FYI | Jul 13 2009
By Chris Shaw
According to Westpac senior international economist Huw McKay there wasn’t one single factor that drove the correction we have seen in global markets in recent weeks, rather it was more a combination of the market becoming exhausted from its rally from early March and an overall recognition global demand remains weak and productive capacity is excessive, both of which suggest further tough labour market conditions for some time.
These factors support the bank’s caution with respect to the growth outlook for both the developed world and highly leveraged emerging economies, while in contrast Westpac remains more optimistic on the future for those emerging markets where national balance sheets are strong and structural growth fundamentals remain intact despite the downturn.
In terms of how this plays out in expectations, McKay is forecasting global growth of minus 1.4% this year before a recovery to 2.5% growth next year, with China expected to deliver relatively steady numbers and economies elsewhere, Europe excepted, posting mildly positive growth in 2010.
Looking at the Australian economy the bank notes manufacturing activity continues to contract at a pace last seen in the 1990/91 recession, with sentiment suggesting a further mild contraction in the September quarter as business spending is expected to fall further, helped by the fact credit remains tight.
This is flowing through to an outlook for unemployment to move above 8% sometime in coming months given cost expectations remain above price expectations, meaning firms will be cautious on labour levels while margins remain under pressure. This can be seen in the fact 12-month profit expectations are at their equal third weakest level on record of minus 8%, which compares to a decade average of positive 13% growth.
Despite the expectation of a further deterioration in the labour market, Westpac now sees an earlier bottom for this measure than it had previously anticipated, with the final quarter this year now likely to be the low point rather than early in 2010 as it had been expecting. This means unemployment should now top out at around 8.2%, down from the 9.0% the bank had previously forecast.
First home buyer incentives have supported the housing market but the bank notes there has been a broadening of demand of late as upgraders have entered the market in bigger numbers. Investors need to follow through to keep the sector’s momentum going but the bank suggests with price expectations jumping recently such a trend may emerge in coming months.
For households the combination of low interest rates and fiscal stimulus has worked to keep consumer demand at reasonable levels, though the bank notes the winding down of stimulus measures poses a significant headwind in coming months and in the December quarter in particular given expectations of further deterioration in labour market conditions.
In terms of what this outlook implies for the Australian dollar the bank’s chief economist Bill Evans notes while the Australian dollar rose strongly in the June quarter he was consistently skeptical of the move given markets appeared to be moving ahead of the pace of real economic activity, so increasing the risk of a correction.
This outlook has come to fruition in recent weeks and Evans sees the global mood now as one of increasing pessimism for the economic outlook, so even allowing for some good domestic economic numbers the Australian dollar appears likely to trade lower in coming months.
This is despite his view the Reserve Bank of Australia (RBA) is now on hold with respect to interest rates, unless of course there are some data shocks that necessitate a further easing. Looking ahead the interest rate outlook depends on the path of the economic recovery, Evans suggesting the RBA is likely to be very cautious with respect to normalising rates as they attempt to avoid killing the recovery before it takes hold.
This implies any initial rate hike will be left as late as possible but once the normalisation process gets underway Evans expects the RBA will move swiftly and rates should be back to neutral levels by 2011 before becoming contractionary at between 5.0-6.5% sometime in 2012. In growth terms the bank is forecasting GDP growth of minus 0.6% this year before an improvement to 1.0% in 2010.
In New Zealand the bank suggests optimism is slowly returning to the economy as confidence has recovered somewhat and net migration has increased of late. The current half should see growth again turn mildly positive with the bank forecasting GDP growth of minus 2.1% this year and a recovery to 2.6% growth in 2010, which suggests the Reserve Bank of New Zealand is now likely to keep rates on hold.
Looking at other economies Westpac suggests in the US firms have adjusted well to the collapse in demand as the inventory de-stocking phase appears to have about run its course. There are also signs the long housing market correction is creating a base for the future and while these are positives the bank notes the future still hinges largely on the US consumer given fiscal stimulus measures will weaken next year.
This implies while conditions are improving from very weak levels there are few signs yet of a durable recovery and so 2010 GDP growth is forecast at a modest 1.4%, though this is well up from the expected outcome this year of minus 3.1%.
In Europe there are less positive signs as the bank notes credit markets remain in a difficult state and activity levels continue to contract, somewhat reflecting a problem in economic structure given Europeans tend to be high savers and their economies tend to rely on exports for their growth.
While the UK economy appears closer to a bottom than is the case on the European mainland the bank remains cautious on the region overall and so expects GDP growth for Europe overall of minus 4.9% this year, while 2010 should still be negative at a forecast of minus 0.2%.
In Japan the bank also sees some tentative signs of recovery but cautions these are reflective of a re-stocking phase rather than a self-sustaining upturn. With external demand likely to take a significant period of time to strengthen noticeably and given the wealth destruction households have suffered from asset price declines, the bank sees little to get excited about, forecasting growth of minus 6.8% this year and modest growth of 1.4% in 2010.
In China the evidence suggests domestic investment has de-coupled from exports and with public projects giving the economy as a whole a push along growth remains on an upswing in the bank’s view. Its forecasts reflect this, with growth of 7.5% expected this year followed by 8.3% in 2010.
