Australia cuts interest rate as mining slump prompts worries

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An unexpected interest rate cut from Australia's central bank, triggered by fears of a slowing mining sector, offers Canadians a glimpse of what to expect in the event of a prolonged economic slowdown in China.

For years, Australia's economy has been powered by China's strong growth. Because the two countries are so close together, China has been a heavy buyer of Australian iron ore and coal, propelling the Commonwealth country's economy. Australia's annualized GDP growth rate is 3.7 per cent, and its unemployment rate is only 5.1 per cent.

But lately there have been signs of a slowdown in Australia's resource sector, which was a prime reason for cutting the country's key interest rate by 0.25 percentage points to 3.25 per cent on Tuesday.

In a statement, Reserve Bank of Australia governor Glenn Stevens specifically cited fears about softer resource investments, as miners curtail their expansion plans.

"The peak in resource investment is likely to occur next year, and may be at a lower level than earlier expected," he wrote. "As this peak approaches, it will be important that the forecast strengthening in some other components of demand starts to occur."

The key message is that mining dollars are slowing, so the central bank wants to encourage spending in other sectors.

Canada's economy isn't precisely the same as that of Australia, which is more closely tied to China and does not have a strong energy sector. But both Canada and Australia are heavily into mining, both have strong currencies, fuelled by global demand for resources, and both need solid Chinese growth to offset the anemic U.S. economy and the recession-riddled euro zone.

Evidence of a fallout from China's economic slowdown has been relatively anecdotal to date, but Australia's acknowledgment that mining investments are drying up is a reminder that the ripples are spreading. Commodity prices have also taken a hit.

Iron ore and coal are two of Australia's major exports, and iron prices have dropped by a third since July while thermal coal is near its lows over the past two years.

While Canadian investors may find some comfort knowing that energy-related names make up about 25 per cent of the Toronto Stock Exchange – slightly higher than mining-related companies – global demand for oil and gas is also driven by China.

Canada is not yet heavily tied to China, with the United States still accounting for the vast majority of Canadian exports. And unlike Australia, mining investments aren't the major leading growth driver in Canada.

As analyst Andrew Garthwaite at Credit Suisse noted during the summer, mining capital expenditures in Australia have doubled as a percentage of gross domestic product since 2008.

Because Australia is so correlated to Chinese growth, he advocated shorting the Australian dollar and Australian stocks as "an effective way to short China."