Australia | Dec 06 2007
By Greg Peel
At first glance the September quarter GDP figures released yesterday showed an Australian economy that was still very strong. Bear in mind, these numbers cover the period from July to September in which the credit crunch first hit and in which the US Federal Reserve temporarily reversed global stock market sentiment with its “shock and awe” 50 basis point rate cut. Since that time, another 25 point cut has been forthcoming but it has become apparent that the credit crunch is getting worse and that the Fed will probably cut further. It’s only really been since the end of September that real recession fears have grown in the US.
Note also that within the period, the RBA raised its cash rate by 25 basis points which represented the first rise since November 2006. It has since raised another 25 basis points in the unprecedented election campaign move.
The point here is that the world suddenly woke up to the subprime crisis within this quarter, and from an economic point of view would not have really reacted much yet. There was a bit of an initial scare, until it seemed clearer that Australia’s exposure was limited. The Australian consumer was hit with only one rate hike after nine months of spending freely. Economists in the US have already largely dismissed US September quarter growth of 4.9%, suggesting the numbers represented a superseded era.
Nevertheless, Australian growth of 1.0% was right on expectation and agreed to be strong by all observers. The annual rate of 4.3% growth compared to a 3.7% measure after the June quarter. It was of little surprise that household consumption was clearly the major driver of growth, rising 1.2% in the quarter. Annual domestic demand growth measured a very strong 5.5% for the 12 months to September.
Macquarie’s economists have been arguably among the most bullish of their peers. They suggested this morning the GDP figures indicated an “economy with considerable momentum” but also with a good balance of growth. The momentum factor may prove important, because as we are now almost through the fourth quarter the Australian economy is beginning to look not so much like the little train that could, but more like the little train that may or may not.
While the quarterly figure of 1.0% growth was as expected, the 4.3% annual rate actually missed the consensus mark by a long way. Economist forecasts had averaged 4.8% (Macquarie was 5.0%), and the difference came from a revision of growth numbers for the two previous quarters. June saw 0.2% shaved off and March 0.3%. While not exactly sounding alarm bells, these revisions have snapped some economists out of their previously hawkish biases.
Merrill Lynch suggests that perhaps the “biggest story” to come out of the Accounts was the deteriorating trends in costs (ie higher) and productivity (lower). Productivity fell 0.9% in the quarter while unit labour costs surged by 1.6%. “As wage and cost pressures increase,” note the economists, “corporate profit growth is starting to stall”. They point to a “decisive” shift down in profit as a share of national income, noting this figure is now down 0.8% from the peak in March. As a consequence, Merrills believes the Australian domestic growth cycle is peaking.
UBS economists point out that 2007 started with a significant upward revision to previous GDP figures, but the third quarter has now brought significant downward revisions. While 4.3% growth is still strong, the revisions have “taken some of the heat out of the economy’s perceived pace”. Such a turnaround sits in comfortably with UBS’s view that global economic growth is going to slow “noticeably” from here. As such, the economists believe that Australia has reached the top of the current cash rate cycle (after ten interest rate rises since the trough of 4.25% in December 2001).
In other words, UBS does not believe the RBA will hike again in the near future. Nor does Merrill Lynch, whose economists are calling the RBA on hold for the first quarter of 2008.
The economists at GSJB Were are even more emphatic. Australian economists had not only the National Accounts to absorb yesterday, but the first ever RBA statement to accompany a non-change in monetary policy. Unlike the September quarter numbers, the RBA’s view expressed yesterday is right up to date. To Weres, there were three major factors highlighted in the statement.
The first is that the global growth is now expected by the RBA to be “closer to trend” in 2008 rather than “above trend”. This is a subtle, but nevertheless decisive downgrade. Inflation is still the major concern of the RBA, but while the central bank sees inflation pushing outside its 3% comfort zone in the first half of the year, it sees this as only being temporary. Thirdly, the RBA has acknowledged that financial markets will probably do the work for them anyway, given tightness in global credit markets is already resulting in independent borrowing rate hikes of as much as 25 basis points from some financiers.
Due to all of the above, Weres suggests a further rate hike “can’t seriously be entertained in the first quarter, 2008”.
JP Morgan economists have also picked up on the borrowing cost theme, and they expect the big four banks to raise their own rates by 25 points before year end. This would be the equivalent of a 14 basis point hike from the RBA, they suggest. However, “In our view…the rise in mortgage rates does not cancel out the need for the RBA to raise the cash rate one more time,” they offer. “Inflation pressures are too large to ignore”.
And therein lies the balance. Even the RBA believes inflation will push over 3% next year, given the continuing pressures of strong domestic demand, rising wage costs and overstretched capacity. However, the RBA’s intention in raising rates is to soften domestic demand to a more manageable level. There is every possibility a combination of a slower global economy and continuing credit market disruption will achieve this anyway, and the RBA has articulated that possibility.
Which is why ABN Amro economists are less specific in their own interest rate view. The RBA will raise rates again, ABN suggests, if credit markets settle down and the global economy is not in as bad shape as many are now fearing. But de facto rate rises from banks can yet achieve RBA policy, so ABN is not making any commitments at this point.
But despite a change of mood from its peer group, Macquarie remains steadfast.
Australian firms are still planning an aggregate 20% increase in investment in FY08 (at least on last count), Macquarie notes. Household building approvals are ticking up, and state governments are boosting infrastructure budgets. But most importantly, household budgets are in good shape. Yesterday’s Accounts show household saving has reversed from -0.2% a year ago to +3.2% in September. At the same time, household consumption has increased by 4.5% year on year. Taking into account the last tax cuts and rate rises, household disposable income has grown by an impressive 10% over the last year, Macquarie calculates. And of course, there’s another $105 billion in tax cuts yet to come.
What this means is the average Australian is in a good position to weather the storm of higher interest rates and higher petrol prices, the economists believe. In other words, Aussies will keep on spending, the economy will remain strong, inflation will rise, and the RBA will need to raise rates again.
Macquarie economists paint a compelling picture, but one by one their peers are beginning to turn the other way. As is usually the case, the only certainty at this point is the uncertainty, made even more significant by the global credit crunch which is as yet unresolved. With only a handful of days to go, the world cannot agree on whether the Fed will cut rates or not, or if so by 25 points or 50. It is hardly surprising then that Australian economists are struggling to agree on probable RBA policy in February.
But then it’s hardly surprising that economists don’t agree.