Interest Rates and commodity prices

Interest Rates and commodity prices

As one of the world’s largest producers of commodities, the country’s economic fortunes are mostly at the mercy of the world’s commodity prices.

When commodity prices are high and demand strong, so too mostly, is our economy. Hence when markets and commodity prices are weaker Australia often struggles. During the past year and a half, propelled by a strengthening global economy (finally so it seems recovering after the GFC), increased demand from China (now the world's largest consumer of commodities both worldwide and Australia), plus the weaker US dollar, Australia has seen an economic windfall, boosting nominal GDP, the broadest measure of change in national income in Australia.

For a country such as Australia our nominal GDP is largely associated with commodity prices with the most recent national account putting our nominal GDP growth at a very heathy 7.7% per annum in the first quarter of 2017. This is our highest rate of growth since the GFC

The chart below shows the relationship between changes in nominal GDP and Australian terms of trade, something that is simply derived by dividing the value of exports by imports. This is opposed to real GDP which measures output in volumes, nominal GDP measures changes in both volumes and prices over a specific period.

 Australia's national income has surged over the past year, largely due to booming commodity prices, that has helped in boosting corporate profits and government revenues. The problem is unlike the past whilst the national income has risen quickly, it doesn’t seem to have flowed through to the household sector through higher wages, as it usually would.

It is usually wages growth that is the primary and most direct mechanism for higher national income growth that flows through to the household sector, however despite the increase in revenue to the Government during this time and commodity prices and demand continuing to rise there has been no lift in wages growth despite the lift in nominal GDP growth. Because labour market supply currently exceeds demand there is no incentive for firms to pay higher wages and it is this single factor that has pushed down on wages growth remains the reason why no transmission from higher commodity prices to wage growth right now.

Many Australians don't feel the economy is strong right now despite the recent increase in commodity prices has not and will not generate a lift in investment like in previous cycles. This is the reason why for the past year or more, employee salaries and wages growth has been extremely weak, yet there has been a big rise in national income primarily captured through a lift in company profits and taxes. With this in mind, talk of a rate hike from the Reserve Bank of Australia will not occur for some time yet.

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