Sunday, November 25, 2012

The RBA will lower rates to blunt the impact of slower mining investment

Australian mining investment growth has been tremendous in the past couple of years, with current financial year inflow of some 7% of the GDP. Companies like Fortescue have tapped the hot US junk bond market to pump cash into mining operations. At the same time non-mining investment has been declining, making Australia's economy more vulnerable to a downturn in demand for raw materials.

Source: Merrill Lynch

But the party is about to end. In spite of China's recent mild economic rebound (see discussion), infrastructure spending is not going to generate the demand for iron ore and coal that it used to. Mining firms need to shift their focus. What makes it particularly painful for Australian mines however is their high costs relative to the competition. Mining labor costs have grown at over 4% per year since 2009. And as other nations with large mining sectors have seen their currencies devalued, the Australian dollar has remained relatively strong - making Australian product more expensive.

Source: Merrill Lynch

With investment in Australia's mining sector slowing, the nation will need to transition to other sources of growth. To help with the transition, the RBA is likely to lower rates again in December.
Merrill Lynch (Australia): - ... in our view the case for further easing isn't substantially data dependent. Rather, it is based on the need to nurture alternative sources of economic growth as the mining investment boom approaches its peak, and a recognition that – in the face of the substantial ‘headwinds’ confronting those alternative sources of growth (such as the persistent strength of the A$, depressed business confidence, and ongoing fiscal consolidation) – further support from monetary policy is likely to be needed in order to ensure that this ‘baton change’ in the drivers of growth happens smoothly.


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