Australia | Sep 06 2007
By Chris Shaw
As the credit crisis in the US economy plays out and financial markets globally try to assess what damage if any the issue has caused, TD Securities senior strategist Joshua Williamson has attempted to assess the impact on the Australian economy given its strong market and trade flows with the US.
He has taken two approaches, the first being to assess how the Australian economy has coped in previous times of financial market shocks. Here the news is good for domestic investors as he points out past versions of market shocks such as the Long-Term Capital Management and Russian debt default crisis of 1998 and the East Asian crisis of 1997 had little actual impact on the health of the Australian economy.
In part this reflects the significant reforms to the Australian economy made over the past 25 years, ranging from deregulation to a greater liberalising of the labour and product markets, which he suggests has left Australia’s domestic economy in far better shape to cope with global fluctuations.
The second approach was to consider Australia’s current economic fundamentals and the scope for any similar problem to emerge domestically as has come to the fore in the US.
Again the news is good as he notes the level of exposure to sub-prime mortgages in Australia is significantly lower at around 1% of mortgages compared to around 15% in the US, which is a positive for the domestic housing market.
This is significant as a solid housing market underpins domestic consumption and it has been the domestic consumer that has driven the US economy in recent years so any slowing of their activity would suggest negative implications for that country’s overall economic growth.
Another potential negative for growth both in Australia and elsewhere in the world is an increase in credit costs, which has happened in recent weeks as the volatility in credit markets has driven up borrowing rates.
This increase is most likely to impact on business investment and household consumption, but again both areas look strong in the Australian economy in Williamson’s view.
The fact most mortgage holders in Australia have positive equity in their homes means they are not subject to the same issues as those US house buyers who now cannot meet repayments and have homes worth substantially less than what they paid for them, so domestic consumption is likely to remain solid.
Australia’s businesses also are showing signs of confidence as Williamson points out total private business investment rose 14% year-on-year in the June quarter and expectations of future capital expenditure are up 24% on a year ago.
His conclusion is the Reserve Bank of Australia (RBA) will continue to focus its attention on inflation rather than fluctuations in borrowing costs in capital markets, so he sees no change to the tightening bias in place and the likelihood interest rates will go higher in coming months given the expectation of increasing inflationary pressures.
The TD Securities timetable is for a rate increase either late this year or early in 2008, with the latter considered most likely. Macquarie agrees, noting an increase at the next available policy meeting in October would not give the bank enough time to fully assess the impact of the current crisis.
While Australia is likely to experience a rate hike the situation is different in the US as Williamson is expecting the Federal Reserve to cut rates in coming months, with a 0.25% decrease this month and another before the end of the year seen as likely.
New Zealand interest rates also have a softening bias in the group’s view and Williamson sees scope for as much as 0.75% in cuts through the course of 2008, with 0.5% of that by the end of FY08.
Canada in contrast can expect further hikes and like Australia Williamson expects two more increases of 0.25% each, likely in December and January.