China building boom splits Australia into two-speed economy

[SYDNEY] A twin-speed economy is developing in Australia and posing a challenge for the central bank, as Chinese demand for iron ore buoys the resource-rich west while eastern states struggle with Covid-19 outbreaks and border closures.

The diverging fortunes of east and west are reminiscent of conditions created by the mining boom a decade ago, and are playing out in Australia's property market.

"Our market's quite hot," said Bev Haymans, a real estate agent in the upmarket coastal suburb of Cottesloe in Western Australia's state capital of Perth. "There's a real sense of positivity."

Meanwhile, 3,300 kilometres to the east in Sydney's beachside suburb of Bronte, Hannan Bouskila is struggling. April's coronavirus lockdown was "very tough" for the housing market, the 17-year veteran of the real-estate industry said, and the renewed outbreak in neighbouring Victoria state has made everyone nervous again.

The divergence poses a challenge for Reserve Bank of Australia (RBA) chief Philip Lowe as he seeks to tackle spiralling unemployment and the economy sinking into its first recession in nearly 30 years.

The central bank cut its benchmark interest rate to a record low of 0.25 per cent in March and is expected to keep it there on Tuesday to support the economy. Data the following day is expected to show the country officially fell into recession in the second quarter, with economists predicting a 6 per cent contraction from the previous quarter.

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"The divergences across the states at the moment are vastly larger than normal, as multi-speed economies have opened up," said Stephen Walters, chief economist for New South Wales Treasury and previously an official at Western Australia's Treasury. "This is an age-old problem for the reserve bank. It has flared up regularly since monetary policy became independent in the 1990s."

Driving the divergence is demand from China, the first major economy to resume growing after the pandemic. With Chinese factory activity roaring back to life, iron ore shipments from Western Australia's Port Hedland have surged to record highs.

Now, with iron ore trading for more than US$100 a tonne and gold near a record, miners in Western Australia are set to ramp up investment to replace aging capital stock and retiring mines. Rio Tinto Group, the world's No 2 miner, last November lifted planned sending on new iron ore mines in Australia to US$4 billion, while rivals BHP Group and Fortescue Metals Group are each investing more than US$3 billion in their own developments.

Western Australia "has been able to continue safely operating our resources sector throughout the pandemic, with sustained demand from China and higher commodity prices putting our exports on course for continued growth," said Chris Rodwell, chief executive officer at the state's Chamber of Commerce and Industry.

On the east coast, in contrast, households have been gripped by renewed fears about the virus. Consumer sentiment collapsed 15.5 per cent in New South Wales - the country's most populous state - amid panic that virus cases there would spike following Victoria's outbreak.

Walters, a former chief economist at JPMorgan Chase & Co, said the RBA's unconventional policies help it address the different speeds in the economy.

"They have a lot of discretion about which bonds they buy," he said, referring to purchases of state government securities. "So they can actually have some impact on these different regional economies."

"Australia's key mining state, Western Australia, is finally beginning to shrug off the hangover from the mid-2000s mining booms. Once the virus is contained, the two or even three-speed dynamic within Australia's economy will begin to test policymakers. This is a good problem to have, but it is yet another challenge for fiscal policy, as cross-state stabilisation frameworks could be seen to penalise Covid-free states as they divert funding toward those impacted by the virus," said Bloomberg economist James McIntyre.

The record-low cash rate and buoyant terms of trade already have sent Australia's currency soaring: The local dollar is up about 28 per cent since March 19, when the RBA cut rates and set a three-year government bond yield target, both at 0.25 per cent. The Aussie was trading at 73.67 US cents at 11.49am in Sydney and the central bank on Monday offered to buy another A$2 billion (S$2 billion) of government bonds.

Westpac Banking Corp expects the currency to climb to 80 US cents by the end of 2021.

The currency's upswing, "which began in March 2020 and is partly associated with China's extraordinary recovery from its 10 per cent contraction in the March quarter, looks set to last at least two years", said Bill Evans, chief economist at Westpac. He expects Australia's current-account surplus to swell to A$46 billion this year, further supporting the currency.

Confidence in Perth and its property market is mimicking the path of the Australian dollar.

"We have a lot of people who are mining or resource-based and they all feel particularly optimistic" about Western Australia, said Mr Haymans, the Perth realtor. "Everyone is quite buoyant."

BLOOMBERG