[HSC] Economist: 17 — 23 July 2017

The week in review.

Jono Vandenberg
Jul 23, 2017 · 6 min read

This series of weekly articles aims to compile the important economic news of the week into bite-sized summaries with HSC-specific takeaways.
You can expect a new article every Sunday at 6pm!

A lot of HSC-relevant info was released this week! We have updates on the Aussie Dollar’s movements, Unemployment rates, and changes to APRA’s Capital Requirements and how it might impact the Distribution of Income!

Required Readings

  • The RBA inadvertently contributed to the continuing appreciation of the AUD towards $US0.80.
  • 14,000 jobs were created in June, which was enough to keep unemployment steady at 5.6%.
  • APRA has announced stricter capital requirements in a bid to make Australian banks ‘unquestionably strong’.

1. Appreciating AUD & The RBA’s ‘Goldilocks Rate’

The appreciation of the Australian dollar, which was discussed last week is continuing at pace, with the AUD peaking at $US0.7989 on Thursday before slipping to a close of $US0.7916 on Friday. Additionally, the TWI has appreciated by 6.5% since the start of June. The appreciation is being driven by both international and domestic factors.

Expectations of interest rate rises in the US have decreased in recent weeks on the back of very weak inflation as well political uncertainty surrounding the Trump administration. This has seen a widespread depreciation of the USD, with the Euro breaching $US1.15 for the first time in over 12 months.

Domestically, positive signs emanating from the labour market, as outlined below, have amplified the appreciation. Furthermore, the RBA announced this week that it considers the neutral cash rate to be 3.5% in the current economic climate. The neutral cash rate refers to the rate that has neither an expansionary nor a contractionary impact upon the economy and was considered to be 5.5% prior to the GFC.

Given that the current cash rate is 2 percentage points below the neutral rate, this announcement was interpreted by some as an indication of upcoming rate rises. This is an attractive prospect for foreign investors and triggered an increase in demand for the AUD. However, Gareth Aird of CBA, believes that this announcement was not a signal of rising interest rates and still expects the cash rate to remain at 1.5% for the rest of 2017.

HSC Relevance

  • The AUD is in the midst of a significant appreciation, nearing $US0.80, with some expecting it to go as far as $0.85. This poses a threat to the ongoing transition of the Australian economy away from the mining sector.
  • A 5% increase in the exchange rate has the same economic impact as a 25 basis point increase in interest rates.
  • The fact that the current cash rate of 1.5% is so far below the RBA’s estimation of the neutral rate at 3.5% demonstrates the significant expansionary stance which is currently being implemented.
  • ***JUICY Band 6 Material!***
    The neutral cash rate is the rate which causes no change in the cash rate the following year according to the Taylor rule. The Taylor rule factors in an economy’s economic performance including unemployment and inflation levels to determine the appropriate cash rate and is commonly used by central banks around the world.

2. Unemployment

Australia’s unemployment rate remained steady at 5.6% in June, after May’s results were revised up to 5.6% from 5.5%. Overall, there were 14,000 new jobs created in June. This was driven by an increase in full-time employment of 62,000 and offset by a decrease in part-time employment of 48,000. The two best performing states were NSW and Victoria, whilst South Australia continues to have the highest unemployment rate in the nation at 6.6%.

Full time employment has been growing steadily since last year and now accounts for 68% of total employment, showing the falling prevalence of underemployment in the Australian economy. However, this figure is still substantially less than the 72% of employment, which full-time jobs accounted for prior to the GFC. This indicates that there is still spare capacity within the labour market, which is likely to dampen wages growth.

In addition to the strong jobs numbers, the participation rate improved slightly. The participation rate for 15–64 year olds, which accounts for Australia’s ageing population, increased from 77.2% to 72.3%. The total participation rate also increased to 65%, compared with 64.9% in May.

HSC Relevance

  • Australia’s unemployment rate remains at 5.6%, which is close to the NAIRU.
  • There remains a disparity between the economic performance of services-led states such as NSW and Victoria and other states such as South Australia, which has been devastated by the collapse in Australia’s manufacturing sector.
  • The gap between the participation rates for 15–64 year olds and the total participation rate shows the significance of Australia’s ageing population and this factor is likely to grow in prominence over time.
  • The improvement in full-time jobs compared with part-time jobs, shows the gradual decline of underemployment within the economy. However, the labour market is not yet operating at maximal efficiency and this will keep the issue of low wages growth prominent.

3. Increased Capital Requirements

In accordance with its goal of making the Australian banking system “unquestionably strong”, Australian Prudential Regulation Authority (APRA) has announced changes to it capital requirements. The minimum reserves required to be held by the big four banks and Macquarie will increase by 150 basis points, with the new standard being 10.5%. Meanwhile, smaller banks will face a 50 basis point increase in their capital requirements. APRA has given all banks until January 1, 2020 to comply.

Of the big four banks, ANZ is best placed to comply with the new regulations, with NAB and Westpac not far behind. UBS analyst, Jonathan Mott, pegs CBA’s capital shortfall at $4.2bn, however they are still well positioned to be able to meet the requirement. Overall, the announcement was welcomed by investors who had been expecting stricter requirements and this saw share prices rise significantly across the board. Furthermore, the impact on consumers is expected to be negligible, with APRA only anticipating a 10 basis point hit to profit margins.

HSC Relevance

  • Formerly a tool of monetary policy, capital ratios are now used for regulation by APRA.
  • The increase in the capital requirements may cause a slight increase in borrowing rates, which would worsen the distribution of income, or a slight decrease in interest rates on deposits, which would improve the distribution of income.
  • The changes are a continuation of reforms that began in the wake of the GFC with the aim of improving the liquidity of Australian banks, allowing them to better cope with external shocks, i.e. minimising the negative effects of financial contagion.

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Jono Vandenberg

Written by

Economics Student at the University of Sydney

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Comprehensive and personalised tutoring year 10–12 students. A dedicated and passionate team of 99.95 ATAR graduates, state-rankers and subject experts supporting students with ❤.