Planning for the future has been difficult for manufacturers in the face of ongoing challenges such as rising inflation and supply chain disruptions and uncertainties in the global economy.
Most manufacturers were forecasting operational cost increases in March 2022, according to CommBank’s Manufacturing Insights Report1. Since then, the impact of rising inflation and input costs such as raw materials and energy - has grown.
Many are questioning how long this situation will last.
Looking at where we are in the economic cycle is instructive, notably the Reserve Bank of Australia’s response to inflation and implications for economic growth.
Changes in the demand picture, driven largely by policy and economic developments in China also have a significant impact on steel price movements and the outlook for global sector fundamentals.
The outlook for the belt-tightening cycle
“Like many other jurisdictions globally, the Australian economy fared better than expected in the wake of the pandemic,” Philip Brown, Director of Fixed Income and Rates Strategy at CommBank told a recent event in partnership with the Australian Steel Association in Brisbane.
“Fiscal and monetary stimulus coupled with the vaccine roll-out supported the strong and sustained recovery.”
This has created a surplus of demand across the economy that’s underpinning inflation, Phil pointed out. As a result, the Reserve Bank of Australia (RBA) is raising rates while the Australian Government reins in spending to cautiously unwind that stimulus.
The CommBank team are already seeing signs of rate rises impacting non-discretionary spending, in essence, reducing demand.
“The volume of residential mortgages due to roll-off lower fixed rate terms onto higher rates in 2023 will deliver an effective interest rate rise next year, even if the Reserve Bank of Australia does nothing,” Phil said.
These are among the factors supporting the CommBank Economics team’s view that while the RBA will move to raise rates again later in 2022, it is likely to plateau after that. An expected slowdown in economic growth through 2022 and 2023, coupled with an effective rate rise, means the RBA doesn’t need to keep raising rates and will likely need to cut rates.
“One of the reasons that it's not going to affect the economy too negatively is because the labour market remains incredibly tight and possibly as good as it’s going to get in this cycle.”
Soft landing or hard?
Compared to other major global economies like the US and the UK, Australia is likely to have a softer landing taking into account factors such as the nation’s lower inflation relative to other economies and the commensurate central bank responses.
In the US, the Federal Reserve has a more hawkish stance and is still talking about trying to thread the needle between raising rates fast enough to control inflation without completely derailing the economy, Phil said.
“The Federal Reserve is not talking about that; they are talking only about rising rates fast enough to curb inflation,” he said. “The unwritten part is that it will cause a US recession next year, which is CommBank’s official forecast. We don’t have that problem in Australia.”
The Bank of England also recently changed its forecast, expecting inflation to be 13% and GDP growth to be minus 2%. Whereas in Australia, GDP growth might be 2% or 3%, slowing down from 3% or 4%, and inflation is higher than we’d like it to be, but far lower than other countries.2
The impact of negative real wages is also a consideration. Wages can start rising as people demand pay rises to keep pace with inflation, increasing the costs of production and goods, consequently causing inflation.
“This is known as the wage price spiral,” Philip said. “And while wages in the US are up 5%, increasing the risk of a wage price spiral, wage growth is currently more tempered in Australia despite anecdotal evidence to the contrary”.
The demand side of the steel sector
The impact of macroeconomic developments is also flowing through the steel prices, Vivek Dhar, Director Mining Energy at CommBank said.
Examining the demand drivers and outlook for steel prices, Vivek said as soon as Federal Reserve Chair Powell said there was a risk of recession in the US due to rising rates, steel prices started to correct.
“But what's so important about the falling steel prices is that it has been accompanied by a fall in steel production in all major producing economies except India”, Vivek said. “That gives you some idea of just how much pressure is coming on the demand side”.
The impact comes into sharper focus when considering China's outsized role in driving global steel demand, accounting for more than 50% globally. This makes China a uniquely dominant consumer compared to other metals and energy commodities markets.
According to Vivek, his is important due to recent policy changes in China that have constrained steel output following the stimulus-induced spike at the beginning of 2021. This, and uncertainty in China’s domestic sectors, including construction, has led to weaker demand and a persistent theme of negative margins for Chinese producers.
“However, while emerging market economies and developed economies are facing almost sustained slowdowns due to higher inflation,” Vivek said. “China has cut rates because their economy was slowing.
“I can't stress how counter-cyclical this turning point could be if China relaxes its output policy. Yes, there's pressure on the property sector, but there's a massive pipeline of infrastructure stimulus which can be activated and push the demand impulse higher in China.”
The role of energy in the steel price outlook
The impact of rising energy prices is keenly felt by steel manufacturers. One attendee at the event mentioned that there had been cases in the industry where higher gas prices have even led directly to cancelled contracts.
In terms of the impact of rising energy prices on steel prices, Vivek said when you see gas prices increase, you can almost think of it as a one-for-one kind of impact on steel when you talk about margin pricing.
Other consequences of higher energy prices could influence steel prices. For example, in Europe where Russia has cut supply, and the gas price is now closing in on between $80 to $90 a kilojoule depending on the day, it's leading to shutdowns for energy-intensive industries.3
“There is going to be repercussions, including that we're likely going to see the first notable slowdown in demand,” Vivek said. “But high energy prices could be a stop in terms of where prices end up. Because, if energy prices stay up, then it's hard to see steel prices continue to descend.”
“Steel may not have seen it yet, but you look at aluminium, you look at zinc, we've actually seen prices come back up because European supplies have been taken off the market.
“So, we are seeing the argument that prices may be close to bottoming if energy prices remain elevated”.