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RBA cuts forecasts

The Reserve Bank of Australia (RBA) has cut its growth forecasts for the economy by 0.5% this year, as mining investment declines and other sectors slowly pick up the slack.

In the central bank’s August statement on monetary policy, it noted that the outlook for the domestic economy is weaker in the near-term than it was back in May. Mining investment is expected to decline significantly as large projects in liquefied natural gas reach completion. Lower coal prices have also led to a significant drop in capital expenditure on new projects. The bank warns that mining investment could drop faster than expected, with virtually no development under way for new projects.

Rio Tinto (ASX:RIO) is understood to be going ahead with plans to ramp up iron ore production to 360 million tonnes a year, but at the same time is cutting costs and exiting non-core projects. BHP Billiton (ASX:BHP) has also adopted the ‘focus on costs rather than growth’ story, and it too is shedding staff and non-core assets, while putting several large projects on the shelf for now.

But the RBA is optimistic that other sectors are likely to contribute more growth. The 15% fall in the value of the Australian dollar against major currencies since April, is expected to add to activity in trade-exposed sectors over the next two years or so.

The bank expects global growth to pick up, while low interest rates and strong population growth should contribute to local economic growth. Low interest rates, high rental yields, support for first home buyers and improving conditions in the housing market suggest a recovery in the construction industry. The RBA also noted that forward-looking indicators such as building approvals, loan approval and first home owner grants are showing moderate growth.

Bulk commodities (such as iron ore) will still play a key role in economic growth, with exports expected to increase strongly over the next few years, according to the RBA. With the Australian dollar falling, smaller iron ore miners such as Fortescue Metals Group (ASX:FMG) and Atlas Iron (ASX:AGO) have been given breathing space, should the iron ore price fall dramatically.

Foolish takeaway

The RBA says a key risk is if households become more cautious in the face on anticipated slower wages growth, resulting in weaker consumption growth. Add in government cuts to spending which could also see economic growth slow , and it could mean even lower interest rates and an Aussie dollar in the 60 to 70 cent range.

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Motley Fool writer/analyst Mike King owns shares in BHP.

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