FYI | Jan 08 2008
By Chris Shaw
Investors hoping a new year would “wash away†the sub-prime related troubles that emerged in the latter part of last year won’t be cheered by the 2008 outlook of Commonwealth Bank chief economist Michael Blythe, who cautions the slow “drip-feed†of bad news is likely to continue.
Nowhere will this be more evident than the US economy, where the combination of the problems on Wall Street, higher funding costs and higher oil prices have a chance in his view of flowing through into the broader economy, particularly as the US housing downturn has not yet reached a bottom.
On the positive side though Blythe retains his view the US economy will be able to avoid recession this year, though it will endure a period of below trend growth and the length and severity of this period remain uncertain.
Despite this Blythe remains positive on the global economy as he continues to take the view the rest of the world is de-coupling from the US, as evidenced by the fact the correlation between the US and global growth has halved over the past 10 years.
Japan and Europe are not expected to be major factors in driving world growth as both economies have struggled of late but Asia ex-Japan remains strong and the China (and India) effect continues to support the outlook of solid global growth, with forecasts calling for an outcome of better than 4% in 2008.
Assuming this is the case the outlook is for ongoing strength in the Australian economy, as solid global growth supports the outlook for continued strength in commodity prices. In addition, the convergence theory for the domestic economy of the strong sectors staying strong and the weak sectors improving is forecast to continue, though Blythe notes so far there has been little evidence of this in terms of an improving housing sector.
As inflation has been a key focus for policy makers in Australia in recent years the good news according to Blythe is there remains scope for the inflation outcome to be better than currently expected, this despite the inflationary pressures of rising food prices and oil at nearly US$100 per barrel.
Such an outcome will require further expansion on the supply side of the economy, meaning increases in capital and labour. It also reflects the bank’s view the Australian consumer will tend to be more conservative this year, with Blythe suggesting there are some early signs this is in fact proving to be the case.
Short-term though further policy moves will likely be required to bring inflation under control after it pushed higher late last year, with Blythe expecting a rate hike in February to bring the cash rate to 7.0%.
With further interest rate cuts seen as probable in the US the interest rate differential between the Australian and US economies should widen further over the course of the year, an outcome likely to prove supportive to the Australian dollar.
The headwinds facing the US economy should continue to weigh on the greenback in Blythe’s view, though upward corrections can be expected over the course of the year. This environment should also prove supportive for the euro, so Blythe sees 1.42-1.43 against the US dollar as likely support levels for the European currency.
The yen should strengthen a little further against the US dollar but in Blythe’s view 105 against the greenback is likely to be the extent of any move barring a bear market in global equities.
With this in mind Blythe expects the Aussie will again test US90c sometime over the course of 2008, though longer-term the upside is expected to be capped as the US economy gradually improves later in the year.
Given the position of the Australian dollar as something of an indicator of the health of financial markets the current uncertainty gives room for further weakness in the currency short-term, with US82c seen possible in the early part of this year.
