Will the RBA follow the Bank of Canada’s lead?

BY DEB SHAW | 

  • At first glace, the fortunes of the Australian dollar seem destined to follow the Canadian dollar
  • Yet growth remains lower, with limited political will for Canadian-style deficit spending
  • Added exposure to China doesn't help either, with Chinese debt-fueled growth set to wane

After the Bank of Canada surprised markets by raising interest rates twice earlier this year, one can’t help but compare the Australian dollar to its commodity currency cousin, the Canadian dollar. Since last June, USD/CAD tumbled from an area above 1.35 down to around 1.25 currently. As foreign exchange markets try and guess which central bank will be the next to raise interest rates, the Reserve Bank of Australia appears to fit the bill.

Like Canada, Australia has enjoyed strong economic growth in recent times, although inflation remains subdued. The country is also in the midst of a concerning house boom, coupled with surging levels of consumer debt. Other similarities include a heavy reliance on commodities exports tied to growth in emerging markets, and especially China.

With bullish bets on the Australian dollar at elevated levels, many believe the Reserve Bank of Australia will ultimately raise rates following Canada’s lead. Our view is that this is unlikely for a few different reasons.

 

Australian government spending already high, Canada still in early days

Canadian growth has surprised almost everyone (including its own central bank) this year, and Canada today is one of the fastest growing developed economies in the world. In Q2 2017, year-over-year growth came in at 4.3% in Canada vs. 1.8% in Australia. A closer look at the data shows that the Canadian government’s infrastructure stimulus program is doing much of the heavy lifting, with added support from consumer spending thanks to a continuing housing boom. The country’s left-wing government has been able to accelerate growth rapidly thanks to deficit spending.

Unlike Canada, which ran relatively smaller deficits under its previous right-wing government, Australia has already operated a significant deficit budget for many years. Thus there is limited political will in Australia to expand an already large budget deficit. A rapid government-induced growth spurt is thus unlikely given domestic politics. A comparison of Australian and Canadian growth rates is shown below:

In recent quarters, Canadian growth has blown past Australian growth rates

9-14-2017 AU CA growth
Source: Australian Bureau of Statistics, Statistics Canada

 

Australian reliance on Chinese demand a further risk

As we outlined in an earlier article, Chinese growth rates are likely to fall in rate-of-change terms in the near future, based on leading indicators from China Beige Book. With the country’s credit impulse from 2016 gradually fading, high growth rates will be harder to maintain in the near future. While most commodities have been either flat or in a bear market this year, base metals and commodities related to China such as coal continue to strengthen. This has greatly aided 2017’s bull market for the Australian dollar. While Canada also relies on Chinese demand, it does not rely on the country to the same degree as China is a relatively smaller player in Canadian exports such as crude oil, wheat and lumber.

Given Australia’s relatively subdued economic growth and heavy reliance on Chinese exports, the RBA is unlikely to follow the BoC’s footsteps today. Thus the likelihood of the Bank springing a surprise on the market is remote. The current stance of keeping monetary policy in neutral makes sense, given risks that remain on the horizon.