Australia | Dec 22 2010
By Daniel Hwang, Senior Market Strategist, Forex.com
2010 – The Tale of Two Halves
2010 was a tale of two halves for the Australian economy. The first half of 2010 witnessed improving labor conditions, income strength, and firming growth prospects steady the RBA's hand to continue its cycle of monetary policy tightening. Q2, however, saw a reversal of sorts as a number of reactions came about from higher benchmark rates and emerging external factors.
Higher domestic interest rates in the face of relatively looser foreign monetary policies buoyed the Aussie on the back of widening interest rate differentials. Subsequently, the resultant higher domestic currency played a leading role in the tale of 2H ‘10 inflation moderation.
Externally, the PBoC stepped up their own tightening measures in attempts to curb heightened growth and inflation expectations out of China. The immediate and medium term impact on the Australian economy was expected to materialize as a setback in net exports from declining China commodity demand. Such setbacks, however, have been minor.
The RBA’s policy response to 2nd half inflation moderation and expected commodity demand declines has been a shift towards a looser monetary policy – 1H ’10 amassed four consecutive 25 basis point rate hikes in sharp contrast to only one in the second half.
We expect the economic tale of 2010 to repeat in 2011 but with one notable aberration – it’s likely to replay in reverse order.
2011 – Reverse Chronology
The RBA will almost certainly keep rates steady in the 1Q 2011 and is more than likely to stay the path for the majority of Q2. The principal determinants for future policy direction and a possible more expedient return to tightening will rely on the usual suspects – both foreign and domestic.
Each and every accompanying rate statement by Governor Glenn Stevens in 2010 made mention of US, China, or Euro-zone growth prospects – for good reason. Global growth prospects, specifically out of the aforementioned big three, have historically exhibited substantial influences on Australia’s export heavy economy and will continue to do so in 2011.
US growth prospects have made lengthy strides on the back of positive data surprises alongside accommodative policy implementations. ISM Manufacturing PMI figures look to have bottomed with the last three months witnessing an upwards trend. Furthermore, both the December Empire State Manufacturing and Philadelphia Fed Surveys printed significantly higher than expected at 10.57 vs. expected 5.00 and 24.3 vs. 15.3 respectively, evidencing a US economy that may be turning the corner. However, labor conditions have slackened as suggested by the uptick to 9.8% in the November US unemployment rate and the disappointing November payrolls prints. Considering much of the negative data surprises can be attributed to an increase in the labor force and an average margin of error of +/-100k for NFP, we would take both data surprises with a grain of salt. On the policy front, the recent tax cut extensions alongside growth-accommodative Fed policy have resulted in estimated revisions to US GDP of about +1%. Although not perfectly correlated, an improving US growth outlook bodes well for Australian GDP as both have generally moved in tandem in past years (see Figure 1).
China tightening is likely to remain a dominant influence to Australian growth and policy direction for 2011. Fears of aggressive tightening measures out of China gripped markets periodically sending risk appetites on a number of nosedives throughout 2010. However, recent developments out of China have made clear the likelihood for the current policy stance to remain unchanged. Inflation is expected to level out in 2011 and the Chinese government seems more so concerned of potential long term growth disruptions as a result of rapid tightening. Nevertheless, we expect the PBoC to continue their moderate tightening cycle but believe the ramifications on Chinese growth and subsequently Australian growth are likely to be minor.
In terms of the Euro-zone, concerns surrounding peripheral economies will remain a recurring theme in 2011. Potential EZ periphery impacts, however, are double sided – an implosion or contagion would lead to extensive deterioration for the global economy while containment would see growth prospects boosted considerably. We think it highly improbable for a major implosion leading to a breakup in the union, a story which has been making the rounds of late. ECB and possible concerted global policy responses to emergent situations are likely to suffice in the avoidance of adverse consequences of disastrous proportions.
2010 was a ‘Tale of Two Halves’. Events in 2011 may pen the same narrative for the Australian economy, albeit in reverse. Steady rates that characterized the RBA policy stance for 2H2010 are set to continue into 1H2011. Conversely, 2H2011 will probably see a resumption of 1H2010 monetary policy tightening. The return to tightening in 2H2011 will likely stem from resilient global growth alongside strengthening domestic conditions as employment, wages, consumer spending, and business investments continue their upside trajectories. Overall, the outlook for the Australian economy seems positive with growth in the land ‘down under’ likely to be the direct opposite – above trend.
The views expressed above are the author's, not FNArena's (see our disclaimer).