1. Aussie Dollar
RBA in April: “The Australian dollar has appreciated somewhat recently. In part, this reflects some increase in commodity prices, but monetary developments elsewhere in the world have also played a role. Under present circumstances, an appreciating exchange rate could complicate the adjustment underway in the economy.”
The RBA added a whole new paragraph on the Aussie dollar to heighten their concerns over the current exchange rate. The newfound strength in the Aussie is clearly starting to weigh on economic statistics. Since the last RBA meeting, the Aussie dollar has strengthened roughly 6.5% against the USD, 5.7% against the CNY, and 4% in the trade-weighted index. Given the RBA’s assessments of the causes behind the rally in AUD (commodities and other central banks' monetary policy settings), they seem disinclined to cut rates purely on this basis and are likely to wait for these temporary factors to dissipate and let the Aussie drop back to a sub-US$0.70 level on its own. However, some in the markets were clearly expecting a stronger jawbone or even a rate cut, and the Aussie rallied 0.8% on the release.
2. Commodity Prices
RBA in April: “Commodity prices have generally increased a little recently, but this follows very substantial declines over the past couple of years. Australia's terms of trade remain much lower than they had been in recent years.”
The iron ore price rise may be partly responsible for the rise in the Aussie dollar. But the iron ore spot price has pulled back substantially since jumping to US$63.74 on 7 March. A weaker US dollar alongside Chinese stimulus looks to have helped commodity prices, but both of these tailwinds look likely to fade in the second half of the year. The RBA are likely to let the Aussie dollar follow commodity prices downwards at its own pace.
RBA in April: “Inflation is quite low. Recent information has confirmed that growth in labour costs remains quite subdued. Given this, and with inflation also restrained elsewhere in the world, inflation in Australia is likely to remain low over the next year or two.”
I have argued before that the TD-MI monthly inflation gauge looks a little more sensitive to tradables inflation than the quarterly CPI. The pullback we’ve seen in the TD-MI gauge in February and March is likely driven by the Aussie dollar strength impacting tradables inflation. CPI is still likely to increase to 1.8-1.9% YoY growth in 1Q. But if the Aussie dollar strength continues through 2Q, CPI will weaken, providing a case for a potential cut in 2H.
4. External Demand
RBA in April: “Recent information suggests that the global economy is continuing to grow, though at a slightly lower pace than earlier expected. While several advanced economies have recorded improved growth over the past year, conditions have become more difficult for a number of emerging market economies. China's growth rate has continued to moderate.”
Australia’s trade balance blew out again to A$3.41 billion in February, and net exports look likely to be a drag on 1Q GDP if a similar figure is seen in March. The strength in the Aussie dollar in February and March, alongside a weak external environment, is primarily responsible for the collapse in exports.
RBA in April: “Low interest rates are supporting demand, while supervisory measures are working to emphasise prudent lending standards and so to contain risks in the housing market. Credit growth to households continues at a moderate pace, albeit with a changed composition between investors and owner-occupiers. The pace of growth in dwelling prices has moderated in Melbourne and Sydney and has remained mostly subdued in other cities.”
Housing approvals look to have peaked in 2015 and are steadily trending down. This is set to weigh on growth, particularly in the second half of 2016, and may eventually warrant a rate cut in 2H if new homebuilding really begins to drop off a cliff.