CBA: Australia just received a massive economic windfall, but it's unlikely to last

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The Australian economy received a welcome, a largely unexpected windfall, at the end of last year.

Commodity prices have surged, and, if the Commonwealth Bank modelling is on the money, it points to the likelihood that Australia’s terms of trade logged its largest increase on record in the December quarter.

And that’s good news for the Australian economy, at least in the short to medium term.

The bank’s terms of trade (ToT) tracker — a proxy for the figures released in Australia’s GDP report — surged by 15.5% last quarter, thanks largely to some enormous price increases in Australia’s major commodity exports, iron ore and coking coal.

Terms of trade is simply the value of Australia’s exports divided by its imports, and multiplied by 100.

According to Vivek Dhar, a mining and energy commodities analyst at the CBA, that will deliver many positives to the Australian economy, as it has done so in the past.

“The flow through of higher commodity prices to the broader Australian economy will follow a similar pattern,” he says.

“The AUD, budget revenues and nominal GDP should be supported with a higher ToT and rising company profits, signalling an end to risks of slowing income growth. The trade accounts have already returned to surplus and the current account deficit will shrink significantly.”

Alongside beneficial impacts on national incomes, federal and state budgets and corporate profits, Dhar says that “there is even some potential for a flow through to wages”, no doubt a welcome side effect — presuming it arrives, of course — given they grew at the slowest pace on record during the September quarter last year.

However, while that will have a positive impact on the Australian economy over the short-to-medium term, Dhar says that the current commodity price boom won’t last as long, and deliver as much to the economy, as its predecessors in the past.

“The record surge in prices may tempt belief that we are on the cusp of another commodity boom,” he says.

“We certainly agree that the bottom in commodity prices now lies behind us. But the spike in the second half of 2016 is difficult to justify from any fundamental perspective and some retracement is likely.”

While iron ore prices remain resilient, jumping to the highest level seen since October 2014 earlier this week, the price of Australia’s second-largest commodity export by value — coking coal — has fallen by 43% since late last year.

Given the view that commodity prices will fall further in the period ahead, Dhar says that new investment in mining projects is expected to remain subdued, again differentiating this commodity price boom from others when mining sector investment surged in response to higher prices.

So while the lift in terms of trade has been welcome, it’s unlikely to herald the start of another period of prolonged strength for the Australian economy, just make it better than where it’s been of late.

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