[HSC] Economist — 9 July 2017

The week in review.

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!

This week saw some interesting changes to Australia’s trade balance due to Cyclone Debbie, and another predictable (yet still important!) decision by the RBA with respect to the cash rate.

Required Readings

  • The cash rate has been left at 1.5% for a 12th consecutive month.
  • Australia’s balance on goods and services (BOGS) improved sharply in May, to a surplus of $2.5bn.
  • Unemployment in the US is very low at 4.4%, but sluggish wage growth may mean that this doesn’t flow onto greater demand for Australian imports.

1. Monetary Policy

To nobody’s surprise the RBA decided at its monthly meeting on Tuesday to keep the cash rate on hold at historically-low level of 1.5% for the 12th consecutive month.

Despite headline inflation ticking up to 2.1%, just inside the RBA’s target band, underlying inflation remains low. This coupled with very low wages growth, were cited by Governor Dr Philip Lowe, as a couple of the reasons for maintaining the loose stance of monetary policy.

Furthermore, Dr Lowe expressed his desire to avoid an appreciation of the exchange rate, something that may be induced by a raising of the cash rate. The Australian economy is currently transitioning away from the mining sector and this shift has been aided by the depreciating exchange rate in recent years, with Dr Lowe arguing that “an appreciating exchange rate would complicate this adjustment”.

HSC Relevance

  • The cash rate has been left at 1.5% for a 12th consecutive month.
  • Underlying inflation is very low currently, partially due to low wages growth, which is inhibiting consumption growth.
  • The RBA is keen to maintain international competitiveness by avoiding an appreciation of the exchange rate.
  • The fact that the RBA needs to keep the cash rate so low to prevent an appreciation is an example of a global influence upon monetary policy.

2. Australia’s Balance of Trade

https://tradingeconomics.com/australia/balance-of-trade

Australia’s trade balance recorded a surplus of $2.5bn in May, a major jump from April, when Cyclone Debbie tore its way through Australia’s exports leaving only a wafer-thin $90m surplus. Exports rose by 9% compared to the month prior, whilst imports rose by 1%. The major areas of growth were coal exports (up 62% in value) and liquified natural gas (LNG) (up 23% in value).

These results far outstripped economists expectations of a $1.1bn surplus and it remains to be seen whether net exports will make a positive contribution to GDP in the June quarter.

HSC Relevance

  • Australia’s balance on goods and services (BOGS) improved sharply in May, to a surplus of $2.5bn.
  • The figures from April were heavily skewed by Cyclone Debbie, which disrupted exports.
  • Australia’s recent strong export performance can be attributed to the pickup in commodity prices and the low exchange rate.
  • The recent volatility evident in the graph supports the notion that the BOGS is predominantly a cyclical component of the current account.

3. US Unemployment Data

https://tradingeconomics.com/united-states/labor-force-participation-rate

The latest unemployment figures from the US came out late on Friday night and made for fascinating reading. 220,000 jobs were created in the US in June, which exceeded expectations, however, the unemployment rate ticked up from a 16-year low of 4.3% to 4.4%, something you would not expect with such strong jobs growth numbers. Furthermore, wages growth was poorer than expected at only 2.5% year-on-year.

One of the key reasons for these, seemingly contrasting, movements, was the change in the participation rate, which increased from 62.7% to 62.8%, accounting for the 0.1% increase in the unemployment rate. In fact, the current participation rate is more than 4 percentage points lower than the levels seen in the early 2000s, which indicates that the US labour market is still a distance away from operating efficiently, and perhaps that is why wages growth remains sluggish.

Another potential explanation for the low wages growth is the collapse in the Phillips Curve (the relationship between unemployment and inflation). Larry Hatheway, chief economist at asset management firm GAM, suggested that since the GFC there have been two significant changes that have flattened the relationship between unemployment and inflation. Firstly, long-term inflation expectations are down, which slows the self-perpetuating cycle of inflation. Secondly, the lingering uncertainty in the market has caused workers to place more emphasis on job security, meaning they are less likely to ask for wage rises. This perspective is supported by the ‘Lost Decade’ in Japan and is potentially applicable to the current economic situation in Australia.

HSC Relevance

  • Unemployment in the US is very low at 4.4%, but sluggish wage growth may mean that this doesn’t flow onto greater demand for Australian imports.
  • The disparity between the strong employment levels yet relatively low participation rates raises questions about the validity of the unemployment rate as a measure of economic growth.
  • ***JUICY Band 6 Material!***
    The current US economic climate (& to a lesser extent Australia’s), may indicate that the relationship between unemployment and inflation is collapsing, at least for the time being.