Net exports are expected to subtract substantially from headline growth in the first quarter. Weak export volumes are the flip side of high commodity prices, reflecting a global shortage of commodity supply relative to demand. It is therefore no paradox that Australia should see large current account deficits in conjunction with a commodity price boom. Indeed, given the magnitude of the domestic investment task required to capitalise on the commodity price boom relative to domestic saving, it is entirely appropriate that Australia’s current account deficit should widen substantially. Any one who suggests otherwise is effectively arguing for lower future living standards.
At the same time, falling import prices have encouraged substitution out of domestic production and into imports, which subtract from the headline production account. The headline GDP figures do not adequately capture these gains to national income arising from the boom in the terms of trade.
Domestic demand is expected to remain relatively firm, having accelerated in the December quarter to 1.6 per cent quarter-on-quarter and 5.7 per cent year-on-year. It is growth in domestic demand that will need to ease if the RBA is to tame inflation, not the headline production account. The demand destruction wrought by rising inflation should make a contribution in this regard, but this is hardly the basis on which to forecast a moderation in future inflation outcomes.
If GDP growth fails to moderate in line with the RBA’s May Statement forecasts, then the RBA’s inflation forecast will need to be raised, all else being equal. Australian bond futures were hammered this week, largely on the back of negative leads from US Treasuries. US Q1 GDP growth was revised up and Fed funds futures are now pricing a tightening in US monetary policy by year-end. The prediction market Intrade puts the probability that US Q2 growth will also be positive at 68 per cent, with a better than even chance of positive growth in Q3 and Q4. The local market has recognised the growing likelihood of further RBA tightening, which is all but fully priced by November.
The RBA continues to pin its hopes on the exogenous tightening in credit conditions to do the tightening work it failed to do last year. The moderation in private sector credit growth in April suggests that tighter credit conditions are having some effect, particularly in relation to business lending. The weaker than expected outcome for March quarter private new capital expenditure was also consistent with this story, although investment intentions remained firm. This represents a mixed bag for the inflation and interest rate outlook. Business investment is required to ease capacity constraints and inflation pressures. In the absence of such investment, demand will need to be curtailed further than would otherwise be the case.
Next week sees the release of the May TD-MI inflation gauge. We expect a further 0.3 per cent month-on-month rise in the headline gauge for May, taking it to a new record annual growth rate of 4.5 per cent. The May release will also see the first bottom-up estimate of the Q2 CPI from the Melbourne Institute.
Also on the docket next week, April retail trade is expected to post a modest 0.3 per cent month-on-month rise following a 0.5 per cent month-on-month gain in March. Q1 gross company profits are forecast to rise 1.4 per cent quarter-on-quarter following a 3.9 per cent quarter-on-quarter gain in Q4. Q1 inventories are forecast at 0.6 per cent quarter-on-quarter, yielding a 0.3 percentage point subtraction from Q1 GDP growth. The Q1 current account balance Tuesday is expected to post a deficit of $20 billion, with net exports expected to subtract 1 percentage point from Q1 GDP growth. April building approvals are expected to decline 2 per cent month-on-month, extending recent weakness in this series. The RBA Board meets on Tuesday, widely expected to see the official cash rate left unchanged at 7.25 per cent, with most attention focused on the accompanying statement. Thursday sees the release of the April trade balance, forecast to narrow to $2 billion, driven by a 0.7 per cent month-on-month decline in imports and a 3 per cent month-on-month rise in exports.
Dr Stephen Kirchner is an independent financial market economist. His blog can be found at http://www.institutional-economics.com