Down on its luck

By Z.G.

THROUGH a combination of good policy and good luck Australia has managed to avoid recession for more than two decades. Thanks to its close trade links with China, and a well-targeted fiscal stimulus, it was one of the few developed countries to avoid a recession during the financial crisis. However, figures released on March 4th show that GDP growth slowed to just 0.5% in the last three months of 2014. More worryingly, unemployment has trended upwards to 6.4%, the highest level in 13 years.

The slowdown is largely due to the fall in global commodity prices over the past year, as new supply finally caught up with Chinese demand. High prices for iron ore and coal had fuelled a mining-investment boom in Australia. But this peaked in late 2012; investment is now expected to fall by a further 40% over the next four years, according to BIS Shrapnel, an economic forecaster.

The fall in commodity prices has torn a hole in the national budget as tax revenues came in lower than projected. The finance minster recently revised the deficit higher to 2.5% of GDP and pushed back the forecasted return to surplus to 2019. This has increased political tensions within the government, as minsters recoil from the prospect of another unpopular cost-cutting budget due to be unveiled on May 12th.

While the fall in mining investment has long been expected, a rebound in the services sector, which still makes up two-thirds of the economy, has failed to materialise. This is in part due to the relative strength of the Australian dollar. In trade-weight terms it has depreciated by only 6% over the past year, in contrast with falls in commodity prices of 27% over the same period.

The reluctance of the Reserve Bank of Australia to ease monetary policy has contributed to this. Interest rates were kept on hold throughout 2014, even as the labour market deteriorated and the economy slowed. This foot-dragging has been driven by a fear that low interest rates may inflate an already frothy property market. House prices have risen nationally by more than 8% over the past 12 months. In particular, Sydney's housing market has been showing signs of a bubble. There, prices have risen by nearly a third over the past two years.

Luckily, this looks set to change. Australia’s Prudential Regulation Authority has been cracking down on risky mortgage lending, which gave the central bank enough room to cut interest rates in January, to a record low of 2.25%. Analysts expect this easing to continue, with interest rates forecast to fall to just 1.5% by the end of 2015. Lower interest rates alone are unlikely to drive growth across the economy. But they should, with a little luck, ease Australia’s transition away from a mining-led boom to something more sustainable.