Boom, here comes a rebalance

The mining investment boom is a big part of the Australian story and will continue to be for some time yet. However, as this sector grows and represents an ever larger share of the economy, other areas have to make way. Such is the nature of structural change.

The key catalysts for this change were the 2009-10 Australian dollar appreciation and above-neutral Reserve Bank rates through most of last year. The high Australian dollar has slowed trade-exposed industries.

In particular, tourism has been weak and manufacturers have been under pressure. The retail industry has also weakened, as Australians are spending more online and travelling abroad more than ever before.

Mining companies have also imported more capital goods for their capacity expansions and fewer students are coming to Australia.

Indeed, the strong AUD has had more impact than anticipated, pushing down inflation and driving demand leakage through imports.

This has led to uneven growth in the Australian economy. Mining has been very strong, while growth has been weak elsewhere.

However, some rebalancing should now be expected, and there are tentative signs that it may be under way.

Housing approvals are stabilising, retail is rising and manufacturing jobs appear to have levelled out. Meanwhile, the Australian dollar has stopped appreciating, trading in a fairly steady range for about 18 months.

The AUD appreciation was a key factor in pushing down inflation. It was also a major agent of change, helping Australia swallow the largest mining investment boom in its history without rising inflation.

To do this, trade-exposed sectors slowed down to make way for mining investment, and there has also been substantial demand leakage via imports.

But this effect does not go on forever. There are already some early signs that the effect of the dollar’s appreciation may be wearing off.

In particular, international departures by local residents have levelled out, after ramping up. There are also early signs that employment in the manufacturing industry may have bottomed.

In addition to the impact of a more stable dollar, lower rates and some redistribution in the budget should help support some rebalancing of growth. Effective mortgage rates are now below average levels, as a result of recent RBA rate cuts.

The recent budget also announced measures that should provide some support for the retail industry. While the overall budget is expected to be tight, the new spending introduced was largely aimed at lower income households, which have a higher propensity to spend additional earnings.

There are also already signs of improving conditions in a number of the sectors of the economy that have been the weakest recently, including retail and housing construction.

At the same time, the pipeline of mining investment is still expected to be a major contributor to growth.

The stable, in fact recently depreciating, dollar, also has another effect on the economy. It will mean a greater risk that inflation increases from here. After all, the bulk of the lower inflation story so far has been due to the appreciation of the exchange rate and the downward pressure it has put on tradable goods inflation. The locally produced, non-tradable inflation has been running at a rate that is above the RBA’s comfort zone.

Much as the appreciation of the exchange rate has been a key agent of change in the structure of the economy, so too has it been the major contributor to downwards pressure on inflation. This, too, will probably end soon.

Overall, after uneven growth in the Australian economy recently, we expect some rebalancing in the second half of this year.

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