Australian GDP growth was relatively flat throughout the 2nd quarter of 2015 as global commodity prices remained severely depressed. The GDP result was well below expectations, indicating growth of 0.2% q/q in the wider economy. This represents the weakest period of growth since early 2013, and data from the third quarter is likely to follow suit, when released in December. The GDP result is likely to fall in line with the declining domestic mining investment which is clearly apparent within the economy.
Despite the softening economic growth, the labour market actually improved with the unemployment rate falling from 6.3% to 6.2% in August. July also saw the labour force participation rate increase from 64.8% to 65.1% before declining back to 65.0% in August. However, retail sales failed to follow the firming labour market and actually contracted -0.1% m/m in July whilst rising 0.4% in August.
The PMI reports also highlight the disparity between the manufacturing and services industries within the domestic economy. The Australian Manufacturing PMI index remained relatively flat throughout the quarter with July, August, and September providing results of 50.4, 51.7, and 50.4 respectively. Although the results were slightly positive, they still failed to indicate any form of concerted expansion within the sector. In comparison, the Services PMI provided results of 54.1, 55.6, and 56.2 throughout the quarter.
Australian Inflation was also surprisingly robust, despite the slowing domestic economy and diminished demand for commodities. Inflation managed to claw its way higher, to an annualised rate of 1.5% q/q in the 2nd quarter, but much of that rise was due to rampant real estate prices which are heavily weighted within the CPI measurement.
Despite some encouraging signs, from both the labour market and price inflation, the Reserve Bank of Australia has maintained interest rates steady at 2.00% throughout the quarter. Complicating matters for the central bank is the ongoing turmoil within Chinese equity markets as well as signs of slowing demand from the Asian power house. As a major consumer of commodities, China is a critical trading partner and the RBA will therefore be monitoring the developments closely.
The Australian dollar is also providing some much needed support to the economy as continued depreciation against the US dollar helped to buoy exports. The AUD started the quarter at 0.7702 but, despite the absence of any sort of looser monetary policy, continued to depreciate and closed the quarter around the 0.7000 level. Much of the decline was fuelled by ongoing speculation over a US rate hike, but will no doubt still be welcomed by the RBA.
Economic Outlook
Given the weaker trading conditions within Asia, the Australian economy is liker to suffer a slight downgrade to the growth expectations for the latter part of 2015. It is likely that the economy will need to continue to be supported by an accommodative monetary policy into 2016. Global trade conditions, in particular commodity prices, are likely to remain under pressure for the remainder of the year and the RBA has subsequently downgraded Australia’s terms of trade forecasts by around 4%. Growth in China is expected to remain moderate, however, it is difficult to quantify much of the provided economic data. Any further market turmoil or diminishing domestic demand from the Asian powerhouse could cause the need for some decisive policy action from the Reserve Bank.
Moving forward, below average GDP growth is likely to continue given the transitory effects of capital exiting the mining sector. Subsequently, interest rates are expected to remain stable and generally accommodative, excluding any external shocks to the global macro economy. In addition, inflationary pressures are expected to remain within the 1.5% - 2.0% range whilst wage growth remains relatively flat.
Forecasts for the Australian dollar remain bearish, especially given the rhetoric around any hike to the US Federal Funds Rate. This aspect of US monetary policy remains one of the chief medium term risks to the AUD and adds to the uncertainty surrounding its valuation. Given the diminished demand within commodity markets, coupled with the uncertainty over a US rate hike, it appears likely that we could see the AUD depreciate further against the US dollar. In fact, further exchange rate depreciation would likely be welcomed and could assist in cushioning the Australian economy from any potential external shocks emanating from China.
Ultimately, the Australian dollar is facing a variety of external threats as it heads into the 4th quarter of 2015. Only time will tell if the currency will be able to hold its own above the key 70 cent handle given the looming spectre of a US rate hike.