Australia’s economic performance and outlook remains relatively encouraging as 2013 progresses. The RBA appears to share this fairly sanguine view. RBA Governor Stevens’ testimony to the House Economics Committee on February 22nd was of the “glass half full” variety. As expected the RBA again left its cash rate unchanged at 3% at this week’s monetary policy meeting with accompanying comments also slightly more upbeat. 

Admittedly part of the relative optimism relates to international economic developments over the past 6 months, rather than the evolution of the domestic economy. Eurozone threats have abated, the slowdown in China has come to an end. The US may even deliver upside growth surprises in 2013 for the first time in a number of years. Sentiment in financial markets is now much improved.

The Australian economy was running at roughly trend rates as 2012 came to an end. GDP rose by 0.6% QoQ in QIV 2012 and at 3.1% YoY sequentially through 2012. While there may be something of a soft patch in early 2013, another year of around trend expansion is anticipated. Global growth is expected to re-accelerate somewhat in 2013, driven by Asia and China. Europe and the UK will remain the main underperformers, the crisis in Europe remains one of the major downside risks to the global economy and financial markets.

Plainly this global growth mix still strongly favours the Australian economy. As is well known the composition of Australia’s trade is skewed geographically towards the Asia-Pacific region with China dominant. Australian economic growth itself is increasingly correlated with that in Asia and decreasingly correlated with that in the traditional advanced economies. The Australian terms-of-trade is dominated by commodities prices which are also increasingly driven by Asian growth. Around two thirds of Australian exports are sent to Asia, around 60% of these exports are commodity resources. 

IMF simulations highlight the relative importance of Asia to Australian growth prospects and conversely the relatively limited impact that developments in the US, Europe and the UK have on Australian economic performance. The IMF’s research indicates that a 1% shock to growth in emerging Asian economies hits Australian growth by around 1/3%. An equivalent 1% hit to US growth shaves less than 0.1% off Australian economic performance, a hit to growth in the rest of the world i.e., the bloc including Europe, the UK and Japan, has even less impact on Australian GDP. Emerging Asian and Chinese economic prospects are clearly key for the Australian economy, Europe and the UK are less directly relevant.

Of course none of this is to say that Europe and the UK do not impact the Australian economy at all. The European crisis has impacted financial markets globally, fiscal austerity has dampened domestic demand in Europe. This in turn spills out to the wider global economy including Australia. The European shock has induced monetary and fiscal policy response in various parts of the wider global economy, including Australia.

The UK economy’s direct links with the Australian economy and its impact on Australian cyclical economic outturns is nowhere near as important as those of Emerging Asia. But there are still important economic links. Apart from the obvious historical ties and shared interests, the UK is Australia’s sixth most important trading partner. This is particularly true of Australian services trade. In 2011-12 the UK was the destination for 7.7% of Australian services exports totalling A$3.9b.  and the origin of 8.3% of Australian services imports totalling A$4.9b.

Equivalents for merchandise trade were lower as a share of the total, but larger in absolute terms. Australian merchandise exports to the UK totalled A$8.0b. or 3% of total merchandise exports in 2011-12. Merchandise imports from the UK were A$6.9b. or 2.9% of the total. 

The UK is also the second largest source of foreign investment into Australia and a major destination for Australian investment overseas. The total stock of UK investment in Australia was A$470.8b. at end- 2011, with the stock of Australian investment in the UK at A$192.9b. Direct investment accounted for A$69.7b. of the UK’s investment in Australia, with Australian direct investment in the UK totalling A$52.1b.  Plainly these numbers are significant. 

Australia’s economic prospects are increasingly driven by the Emerging Asian economic growth story. The regional Asia-Pacific growth story will only increase in importance for Australia in coming decades and Australia’s engagement with its regional neighbours will advance commensurately. But economic ties with the UK are still significant and will remain important in decades to come.  

Martin McMahon

European Economist
Commonwealth Bank