Chief economist update: Lower iron ore a boon to the Aussie budget

"It was the best of times, it was the worst of times..."
- Charles Dickens, A Tale of Two Cities.

In the case of iron ore prices, it's a tale of two markets this year - a bull market in the first half; a bear market in the second half.

Iron ore fulfilled the condition for a bull market (defined as a 20% increase from its nearest bottom) this year in mid-June this year when prices rose by 21.6% to US$102.76/tonne from the (March) 2019 low of US$84.53/tonne.

Sure enough, the optimism engendered by the bull market took prices even higher to a peak of US$123.19 in July that was quickly followed by a dive into a bear market (defined as a 20% increase from its nearest bottom) with prices dropping by more than 20% to US$96.56 a month later.

Reduced supply - due mainly to the mining dam disaster in Brazil - and increased demand - due to higher Chinese steel production - sent iron ore prices soaring in the first half of this year.

These main "up" factors started to unwind by the second half. Supply started to recover and Chinese demand for steel fell and steels mills are even reportedly reducing their inventories.

Iron ore is currently trading at US$81.36/tonne. Whether it goes up, down or remains steady from here has a direct bearing on Australia.

Where iron ore prices go directly impacts the domestic economy and the budget.

In the Budget Papers 2019-20, the Australian Federal Treasury assumed iron ore prices to fall to US$55/tonne this year and the next and at the same time provided a sensitivity analysis that showed: "An increase of US$10 per tonne FOB in the iron ore price results in an increase in nominal GDP of around $6.3 billion in 2019-20 and over $13 billion in 2020-21. 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".

Correspondingly, an increase/decrease of US$10/tonne in the iron prices will raise/lower tax receipts by A$1.1 billion in 2019-20 and by A$3.7 billion in 2020-21.

Current iron ore pricing - around A$30/tonne above (even more when averaged over the fiscal year 2019-20) the Treasury's assumption - further cements the government's claim that it would produce the first budget surplus since 2008 ... and then some.

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