Soft labour market conditions and a subdued inflation outlook were two reasons that the RBA cut interest rates in May. However, they were not the only factors.
The outlook for business capital expenditure – or, investment – was also a major contributing factor behind the RBA’s decision to cut.
The drop-off in mining sector investment was well known to the RBA before it met in May. It was even given a name among many in financial markets – the mining “capex cliff”. However, over 2014 there was a hope that non-mining business investment, aided by a weaker Australian dollar and improved conditions within the domestic economy, would go some way toward offsetting the huge decline in mining expenditure.
However, following the ABS’ Q4 Private New Capital Expenditure and Expected Expenditure report released in late February, and recent liaison with industry contacts, it appears that hopes for a sustained pick-up in non-mining investment have been dashed. After rising fractionally in 201/15, they are now expected to fall.
This is demonstrated in the chart below from the RBA’s May statement on monetary policy.
This drop-off in non-mining investment, shown with the red arrow, along with further downgrades to mining sector activity as a result of sharply lower commodity prices, has seen the expected drop in total investment – the capex cliff – grow even further.
It, assisted by the subdued outlook for inflation and the labour market, was the chief reason interest rates were cut in May.
Here’s the RBA’s outlook on mining sector investment:
“The latest estimates derived from the ABS capital expenditure (Capex) survey imply that the value of mining investment could decline by over 10 per cent in both 2014/15 and 2015/16, although there is considerable uncertainty around these estimates and the Bank’s liaison points to an even larger fall. Indeed, the pace of the decline in mining investment could be greater than had previously been anticipated if declines in commodity prices place further pressure on mining sector profitability, particularly in the oil and gas sectors. Mining sector profits fell by 17 per cent over 2014.”
And, perhaps more influential than that, non-mining investment:
“Non-mining investment has been subdued over recent years and the data suggest that this will continue for some time. The latest Capex survey implies that any recovery in nominal non-mining investment in 2014/15 will be reversed in 2015/16.”
With the outlook for business investment likely to remain subdued, other areas of the economy, most likely households, will need to improve to offset this forecast slowdown.
Should the federal budget not deliver the goods next week, or economic growth in our major partners improve, it suggests the RBA’s recent rate cut may not be the last seen in 2015.