Australia | Aug 06 2008
By Greg Peel
“Australia’s economy will continue to grow for another two years at or above trend. If anything, the problem will continue to be one of constraining growth in the face of rising inflation. In entering this period of turmoil [the credit crunch], Australia’s growth was showing considerable momentum – above trend and accelerating. This was despite already rising fuel prices and interest rates.
“There is little real sign of a ‘credit crunch’ in Australia. Australian banks have not posted major losses, and although borrowing costs are now higher, credit demand has not weakened” – ANZ economists, February 2008.
This article is not intended to put the boot into any analysts or economists who have happened to have made a few bad calls lately, but rather to highlight just how quickly the playing field has changed in Australia. Nevertheless, there has been a more than healthy dose of “credit crunch denial” pervading in Australia over the last twelve months, and it has taken a couple of events in recent weeks to spark a bit of a rethink.
The two events were firstly, the combined bank shocks from NAB and ANZ, which were specifically related to the old “subprime crisis” and to the specific effect on the Australian economy, while the the second was yesterday’s statement from the Reserve Bank. The former highlights just how 90% of bank sector analysts misread the credit crunch from Day One, and that latter shows how economists have, in retrospect, not faired much better.
In short it has all come down to misconceptions about Australia’s immunity to anything going on in the US, initially because we have minimal subprime exposure (now disproved) and also because we have China in our corner (now of little support).
Australian economic growth has collapsed before the population’s eyes, spurred on by what began as a slowdown in the US and became a global phenomenon. The credit crunch and rising interest rates and petrol costs have exposed not only overextended gearing among many an Australian corporation or investment fund, but also vast hidden leverage in stock market investments and a decade-long debt binge among the average Australian householder. The party is now over and the hangover is only just kicking in. Domestic demand has not slowed, as the Reserve Bank tried to achieve with its twelve incremental cash rate increases since May 2002 – four of them in the last twelve months – it has crashed.
By February it had become apparent to the world that the period of low global inflation had ended. Rising commodity prices turned around exported deflation from China and the Fed’s aggressive interest rate cuts killed the US dollar and sent commodity prices into an upward spiral. As late as June, the economists at ANZ were still expecting the RBA to hike twice more in 2008 – to 7.75% – as the oil price really took off and alarmists started calling 200 dollars. Although by June, the signs were showing the Australian economy was indeed beginning to slow, which saw ANZ begin to lose support from economist colleagues.
But ANZ was not alone earlier in the game. February also had Macquarie’s economists calculating that in order for the RBA to reduce inflation to the comfort level of 2-3%, the central bank would have to take rates to 8.00%. Oil had just traded through US$100/bbl.
Today it is a different tune from both camps, and from all economists who spent most of early to mid 2008 fearing that climbing inflation coupled with ongoing strength in the Australian economy (don’t forget coal and iron ore prices have soared) would force the RBA to tighten aggressively. Today the consensus opinion is that the RBA will make its first rate cut of 25 basis points in September, followed by another very quickly thereafter, in either October or November. Beyond that, more cuts of 50 points in total will come in either early or mid-2009.
It’s a far cry from either 8% or “on hold for the foreseeable future”.
Whether this is actually good news is debatable. The last time the RBA engaged in an aggressive cutting cycle, it was for nine months in 2000-01, when the cash rate was cut from 6.25% to 5.00%. By December 2001 it had cut to 4.25%, but Australia endured a recession throughout 2002. The stock market drifted lower, then staged a recovery, only to drift lower again in 2003 as the RBA began its tightening cycle. Then China appeared out of nowhere.
Indeed, the Macquarie analysts are actually concerned the sudden turnaround in RBA intention suggests it might know something about the economy we don’t. “Has the RBA’s business liaison program revealed some financial fragility in the economy that has not yet been unveiled?” while suggesting that “for this reason lower interest rates are unlikely to be the green light for growth investors might hope for”.
The other big turnaround of course is in Aussie dollar forecasts. Given ANZ’s hawkish view on inflation and interest rates, the economists were also recently predicting a rate of US$1.04 by year-end. That forecast has now reverted to US$0.92 by year-end. We’re already below that. Fundamentally, notes ANZ, the Aussie is driven by interest rates and commodity prices. While rates are now set to move lower, commodity prices have already begun to drop dramatically.
In short, it’s now a very different landscape to that of only a month or so ago.