The Reserve Bank demonstrates 'masterly inactivity'

Meanwhile, non-commodity exporters have been struggling with the effects of a strong currency, adverse geo-political developments and a more profitable domestic market, so that non-commodity exports now represent a smaller proportion of GDP than at any time since 1999. One result of these trends has been that Australia now accounts for just 0.9 per cent of total world exports, our lowest “market share” since at least 1948, and well below our share of global GDP (which has been rising in recent years) of 1.5 per cent.

Another result, of course, in conjunction with the rapid growth in imports associated with the strength of domestic spending, is that Australia’s current account deficit once again exceeds 6 per cent of national income.

So far this has been financed quite comfortably, partly because financial markets can see that Australia’s deficit owes more to increased investment than to diminished saving (with falling household saving being offset by increased corporate and government saving), in contrast to the drivers of the widening US current account deficit; and partly because of the substantial yield premium which offshore financiers of Australia’s deficit in recent years have enjoyed.

However, although export growth should pick up this year, the risk is that it will continue to fall short of optimistic expectations. As such, with domestic spending likely to grow by less than 5 per cent this year for the first time since 2001, overall economic growth in 2005 could be a touch under 3 per cent, on average, compared with the likely 3.6 per cent outcome for 2004.

The combination of unchanged Australian interest rates and progressively rising US rates will gradually erode the large interest rate premium which, along with buoyant commodity prices, is currently supporting the Australian dollar despite Australia running a current account deficit which, relative to the size of our economy, is even larger than America’s.

Against that background, the closing months of 2005 will likely see the Australian currency begin to decline once more. With domestic labour and other costs likely to be rising more quickly as 2005 progresses, that sets the stage for higher interest rates in the first half of 2006.