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CommSec expects the Reserve Bank to remain on the interest rate sidelines over the rest of 2014 before feeling more comfortable to lift rates early in 2015.

Terms of Trade falls to a 4-year low

Craig James
2 September 2014

by Savanth Sebastian

The terms of trade (ratio of export prices to import prices) fell by 4.1 per cent in the June quarter to a 4-year low.

The current account deficit widened from $7,804 million to $13,742 million in the quarter. The foreign debt to GDP ratio was 55 per cent – the highest levels in 51Ž2 years.

Trade sector detracts from economic growth: Net exports (exports less imports) will detract 0.9 percentage points from economic growth in the June quarter. CommSec estimates that the economy grew by 0.6 per cent in the June quarter to be up 3.2 per cent over the year.

Dwelling approvals: Dwelling approvals rose by 2.5 per cent in July. Approvals are up 9.4 per cent over the year. The current number of dwelling approvals (16,318) is still well above the decade average (13,529).

Consumer confidence falls: The weekly ANZ/Roy Morgan consumer confidence rating eased by 0.8 per cent in the week to August 31.

The balance of payments data has implications for trade-exposed businesses and companies vulnerable to changes in the Aussie dollar. The approvals data has implications for banks, building and building material companies. The consumer confidence figures have implications for retailers, and other consumer-focussed businesses.
 
What does it all mean?

The substantial deterioration in the current account balance and increase in foreign debt is disappointing but it does come after a rather substantial improvement in the prior quarter. In addition debt serviceability worsened while the terms of trade deteriorated to 4-year low. In that context it is understandable that the Australian dollar weakened straight after the release. And looking forward it explains why the Reserve Bank continues to highlight the material downside risks to the currency.

From a broader sense Australia is certainly less vulnerable to external shocks than compared with the past and the demand for Australian resources will continue to underpin the trade accounts. That is not just an ongoing lift in iron ore volumes, but also the anticipated lift in LNG exports.

However the real focus in the external accounts data was on the terms of trade. Over the June quarter export prices fell at a much faster rate compared with imported goods, resulting in a 4.1 percent slide in the terms of trade ratio. From a longer term view, the terms of trade has now fallen for over two years and is now holding at a four-year low. In effect it ensures that the Reserve Bank will maintain a neutral bias, with an ongoing dovish tone. However the likelihood of another rate cut is unlikely in the near term. Rather policymakers may jawbone about the potential to cut rates rather than commit to further rate cuts

Building approvals recorded a healthy rebound in July, confirming the strength in housing construction. There is no doubt that approvals have eased in recent times from some heady levels and in the short term a further consolidation is likely. But keep in mind that dwelling approvals (16,318) are holding well over 20 per cent above decade averages, underpinned by pivotal private sector house approvals, suggesting that home building is set to lift further over the second half of 2014.

Lower interest rates, strong population growth, improving, and pent up housing demand will see the housing sector gather pace over the medium term. In addition the recent cuts to fixed interest rates by the major banks will spur a further round of home building. It is pretty clear that the housing sector is becoming the backbone of the Australian economic growth outlook.

What do the figures show?

Balance of Payments

The broadest measure of Australia's external position - the current account – worsened in the June quarter (larger deficit). The current account deficit widened from $7,804 million to $13,742 million in the quarter. The balance of goods and services was in deficit by $4,691 million after a $2,567 million surplus in the March quarter.

At the end of the June quarter, net foreign equity was negative $1.2 billion – essentially Australians own more assets overseas than foreign investors own here in Australia.
The trade sector (exports less imports) will detract 0.9 percentage points to economic growth in the June quarter.

The terms of trade (ratio of export prices to import prices) fell by 4.1 per cent in the June quarter to a 4- year low of 83.4 after a 1.4 per cent fall in the March quarter.

Net foreign debt rose by $17.2 billion to $865.5 billion in the June quarter.

The debt servicing ratio (net income on foreign debt to goods and services credits) worsened from 6.9 per cent in the March quarter to 7.1 per cent in the June quarter.

Government Finances

Government consumption spending rose by 0.3 per cent in the June quarter after a 0.4 per cent rise in the March quarter. And total public investment fell by 3.9 per cent in the June quarter after falling by 6.0 per cent in the March quarter. Overall, spending by the government sector fell by 0.6 per cent in the June quarter after a falling by 1 per cent in the March quarter

Building Approvals:

Dwelling approvals rose by 2.5 per cent in July after falling by 3.8 per cent June. Approvals are up 9.4 per cent over the year.

The current number of dwelling approvals (16,318) is still well above the decade average (13,529) and five-year average (14,238).

House approvals rose by 1.5 per cent in July (private sector down 1.3 per cent). Meanwhile ‘lumpy’ apartment approvals rose by 4.0 per cent in July after falling by 7.3 per cent in June.

House approvals are up 13.6 per cent over the past year while apartments are up 4.0 per cent.

Across states in July: NSW approvals fell by 5.7 per cent; Victoria fell by 4.6 per cent; Queensland rose by 0.9 per cent; South Australia fell 1.8 by per cent; Western Australia rose by 23.1 per cent; Tasmania fell by 7.5 per cent.

The value of all commercial and residential building approvals fell by 10.4 per cent in July after rising by 6.7 per cent in June. Residential approvals rose by 0.8 per cent with new building up by 0.9 per cent and alterations & additions down by 0.6 per cent. Commercial building fell by 26.5 per cent in July after rising by 24.8 per cent in June.

Consumer sentiment:

The ANZ/Roy Morgan consumer confidence rating fell by 0.8 per cent to 112.6 in the week to August 31 after rising by 0.9 per cent in the previous week. The confidence rating is down 3.1 per cent on the 7-month highs recorded for the week to July 27.

One of the five components of the index rose in the latest week:

The estimate of family finances compared with a year ago was down from +10 to +4;

The estimate of family finances over the next year was steady at +19;

Economic conditions over the next 12 months was down from -1 to -4;

Economic conditions over the next 5 years was down from +10 to +9;

The measure on whether it was a good time to buy a major household item was up from +30 to +35.

What is the importance of the economic data?

The Bureau of Statistics' monthly Building Approvals release contains figures on local council approvals to build residential structures such as homes and units as well as commercial premises such as offices and shops. Approval is one of the first stages of the construction ‘pipeline’ and is thus a key leading indicator of future activity. An increase in approvals would point to stronger future activity for construction-related companies.

The quarterly Balance of Payments figures have few short-term effects on financial markets. The importance of the data is merely to highlight Australia’s trading position with the rest of the world as well as the contribution of foreign trade (exports less imports) to the latest estimates of economic growth

What are the implications for interest rates and investors?

The recovery is still in its infancy and the Reserve Bank has some work on its hands to disentangle the various parts of the economy. CommSec expects the Reserve Bank to remain on the interest rate sidelines over the rest of 2014 before feeling more comfortable to lift rates early in 2015.

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