It seems to have become common wisdom that Iron Ore’s whizz up to USD170 per tonne means that there is no way the RBA can cut rates at their February meeting.
I think that this is wrong – the broad economy is weak, and if inflation is low (core 0.5%qq or lower), there is scope for further easing. A low inflation print would do two things: it would demonstrate that current inflation pressures are low, and it would confirm that the elevated Q3 result was really more about policy changes than a true inflation surge.
The ‘Iron Ore is Australia’ argument is a bit dim in any case. First of all because Iron Ore is only one source of investment demand – coal and gas remain subdued. Second, because i think that this approach cuts out all the important linkages, and i see change in those linkages.
The link between high commodity prices and inflation is via overall demand in the economy. During both phases of the mining boom, high commodity prices have tended to boost overall demand via higher mining sector investment, and higher corporate tax payments (which were ultimately recycled as higher government spending and consumption boosting tax cuts).
With deficits at all levels of government, it seems unlikely to me that the second channel would operate in the short to medium term. By that, i mean that any boost in mining sector related government revenue is likely to be banked by governments. Of course it is true that this may replace further belt tightening measures, and therefore it is not entirely accurate to say that it has no impact on the balance of risks — but at this point it seems fair to say that this channel is unlikely to boost demand / inflation in the short run.
So if the increase in prices makes a case (by itself) against a rate cut, it must be that we should expect it to boost mining investment. Here’s where Tom and RIO come into it – with so much money written down, my judgement is that RIO (and other major miners) will husband capital, and therefore keep their capex plans unchanged (or perhaps even trim a little).
Of course, BHP and the minnows could still step up — however i don’t see this happening. The iron ore outlook is for oversupply in the medium term, which will put prices well below USD100 per tonne, so i cannot see BHP gearing up. The stuff they trimmed in H2’12 is likely to stay trimmed. In the case of the smaller players, i don’t they have the confidence to re-ramp just yet.
The weird commodity price crash in q3’12 rattled their investors, and i think this will keep most circumspect. The so called ‘iron ore floor’ does not exist, which means that investment in this sector is riskier than many thought. If i am right in this judgement, then investment demand will remain subdued in the medium term (though clearly a sufficiently long period of high prices will repair ‘animal spirits’).
So, while it is clearly the case that a higher iron ore price is better than a low one, i do think that there is CPI number that will get a cut. A 0.5%qq result ought to do the trick.