Over the weekend, China reduced its Reserve Requirement Ratio by 50 basis points to 18.5%.
This is unambiguously bad news for Australia as it reflects Chinese economic softness which the authorities are working to arrest and then hopefully reverse with the policy easing.
The easing in China comes hard on the heels of recent policy easings in the US, Eurozone, UK, Canada, Japan, Brazil and a host of other counties as they deal with a growth slowdown and on-going low inflation.
China’s economic momentum is a vital determinant of the performance of the Australian economy. A quarter of Australia’s exports end up in China, the prices paid by the Chinese for many resources is still high (although falling from recent peak levels) and the investment boom in Australia owes a lot to the Chinese and private sector partners developing the necessary structure to pump out raw material exports over the next few decades.
If the Chinese economy is strong, the Australian economy gets a bit of a free ride. Conversely, if China is slowing, there could be headwinds for us.
Economics 101 tells us that policy makers only easy policy if response to weaker growth prospects and low inflation. They tighten policy when the economy is strengthening. Which makes the easing in China over the weekend a little disconcerting because it is being delivered due to Chinese economic softening. GDP growth has eased a few percentage points through 2011, export growth is weak, the property market also has some characteristics of a busting bubble and inflation is on a clear downtrend, even with the unusual blip in January.
It’s a scenario that should be more worrying than comforting and it is one of the global issues that leaves the door open for interest rate cuts from the RBA in the months ahead.