Chief economist update: Iron ore up or iron ore down?

Iron ore prices are going to go up. Iron ore prices are headed lower. Iron ore prices will go up and then head down.

These are the different forecast permutations on the outlook for iron ore. Here's a quick sampling of the Australian Financial Review's (AFR) report before iron ore prices hit a two-year high of US$92.19/tonne in February this year and after the Vale mine disaster in Brazil in late January 2019.

"The surge led Capital Economics to bet the price could spike as high $US100 a tonne in the weeks ahead before dropping back to $US65 by the end of the year. It also led Goldman Sachs to reset higher its price targets for the next three, six and 12 months. Fitch Ratings edged higher its iron ore forecasts to an average $US65 this year and $US72 in 2020."

In another AFR article, "Liberum reiterated its then expectation that iron ore would drop back towards $US50 a tonne later this year, and towards $US40 in 2020."

Latest trading stats indicate that iron ore prices are heading down - while up 19.0% this year to date, prices are 8.4% lower than their February 2019 peak.

This is because the disruption to supply from Brazil's mining disaster is being negated by the slowdown in China and its continuing effort to reduce pollution by restricting steel production (of which iron ore is the major raw material), notwithstanding Beijing's latest salvo at stimulating its economy through fiscal and monetary policies.

The price of iron ore is important for the outlook for Australia or as the Budget Papers put it, along with other commodity prices, "a key uncertainty in the outlook for nominal GDP."

The Budget Strategy and Outlook 2018-19 paper forecasts iron ore prices of US$55/tonne in 2018/19 and 2019/2020 while at the same time tabling a sensitivity analysis of iron price movements.

According to the Budget Papers, "An increase of US$10 per tonne FOB in the iron ore price results in an increase in nominal GDP of around $5.5 billion in 2018-19 and just over $12 billion in 2019-20.

Similarly, a decrease of US$10 per tonne FOB in the iron ore price results in a decrease in nominal GDP of an equivalent amount" and an increase/decrease in tax receipts of around AS$1.2 billion in 2018/19 and A$3.6 billion in 2019/20.

With iron ore prices averaging around US$72.31/tonne so far this fiscal year - nearly US$20 higher than Treasury's projections - they'll help counteract the slowing economy and at the same time allow Prime Minister Scott Morrison to offer some largesse in order for the Coalition to remain in government after the upcoming Federal elections.

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