Economic and Financial Outlook for Australia 2016

Policymakers and investors are cautiously optimistic about Australia’s economic prospects, although a deteriorating China outlook continues to pose challenges for the world’s twelfth-largest economy. Australia’s gross domestic product (GDP) – the value of all goods ands services produced in the economy – defied expectations in the latter half of 2015, growing at a seasonally adjusted 0.9% in the third quarter. In year-over-year terms, Australia’s GDP expanded 2.5% in the third quarter, double the rate of comparable economies such as Canada and higher than the OECD average.[1]

The China Wildcard

China’s economic rebalancing away from investment and exports toward consumption and services has direct consequences for Australia. China is not only Australia’s largest trading partner,[2] but a key player in the global commodity markets. Therefore, it’s difficult to divorce the two countries when examining Australia’s future. China’s economy grew 6.9% in 2015, the slowest rate of expansion in 25 years and just below Beijing’s official target of 7%.[3] What’s more, Chinese growth is forecast to slow significantly over the next two years, averaging 6.3% in 2016 and just 6% in 2017, according to the International Monetary Fund’s January World Economic Outlook report.[4]

“The outlook for China continues to be a key source of uncertainty” for the Australian economy, the Reserve Bank of Australia said in its quarterly economic snapshot in February.

“The recent bout of global financial market volatility has been characterised in part by concerns about the evolving balance of risks in China and the ability of Chinese authorities to manage a challenging economic transition,” the Bank added.[5]

China has been at the centre of growing financial instability since last summer. Stock market volatility came to a head in the first week of 2016 after a massive selloff triggered China’s circuit breaker on two separate occasions, which forced an early shutdown of trading activity.[6] This not only sparked global financial chaos, but undid months of regulatory efforts to stabilize the country’s financial markets. Australia’s stock markets took a beating as a result, with the S&P/ASX 200 plunging 8.6% in the first three weeks of the month.

Commodity Prices

Australia’s resource-driven economy has been hit particularly hard by plunging commodity prices over the past two years. Iron ore, which represents about 20% of Australia’s national export income, has been in freefall for several years. The steelmaking raw material plumbed seven-year lows in 2015, falling below $40 a tonne in December on weaker Chinese demand.[7]

Australia’s mining boom unofficially came to an end in 2015, although the value of engineering construction began to waver as early as the first quarter of 2015.[8]

The RBA is banking on a pick up in non-mining business investment over the next two years after it remained subdued for much of 2015. Stronger domestic demand, record-low interest rates and a lower Australian dollar are expected to keep the economy buoyant over the long-term. The RBA holds that GDP growth will average between 2% and 3% in 2016. CPI inflation is also expected to rise between 2% and 3% before rising at a faster rate in each of the next two years.[9]

However, the RBA warned that this outlook does not factor in any unexpected fallout from China, which could “adversely affect commodity prices including those that are important to Australia.”[10]

Unlike other export-driven nations that rely on energy commodities, Australia’s economy has received a boost from falling oil prices. That’s because the country is a net importer on oil, which makes a fall in prices a positive development for Canberra’s terms of trade and purchasing power.[11]

Interest Rate Outlook

The RBA cut interest rates twice in 2015 and could be compelled to cut them another two times this year, according to a forecast from multinational investment bank Goldman Sachs.

“The combination of preemptive independent interest rate hikes by the banking system and the emergence of a new and significant threat to Australia’s economic growth comes at a particularly uncomfortable time in Australia’s economic cycle,” Goldman analysts said in a report last October.[12]

Goldman isn’t the only organization pricing in a rate cut. According to a head researcher with TD Securities in Singapore, traders are pricing in a “better than 80% chance the RBA will cut rates in the next six months.”[13] While policymakers appear comfortable in the domestic recovery, concerns about a spillover from China continue to drive rate-cut speculation.

Australia’s cash rate has been cut repeatedly by the RBA since November 2011. In the four years prior to November 2011, interest rates averaged 4.93%. In the four years since November 2011, the cash rate has averaged 2.8%.[14]

Q1 Economic Calendar

Below is a quick rundown of important economic events for Australia through March 31, 2016.

Feb. 15: RBA Meeting Minutes

Feb. 18: Employment Report (Jan)

Mar. 1: RBA Interest Rate Decision and Rate Statement

Mar. 2: Gross Domestic Product (Q4)

Mar. 3: Terms of Trade (Jan)

Mar. 17: RBA Bulletin

[1] Jamie Smyth and Jennifer Thompson (December 2, 2015). “Australia’s GDP rises more than expected.” Financial Times.

[2] China-Australia Relations. Lowy Institute for International Policy.

[3] Mark Magnier (January 19, 2016). “China’s Economic Growth in 2015 Is Slowest in 25 Years.” The Wall Street Journal.

[4] International Monetary Fund (January 2016). Subdued Demand, Diminished Prospects. World Economic Outlook.

[5] Peter Ryan (February 4, 2016). “RBA cautiously upbeat on Australian economy given positive economic indicators.” ABC News Australia.

[6] Sam, The Trading God (January 7, 2016). “US Stock Rout Intensifies amid Deepening China Crisis.”

[7] Emiko Terazono (December 4, 2015). “Iron ore price falls below $40 a tonne.” Financial Times.

[8] Greg Jericho (July 6, 2015). “The one graph that explains the (worrying) end of the mining boom.” The Guardian.

[9] Reserve Bank of Australia (February 2016). Statement on Monetary Policy February 2016.

[10] Reserve Bank of Australia (February 2016). Statement on Monetary Policy February 2016.

[11] Reserve Bank of Australia (February 2016). Statement on Monetary Policy February 2015.

[12] David Scutt (October 15, 2016). “GOLDMAN: 2 reasons the RBA will continue to cut rates.” Business Insider Australia.

[13] Michael Heath (February 4, 2016). “Reserve Bank of Australia Sees Faster Growth, Scope for Easier Policy.” Bloomberg.

[14] Greg Jericho (January 25, 2016). “Cutting interest rates will only help cities that need it least. That’s the RBA’s dilemma.” The Guardian.

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