Australia Policy Potency Sharpens as Iron Ore, Jobs Cut Deficit

The Australian central bank’s bond-buying program is set to become more influential as 10-year high iron ore prices combined with a hiring spree narrow the budget deficit and reduce government debt financing needs.

Iron ore was trading over $180 a ton this week, reflecting China’s massive demand as its economy leads the global recovery from Covid-19. The Australian government based its revenue projections on expectations prices would to fall to $55 a ton by the end of September. Unemployment was expected to average 7.25% over the fiscal year, yet in March it had already fallen to 5.6%.

The fiscal shortfall for the 12 months ending June 30 could be half the A$198 billion ($153 billion) deficit forecast in December, due to the better-than-expected revenue receipts and less expenditure on welfare. Treasurer Josh Frydenberg is due to announce his fiscal 2022 blueprint on May 11, which will contain the latest estimates for the current year.

The stronger position of Australia’s books means that the government won’t need to issue as many bonds to bridge the fiscal shortfall. That also aids the Reserve Bank of Australia as its A$200 billion program will see it hold a greater proportion of debt, making monetary policy more effective.

Australia Policy Potency Sharpens as Iron Ore, Jobs Cut Deficit

“It’s more bang for your buck,” said Phil Odonaghoe, an economist at Deutsche Bank AG. “For every bond that the RBA is now buying, it’s more influential on the yield curve and the currency than it otherwise would be because you’re buying that fixed amount from a smaller supply of bonds in the market.”

Odonaghoe last month -- before the latest leg up in iron ore prices and leg down in the jobless rate -- estimated the budget could narrow to as little as A$100 billion in the current fiscal year. The relentless rise in the iron ore price is also likely to see the resource-rich Western Australia state record a budget surplus, he said.

James McIntyre, economist for Australia and New Zealand at Bloomberg Economics, reckons the prevailing prices could add an additional A$40 billion to government revenue, accelerating the pace of fiscal consolidation.

“A stronger than expected labor market recovery, coupled with a boost to profits from surging commodity prices, could see a major reduction in expected issuance, potentially amplifying the effectiveness of the RBA’s bond purchases,” he said.

Stimulus Debate

The increased potency of monetary policy comes as debate emerges on whether the RBA will roll over its yield curve control on the three-year note to November 2024 from the current April 2024. Similarly, whether it will announce another round of quantitative easing once its second A$100 billion tranche ends in October.

These questions were reignited after the central bank in Canada this week took the biggest step yet by a major economy to reduce emergency levels of monetary stimulus in response to a stronger than expected performance.

“The Bank of Canada’s taper is partly a reflection of lower bond issuance in their next fiscal year -- they had their budget delivered Monday night -- and there’s going to be a similar dynamic in Australia,” said Su-Lin Ong, head of Australian economic and fixed-income strategy at Royal Bank of Canada.

©2021 Bloomberg L.P.

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