What’s Behind Australia’s Sheer Dumb Luck?

As the mining investment slump continues and the housing boom is at an extreme risk of turning nasty, the Australian economy is getting another dose of good luck.

In the last year or so there has been a significant rise in commodity prices, and this is adding to national income and corporate profits, presenting upward momentum to the economy for the first time in four years.

Over the past year, the economy has otherwise muddled along with GDP growth not sufficient to boost employment growth, wages growth or inflation, the latter two hovering at record lows.

The market is so convinced about this change of luck that it is betting that the sharp rise in commodity prices will force a policy tightening within a year.

The money market futures are now pricing in two 25 basis point interest rate increases by the end of 2018, such is the optimism and change in sentiment. There is roughly a 50 per cent chance that the RBA will hike rates before the end of 2017. Just a few months ago, an interest rate cut was anticipated by the market.

Regardless of what might happen to interest rates, the commodity price rise has occurred at a time of record production of iron ore and coal, and even though natural gas prices have lagged the strength in other commodities, gas output and exports are set to surge in the next few years. Not only are the amount of commodities we are exporting rising strongly, but the price received is sharply higher.

So strong is the commodity price surge that Australia is now recording substantial surpluses on its international trade, something that does not happen all that often.

The commodity price uplift and flow-on benefits are sheer good luck for Australia. They are not the result of skill, or the result of good policy – it is sheer dumb luck. At a time when monetary policy has been targeting house prices rather than inflation and unemployment – and the budget repair effort of the government is floundering in intransigence and half-hearted attempts to return to surplus – some good luck was needed. Without it, the economy would now be in trouble and heading for the rocks.

While the economy was never really on the cusp of recession, the shock of the fall in GDP in the September quarter 2016 presented a stark indication of the indifferent economic performance. When the December quarter GDP results were released, there was universal relief that the commodity price surge had fuelled stronger GDP, a rise in the terms of trade and a bottoming in inflation risks.

While commodity prices remain at these elevated levels, the economy should be able to keep its head above water, meaning two to 2.5 per cent real GDP should be sustained. Inflation may creep up to the lower bound of the RBA target range and the unemployment rate, hopefully, will remain below six per cent.

But as this recent experience shows, commodity markets are fickle, extremely vulnerable to new demand from China and additional supply from the mega mining companies. Just as commodity prices have risen sharply over the past year, they could reverse those gains over the next. It will be a race between global demand and the amount of supply the commodities producers can churn out.

In the interim, Australia is set to register a world record 26 years of unbroken economic growth. It is a remarkable achievement and something that has delivered unrivalled wealth and opportunity. It is a legacy of policy reform, a flexible exchange and simple dumb luck, which have all played a part in this world-best achievement.

One day, a policy error will be made or our luck will run out. The recent commodity price surge is covering an array of cracks in the economy and means that if our luck runs out later this year or in 2018, some form of hard landing could unfold. But, for now, the economy is looking good.

Beyond that, no one can be sure, but an inevitable housing downturn, ineffectual policy settings and the risk of the commodity cycle reversing mean 2018 might be the year of living dangerously, at least for the Australian economy.

@TheKouk

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