Australia | Feb 01 2008
By Greg Peel
The team at ANZ Economics this week released their global and Australian economic overviews for 2008. The following is taken, with permission, from that report.
The clouds hanging over the global financial market only deepened in the first weeks of 2008. To date, losses incurred by major banks have exceeded US$130bn, and with more to come it would not be surprising to see the final figure in the US$300-500bn range. More losses will eventuate if the US monoline insurers have their ratings downgraded, precipitating a mass sell-off of municipal and other bonds, and a rise in corporate bankruptcies would cause a fallout in the credit default swap market. The big falls in stock markets in 2008 have been due to fears such underlying forces, and the ongoing problems of falling US house prices and rising mortgage defaults, will send the US into recession.
As far as serious financials crisis go, this one is a biggie. And financial crises usually occur in, or lead to, recessions. Yet so far, if you steer clear of actual US housing data itself, there is little decisive evidence a recession is a certainty, particularly if you consider the US housing market peaked way back in March 2006. Recessions are usually preceded by a deterioration in the labour market, but this has not been the case this time. The December figures were indeed weak, however, so maybe we have to wait yet.
But the reality is that the (non-financial) corporate sector is in much better shape than it was ahead of, say, the 2001 recession. This means payroll and capital expenditures have not needed to be slashed. And the decline of the US dollar has also helped to facilitate an increase in US export earnings. This increase has added more to real GDP growth over the past 18 months than the decline in housing activity has subtracted from it.
The recession of 2001 was all about the response of the corporate sector to the slump in share prices (dotcom bust), while this time a recession will be determined by how the household sector responds to the slump in housing prices. Housing busts always have a deeper wealth effect on consumption than share price busts, despite share price busts actually involving more money. Housing recessions also tend to last longer.
However, consumption downturns due to housing busts have historically occurred at the same time as the housing bust itself, whereas share market busts tend to evoke a decline in economic activity around three quarters after the event. It is now six quarters since the housing peak, yet the first sign of contraction has only just occurred (fourth quarter US GDP 0.6%, down from 4.9%). Furthermore, mortgage holders tend to experience a rise in interest rates prior to a recession, but this time the rise had been mild. This means while householders might become cautious about spending, they won’t necessarily curtail spending so much as to cause a recession.
Ultimately ANZ expects the first half of 2008 to be soft in the US, with the economy slowing but not necessarily reaching negative growth in consecutive quarters. An aggressive Fed has curbed the panic in financial markets, and the rate cuts will take time to affect the broader economy. The Bush Administration’s tax relief package won’t kick in until June.
Weaker import demand from the US will particularly impact on Japan, where there has also been an abrupt contraction in housing activity. Uncomfortably high inflation rates in Europe will make central banks hesitant about cutting rates, despite slowing economic growth. The UK is even worse off, with a contraction in financial sector activity and yet more declining house prices. ANZ sees developed world economic growth slowing to 1.75% in 2008 from 2.2% in 2007 – the slowest rate since 2003. (While this may not seem like much of a difference, it still means a 20% reduction in growth).
Developing countries had suffered very little from the turmoil in the US and Europe, at least until a bit of a January share market sell-off. As developing countries are running large current account surpluses and have accumulated substantial foreign exchange reserves, they are far less vulnerable to changes in capital flows than they were in the 80s and 90s. Indeed, developing country sovereign wealth funds have become a much needed source of funds for Western banks struggling with capital issues.
Most importantly, it is domestic demand driving the growth of developing economies. Of China’s 11.5% growth in 2007, for example, only 2.5% came from net exports, and the percentage was even lower in India. Neither country has truly “decoupled” however, and export slowing that began in 2007 will continue in 2008. China’s domestic demand may also slow somewhat in 2008, affecting smaller Asian economies.
All in all, global investor sentiment remains fragile, despite Fed cuts. It would be premature to assume markets have bottomed. The turmoil of the last six months will trigger a range of broad and long-lasting consequences. Prudential regulation of banking systems will be tightened following such debacles as subprime mortgages, complex derivatives, Northern Rock, and the SocGen fraud. Sovereign wealth funds will become more powerful. The US will become less powerful.
In Australia, the question must be asked as to whether a record 16 straight years of economic growth will now come to an end. ANZ thinks not.
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, Australia’s growth was showing considerable momentum – above trend and accelerating. This was despite already rising fuel prices and interest rates.
Global economic growth is slowing, but mainly in Japan, the US and, to a lesser extent, Europe. The economy with the most relevance to Australia is China’s, and that is expected to remain robust. 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.
And it’s been raining.
ANZ suggests 2007 will show a 4% rate of economic growth, and predicts both 2008 and 2009 will achieve 3.5%. Australian consumers are still spending at a record pace. This spending is supported by ongoing gains in household disposable income. This has occurred despite interest rate rises, and without Australians having to dip into savings. The savings rate is now slightly positive.
Business investment has been booming, and shows no signs of slowing down.
Australia does, however, have a problem with inflation. Fortunately the new government has placed the management of inflation at the forefront of its economic policy objectives, but government initiatives will still take time to have an effect. Employment growth remains strong and participation rates continue to climb, but wage pressures are building nonetheless. The good news is that Australia boasts the most independent central bank in the world, and that bank’s objective is to fight inflation come what may.
It doesn’t sound like doomsday stuff.
