Money & Markets | opinion

Falling commodity prices could have a larger, more sinister impact on Australia's economy

Dustin Bradford/Getty Images

Just when the Australian economy is showing a few tentative signs of improved conditions, along comes a dark cloud to threaten this potentially positive outlook.

While Australian economy watchers are spending the bulk of their time looking at some encouraging signs in the labour market, retail sales and government spending, commodity prices are tumbling.

For Australia and its inextricable link to commodity exports, this is not good news.

The Bloomberg Commodity Index, which is available daily, has fallen 7.1 per cent since the middle of May.

This appears to be reflecting the run of news that is pointing to a topping out of global economic growth through the second quarter of 2018.

The slowing in China, the world’s major commodity consumer, is weighing on commodity prices which are also being buffeted from the trade wars which threaten to disrupt growth in global trade.

The BCI is not that far above the lows plumbed in early 2015 when there were serious concerns about the global growth outlook.

In some respects, the commodity price falls measured in the BCI have been more concentrated in products that are of somewhat less importance to Australia.

Soya beans, gold and copper, by way of example, have fallen sharply. Iron ore and coal prices have been relatively resilient, for now.

That said, the link between the broad commodity prices indices and global economic growth are strong.

This means that when commodity prices are rising, global economic growth is generally firm to strong; and when commodity prices are trending lower, the opposite is true.

Which is where the concern for the Australian economy comes in.

The current cycle of commodity price falls is occurring at a time when government bond yields around much of the world have been well contained.

Sustained, relatively low yields are a strong indicator of slower growth, low inflation or a combination of the two.

The bond market is reinforcing the commodity price signals and casting doubt about the ability of the global economy to sustain a strong expansion over the remainder of 2018 and into 2019.

This is not to say there are serious concerns of some form of hard landing for the global economy.

Many of the major central banks have signalled a pragmatism that will see them delay any further monetary policy tightening.

The RBA is squarely in this camp where despite its stated wish over the past year or more to hike interest rates, it has held off taking such action.

The RBA is also trying to negotiate any fallout from the ever-deepening falls in house prices and a tightening in lending from the banks which is also seeing rises in lending rates outside any moves in official policy settings.

Global developments remain a dominant driver of Australian economic conditions and with that, RBA policy settings.

If the broader commodity price declines continue and, perhaps more importantly, spreads to Australia’s dominant commodity exports including iron ore, coal and gas, the policy risks will change.

The path to lower unemployment, accelerating wages growth and a lift in inflation will be disrupted.

So too will be the government’s projections of a return to budget surplus, a centre piece of its re-election strategy.

The RBA, Treasury and the government will no doubt be paying a lot more attention to commodity prices over the next few months to see whether the recent drop develops into something more sinister or whether it is just a short-term blip.

If commodity prices continue to fall, expectations for interest rate hikes in Australia will turn to cuts, the date of the projected budget surplus will be pushed back a few years and the government’s political will take a hit, especially with the realisation that the company and income tax cuts were unaffordable and based on a temporary run of good news and not a structural improvement in the budget position.

Stephen Koukoulas is a Research Fellow at Per Capita.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.