Australia | Oct 26 2007
By Chris Shaw
According to Commonwealth Bank economist Joseph Capurso the shift in rhetoric by the US Federal Reserve to a focus on the downside risk to economic growth rather than the upside risk to inflation is significant, but regardless of how the US economy performs there is no reason the global economy cannot remain strong.
Decoupling from the US economy is one factor, Capurso pointing to a number of countries having reduced trade exposure to the US when compared to historical levels as well as growth in domestic economies in Europe and Asia as evidence of this trend and as support for a positive global outlook.
This divergence in growth between the US and Asian economies in particular is of importance for Australia given it is a commodity supplier, which is good as Asia is a buyer for Australian products but also as Capurso points out because a stronger mining sector supports growth elsewhere in the Australian economy.
As he notes, building new mines results in a significant increase in construction output, while also lifting wages and employment. As incomes rise so too does spending, which supports growth in the overall economy.
The other benefit is higher mining prices support the currency and as it appreciates import prices are reduced. This allows for increased spending not only on imports but also on domestically produced goods, creating a ripple effect across a number of industries.
The China effect of lower manufacturing prices also plays a role as Capurso estimates a permanent 1% decrease in world manufacturing costs could boost the retail, construction and service (accommodation, cafes and restaurants) sectors of the economy by as much as 3% in less than a decade.
With the strong parts of the Australian economy – capital expenditure, public spending and the labour market – expected to remain strong the implication is the growth outlook for Australia will therefore be largely unaffected by a slowing in the US.
Capurso’s estimates support this view, as he forecasts GDP of 4% for FY08 and 4.4% for FY09, with the cash rate at the end of each year expected to be 6.5%. The major loser in his estimates is the Australian dollar, as after ending the current financial year at close to 95c he expects it to fall to around 80c by the end of FY09. He forecasts the Core CPI rate ending this financial year at 3% before declining slightly to 2.8% by the end of FY09.
While these forecasts rely on the US economy slowing rather than entering a major recession the bank’s Nicola Chadwick expects the Federal Reserve to take further action in an attempt to prevent a recession occurring.
This action should take the form of a further cut to both official interest rates and the discount rate, Chadwick forecasting both will be cut by 0.25% when the Fed meets next week.
She suggests the cut will be to provide additional insurance as there remains downside risk to consumption from the slowdown in the housing market, as evidenced by a fall in consumer confidence levels in recent months.
This may not be the end of the action by the Fed, as Chadwick points out a further cut to interest rates may be made in December if the economy continues to show evidence of downside risk.