019 on Tuesday, February 5. That will be followed a day later by a speech from RBA Governor Philip Lowe to the National Press Club in Sydney. The RBA deluge will conclude on Friday, February 8 with the release of the bank’s quarterly Statement on Monetary Policy, including updated economic forecasts for GDP growth, unemployment and inflation.
As things currently stand, financial markets are now pricing in the prospect of a 25 basis point rate cut from the RBA by the end of this year at around 60%.
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