Chinese manufacturing expands again. There were further signs of recovery of the Chinese economy with the HSBC “flash” purchasing managers index rising from 49.5 to a 13-month high of 50.4 in November.

Aussie dollar spikes higher. The Aussie dollar lifted to US104 cents after the latest data, providing complications for the Reserve Bank. The trade weighted index is only 3 per cent below record highs.

What does it all mean?

By all means Australia would prefer a strong Chinese economy as opposed to a weak economy. But the latest sign of recovery in the Chinese economy carries a sting in the tail. The Chinese manufacturing sector is picking up momentum, suggesting increased demand for raw materials such as iron ore and coal. But firmer demand for raw materials, also suggests stronger demand for the Aussie dollar. And that stronger currency will make life tougher for a raft of Australian industries including retailing, manufacturing, tourism and export industries more broadly.

The firmer Aussie dollar creates challenges for the Reserve Bank. If the Aussie dollar does indeed trend higher in
line with higher demand and prices of raw materials, then there is no issue, that’s what the currency is expected
to do. But if the Aussie rises further and faster than commodity prices then it represents a tightening of policy

About the only groups celebrating a firmer Aussie dollar would be consumers (buying goods online) and travellers (cheaper overseas trips).

Financial markets believe that there is a 61 per cent chance of a rate cut in December. Australian economic data has been soft, while the Aussie dollar has remained firm – the two factors arguing for a December rate cut. The offsets are stronger Chinese and US economic data. So it seems another coin toss whether the Reserve Bank cuts rates in December or holds off until the New Year.

CommSec is pencilling in a rate cut in February 2013. But the issue of an early rate cut is clearly “live”.

What do the figures show?

The HSBC “flash” Purchasing Managers Index for China lifted from 49.5 to 50.4 in November. Any reading above 50 suggests the manufacturing sector is expanding. It was the highest reading for the PMI in 13 months. The “flash” China manufacturing output index rose from 48.2 to 51.3.

The survey data was collected from November 12-20. The final November reading will be published on December 3.

HSBC notes: “The HSBC China Report on Manufacturing is based on data compiled from monthly replies to questionnaires sent to purchasing executives in over 420 manufacturing companies. The flash estimate is typically based on approximately 85-90 per cent of total PMI survey responses each month and is designed to provide an
accurate advance indication of the final PMI data.”

What is the importance of the economic data?

“The HSBC Flash China Purchasing Managers' Index (PMI) has been created in partnership with Markit to provide the earliest indication of economic conditions in China.” The data is published a week ahead of the final PMI data every month.” The data has implications for Australian resources companies and the Aussie dollar.

What are the implications for interest rates and investors?

The latest economic data from China is encouraging. Not only is it encouraging for China, but also for Australia and the globe generally. The low point in the cycle appears to have passed, and further recovery is expected in China in 2013.

Further good economic news from China and the US will put upward pressure on the Aussie dollar. The US economy is gaining momentum on gains in housing and export sectors. If (when) the fiscal cliff issue is solved, there are few other negative issues to take its place.

We expect the Aussie dollar to be around US104 cents by end year and hover between US102-104 cents in 2013.

A rate cut remains on the table. But the Reserve Bank needs to balance better conditions in China and the US with uncertainty about Europe, soggy domestic conditions and a firm Aussie dollar