Australian Economy Facing Trouble Ahead as GDP Contracts Sharply

Key Points:

• Australia posts negative GDP result of -0.5% q/q.

• Interest Rates likely to decline 50bps to 1.00% in 2017.

• Watch for AUDUSD depreciation below the 70 cent handle in the medium-long term.

The Australian Dollar is under pressure early following the shock release of the third quarter GDP figures which came in well below market forecasts at 0.5% q/q on a seasonally adjusted basis. The annual GDP growth figure was also impacted, slipping to 1.8% y/y. The negative results had an immediate impact on the Australian Dollar which declined relatively sharply and is now trading around the 0.7428 mark but questions remain as to whether the vulnerable Aussie Economy is now flirting with an impending recession.

It really isn’t a significant surprise that Australia has experienced a sharply negative quarter of economic growth given the recent downturn in investment and CAPEX. In fact, the home of the Kangaroo has seen 12 consecutive quarters of private investment contraction which was always going to eventually flow through to impact output. However, the depth of the contraction is certainly a concern given that this is only the 4th period of GDP contraction in 25 years.

Subsequently, there has been plenty of talk over the past day of whether the Australian economy could be facing an impending recession. However, the recent uptick in oil and commodity prices is likely to cushion the fall and the country might just dodge the required two negative consecutive quarters for a formal “recession” to be declared.

The reality though is relatively bleak for the mining powerhouse with demand for commodity products likely to remain lacklustre over the next few years. This subsequently highlights the lack of GDP diversity in the Australian economy and the fact that transition of capital to the services and retail industry has been sluggish at best. Australian growth needs to come from spending, investment, and increased employment and it’s difficult to see where that is likely to come from with expectations at the currently low level.

Subsequently, today’s GDP release is likely to be seen as a wake-up call to both the markets and the Reserve Bank of Australia. Although the RBA recently elected to keep the cash rate on hold at 1.50% the reality is that the latest round of data all but assures near term rate cuts. My view is that we are likely to see 50bps shaved from interest rates over the next 6 months in an attempt to provide some much needed stimulus. Obviously, this would have a sharp impact on the AUDUSD and could see the pair trading below the 70 cent handle.

Ultimately, the risk of an Australian Recession in 2016 has likely been overstated by the media, especially given the recent uptick in commodity prices. However, let this negative result provide a warning that, without a looser monetary policy, Australia will indeed face some contractionary pressures in early 2017.