Reserve Bank bets on economic recovery

Link to article

In its May meeting, the RBA left the cash rate on hold at 1.5%. The RBA revised growth upwards to a range of 2.75% - 3.75% by early 2018. It cited a bright global economic outlook as a major driver for higher commodity prices which eases the drag from the slowdown in mining investment. Underlying inflation has also increased to 1.75% and is expected to increase further to 2% in 2018. However, sluggish wage growth and uncertainty about Chinese growth pose threats to Australia’s outlook.

How does this relate to the HSC syllabus?

  • The pessimistic outlook on Australia’s economic growth was mostly driven by the reduction in mining investment. Since AD = C + I + G + (X – M), the reduction in mining investment caused a decrease in aggregate demand, resulting in a decrease in growth (HSC Topic 3 – Economic Issues). This decrease in investment also led to ‘spill over’ effects throughout the economy because of the multiplier effect (HSC Topic 3 – Economic Issues). However, as the global economic outlook has become more positive, demand for commodities in these economies has increased, causing an increase in commodity prices (Preliminary Topic 3 – Markets). As such, Australian miners will be receiving more revenue per unit of commodity, leading to an increase in export revenue.
    • Given the increased revenue generated by the mining sector, mining states such as WA and QLD are experiencing higher growth.
  • Underlying or core inflation is expected to increase to about 2% in 2018, with in the RBA’s target range which indicates towards price stability in the Australian economy (HSC Topic 3 – Economic Issues). However, a major risk to inflation is wage growth which is expected to remain sluggish. Wage growth was previously higher as a result of the structural adjustment from mining to other sectors of the economy. Since labour had to be retrained to cater for the shift from mining to services, there was a shortage in labour i.e. less supply of labour, causing an increase in wages (Preliminary Topic 4 – Labour Market; HSC Topic 3 – Economic Issues). As the transition progresses and individuals retrain themselves, labour supply with skills suited to the services sector increases, cause wage pressures to decrease. Moreover, given the low productivity of the Australian market, wages experience further downward pressure. Given that labour is a significant factor in determining the prices of goods and services, low wage growth leads to low growth in prices, causing a slow-down in inflation.
  • The RBA remains cautious over consumer spending as a result of low wage growth and high household debt levels. Low wage growth means that consumers have less disposable income, causing a reduction in consumption in absolute terms (HSC Topic 3 – Economic Issues). Moreover, higher household debt levels can prove a significant issue for consumption. Larger amounts of income will be spent on interest repayments, reducing disposable income. Importantly, increased borrowing has been a product of the low interest rate environment which has made it more attractive to borrow. As interest rates begin to lift, consumers would likely reduce their spending as their interest burden increases. Given that consumption makes up around 60% of aggregate demand in Australia, this reduction in consumption would cause a sharp decrease in economic growth (HSC Topic 3 – Economic Issues).
  • The uncertainty concerning China’s growth is also a significant threat to Australia’s economic growth. Although Chinese economic growth has been better than expected, regulators may need to tighten monetary and fiscal policy to dampen speculative activity and financial risks emerging in China. A reduction of growth in China would have a negative impact upon Australia’s economic growth as a reduction in demand from China for Australia’s exports would cause a reduction in aggregate demand in Australia. This effect is likely to be significant as China is Australia’s largest trading partner.

Oil recovers after Saudia Arabia says Russia will agree with supply cuts

Link to article

Oil prices increased by 1.5% on Friday on the back of positive US job data and statements by Saudi Arabia’s OPEC governor that an agreement to extent the deal to cap oil output.

How does this relate to the HSC syllabus?

  • One of the factors causing an increase in the oil price was positive US jobs data, with the unemployment rate falling to 4.4% (near a 10 year low). Since the US is one of the largest oil consumers in the world, an improvement in the labour market implies an increase in demand for oil as consumers have more disposable income (Preliminary Topic 3 – Markets).
  • Statements about nearing an extension to the production cap caused an increase in oil prices form the supply side. Earlier in the year, a major driver for low oil prices was oversupply in the market as producers tried to capture more market share (Preliminary Topic 3 – Markets). The deal between OPEC and non-OPEC countries seeks to put a cap on how many barrels of oil these countries can producer, effectively causing a reduction in supply of oil. The reduction in supply, coupled with the increase in demand for oil, will effectively increase the price of oil.
  • Note: Despite the increase in prices on Friday, oil prices fell throughout the week, reflecting market sentiment that OPEC’s current production cuts have been ineffective and a deeper cut is required in the extension. However, OPEC sources say that while OPEC is likely to extend cuts, deeper cuts are unlikely.

Australian dollar taken to the cleaners

Link to article

The Australian dollar fell to its lowest levels since January after banking and major mining shares fell. Copper and iron ore futures fell by 3.5% and 6.5% respectively. The fall was also driven by hawkish US central bank statements which saw markets pricing in a 93% chance of a rate hike in its cash rate next month.

How does this relate to the HSC syllabus?

  • Weakness in commodity prices during the week has been a major driver in the depreciation of the Australian dollar. Given that mining makes up a large proportion of Australia’s exports, a reduction in commodity prices reduces investor confidence in the Australian economy, causing them to sell the Australian dollar as it is perceived as a less profitable investment. The decreased demand for the Australian dollar causes it to depreciate (HSC Topic 2 – Australia in the Global Economy).
  • Tightened monetary policy stance in the US has been a cause of the Australian dollar’s depreciation. Since Australia’s monetary policy outlook seems stable while the US is taking a tightening stance, investors have been selling Australian dollars to buy more US dollars, causing the US dollar to appreciate and the Australian dollar to depreciate (HSC Topic 2 – Australia in the Global Economy).

Theresa Dang THERESA DANG

Theresa Dang is an economics mentor at Keystone Education. She attended Sydney Girls High and achieved an ATAR of 99.70 in 2012. She is now studying Commerce and Law at the University of Sydney. She has experience in a global technology firm, a mutual fund and a bulge bracket investment bank.

Comment