Market calls: another 12 months on hold

Last week, the recent fall in Australia’s commodity export prices led ANZ Research to downwardly revise its economic forecasts over the next few years. 

ANZ now expects lower iron ore, coal and energy prices to reduce growth in Australia’s national income by approximately 1 percentage point in 2015. This will affect profits, wages and government revenues as well as hurt real economic growth. 

ANZ has lowered its real gross domestic forecasts by 0.3 percentage points over 2015 and 2016. It will also delay the return to trend growth of around 3 to 3 and a quarter per cent by another six months. A return to trend growth is now expected in the second half of 2016. 

With global inflation low and domestic wages pressures absent, this weaker growth outlook will provide the RBA with more scope to keep monetary policy accommodative. 

As such, ANZ has pushed back the timing of any RBA interest rate increases by six months. The first steps to take Australian interest rates back to ‘neutral’ levels are expected in November and December 2015 with a 25 basis point rate hike in each month. 

As the recovery gains further traction in 2016, another 50 basis points of rate increases in the middle of that year will see the cash rate lift to 3.5 per cent, ANZ’s estimate of the neutral rate. 

If as ANZ expects commodity prices stabilise near current levels over the next year then these revisions represent a delay in the return to trend growth rather than a change in the trajectory of the Australian economy. 

ANZ still believes non-mining economic activity will take up the slack from declining mining and energy investment. The non-mining recovery has commenced with strength evident in residential and non-residential construction and a gradual improvement in business investment. 

A weaker path for commodity prices, corporate profitability and wages is also weighing on Australia’s fiscal stance.

When the 2014-15 Mid-year Economic and Fiscal Outlook (MYEFO) is released in mid–December it is likely to show a deterioration in the underlying cash balance over the forecast horizon. 

The underlying cash balance will be larger than the $29.8 billion deficit forecast when the 2014-15 budget was published in May. Subsequent years are also likely to show the budget worsening. 

On the currency front, the Australian dollar had another choppy week. Thin liquidity meant market dynamics dominated and key technical levels were broken in the $A/$US and other crosses. As such the local dollar tested a fresh four-year low. 

The weakness occurred despite a slightly better tone to domestic data and despite a relatively quiet week for the US dollar. This independent weakness could be partially explained by the decline in the iron ore price but this link is relatively loose over short time periods. 

What the weakness highlights is that the Australian dollar remains overvalued and the distribution of risks remains to the downside. 

ANZ maintains its $US0.82 forecast for 2015. Either a rate hike from the US Federal Reserve, or a further step down in key commodity prices, would be a more compelling trigger to downgrade forecasts further.