The RBA’s Thought on China

Central banks are in charge of controlling domestic monetary policy. By changing interest rates, central banks are able to affect currencies, housing prices, and equity markets to an extent.  Often,  a central bank doesn’t even have to change interest rates to affect economies. A lot of the time these things will change on nothing but words.

Last week, Mario Draghi, head of the European Central Bank, did just this. He changed the value of the euro with just a few words. But it was a change he tried to avoid. Draghi unknowingly increased the euro’s value by implying there would be no more rate cuts. European policymakers, like their counterparts around the world, see currency gains as unwanted. The euro price increase reduced the competitiveness of the Eurozone as a whole. How did it do this? By increasing the price of export goods.

If you want to buy anything within the Eurozone, you first must buy euros. And, if the euro gains in value, it costs more, overall, to buy European products.

Draghi’s comments undid the stimulus package that the ECB introduced somewhat.

But when figureheads get the wording right, they can simulate an economy. That’s right — they use words — not policies — to stimulate economies. Of course, central bankers need to back up their claims. If they don’t, their words will mean nothing in the future.

Approaching soon on the economic calendar is the US Federal Reserve’s rate decision. On Thursday this week, the Fed is expected to keep rates unchanged, below 0.50%. But I’m betting more attention will be paid to the Fed’s meeting minutes, rather than any potential rate change.

The Reserve Bank of Australia released minutes from their latest meeting today at 11:30am. The RBA meetings definitely carry less gravitas than the Fed on a global stage. However, it’s extremely important to Australia businesses. And right now Australian businesses are worried about China.

China is our main trading partner. We export everything, from agriculture to minerals, to China. And if things are bad for the Chinese, it generally means things are likely to get worse for us.

Not surprisingly, China was a hot topic for the RBA. The RBA was concerned over recent Chinese economic data, which was weaker than expected. Yet they admitted the Chinese New Year holiday had disrupted these figures. In other words, it made it more difficult to interpret the data than might otherwise be the case.

But fundamental changes in China are becoming more apparent. China’s demographics were a key driver for growth in the past. Yet these forces are now reversing. And they’re likely to weigh on future growth as a result.

The RBA did note that if China’s median household income rose it would create long term potential for Australia. If China expands its middle class, then Australian exports should stand to benefit. Things such as rural produce, alongside services like tourism, will benefit from a richer China.

China's Middle class consumers consumption

Source: ‘Understanding China’s Middle-Class’, Kheehong Song & Allison Cui

The above graph shows the increasing middle income class within China. By 2026, it’s expected that 55% of urban Chinese households will be middle class. Obviously, this trend is more persistent throughout the urbanised parts of China.

But this means that millions more rural Chinese also have the possibility to reach middle income status. It’s quite shocking when we consider the possibilities for China’s growth.

Of course, the RBA affect things other than interest rates with their comments.

As the RBA voiced their thoughts this morning, the Australian dollar spiked to US$0.7527. However, the AUD started to decline shortly after, hitting a low of US$0.7479 cents for the day. Many believe the RBA should be doing more to keep downward pressure on our Aussie dollar.

But the RBA don’t believe the AUD is cause for concern at this point.

Härje Ronngard,

Junior Analyst, Money Morning

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