Taking Australia's economic pulse after a challenging year

A glance back over the year reveals the depth of the challenge ahead for Australia's policymakers.

Looking back, it seems apt to describe 2014 as a year of change for the Australian economy.

Many of the country’s economic vitals: commodity prices, the dollar and consumer confidence slid over the course of the year. Amid ongoing concerns about housing affordability -- and an inquiry into foreign property ownership -- property prices continued to rise. Even the integrity the Australia Bureau of Statistics was challenged on the back of questionable jobs data.  Wage growth also slowed to such a crawl that this year’s annual increase in the minimum wage actually drove overall growth.

All in all, it appears to have been a challenging period for Australia.

So before we tackle 2015, lets take stock of how the economy performed over the past 12 months.

The fall of the Australian dollar

To the delight of exporters and the dismay of jet-setting Australians, the dollar continued its fall in 2014. After hovering around the mid-90s for most of the year, it declined sharply in the fourth quarter.

Why did it decline so quickly? It’s largely to do with commodity prices and declining terms of trade. 

A global game of chicken with commodities

The price of Australia’s key export, iron ore, further retreated in 2014. And as anyone who drives a car noticed, over the past couple of months the price of oil has also tumbled.

According to Diana Mousina, the Commonwealth Banks’ Associate Director of Economics, the decline of both resources can be attributed to oversupply. The reason behind that oversupply is a little more complex.

The strategy could be best described as a global game of chicken on commodity prices. Each producer has a break-even price, a threshold where they will start to lose money if they sell their commodity at a lower price. The graph below shows this threshold price for our major iron ore miners. 

Typically, when prices fall due to supply, the response is to cut production to buffer the price. This hasn’t happened with both iron ore and oil. Ore producers failed to cut back and OPEC also failed to reduce its targets in response to the US’ new shale oil projects. As a result, the prices of both resources slid over the course of the year.

As with any game of chicken, it’s inevitable that one party will eventually cave and cut supply and as a result stabilise prices; we may see this in 2015.

It hasn’t hit the headlines this year, but it’s worth noting that our second most-traded (and possibly our most hated) resource, coal, also saw its price fall this year. Thermal coal fell in response changing energy policies and concern over future oversupply. Meanwhile metallurgical coal -- which with iron ore is used in steel-making -- fell in line with the iron ore price. 

House prices continued to climb

This graph from Core Logic RP data perhaps best illustrates just how far house prices have climbed in recent years. This trend well and truly continued in 2014. 

The challenge is that the majority of this growth is occurring in Sydney and Melbourne. Prices in other areas are growing at a much slower pace.

CBA’s Mousina suggests that investors are propping up the market in both cities. She says that investor loans now account for 50 per cent of the bank’s loan book for Sydney and Melbourne. Mousina adds that the majority of these loans are also on interest-only repayment arrangements.

Consumer confidence after the budget

There’s no denying that this year’s budget delivered a significant blow to consumer confidence. Six months after the fact and consumer sentiment is still low. 

Source: Westpac

Consumer spending hasn’t quite followed the same pattern. According to Mousina, only spending in department stores and fashion retail appears to have declined. It seems that consumers are still happy to spend on food and hospitality. In response to higher house prices and increased building construction approvals, Australia’s spend on renovations, furnishing and home-related goods also increased in 2014.

Predictable employment figures, with a youth unemployment shocker

Aside from the ABS’ rare slip-up on job figures earlier this year, employment data didn’t really deliver too many surprises in 2014. Most of the figures fell in line with changes in the leading indicators: job ads and intentions to hire.

There was one shock behind the headline data. Youth unemployment hit new highs over the course of the year and appears to still be climbing. It’s currently at a 14-year high.