Australia | Mar 10 2008
By Chris Shaw
In the month since its February market outlook document Westpac notes there have been a lot of poor economic data coming out on the US economy, which has had the effect of weakening both the US dollar and global capital markets. At the same time commodity prices have continued to push higher, the bank suggesting this is reflective of the growing split between growth performance in emerging and advanced economies.
But how does this play out for the Australian economy? In the bank’s view domestic demand remains quite strong, which sets the scene for 2008 to be another year of solid economic growth given investment, construction and employment momentum all remain at high levels.
Senior economist Matthew Hassan is forecasting GDP growth of 3.8% this year, which allows for some slowing in demand growth as evidenced by the latest estimates by the Reserve Bank of Australia (RBA). While other factors such as the US economic outlook and global credit market issues will weigh on performance this will be offset in the bank’s view by ongoing improvement in the terms of trade and a continuation of the investment boom, which will ensure the labour market remains tight.
This tightness in the labour market has some policy implications, with global head of economics Bill Evans pointing out the wage pressures created by the tight labour market will remain at least until well into 2009 especially as Australia’s terms of trade should continue to improve. This implies an ongoing boost to domestic demand, which in turn implies the outlook for inflation is for continued strength.
This leads Evans to suggest the RBA will need to move to an overtly tight monetary policy position if inflation is to be brought under control, so his view is further increases in interest rates can be expected and rates are likely to stay high for some time.
He points out the latest rate hike was inevitable as on the RBA’s numbers assuming no change in policy underlying inflation would have been above its target range, a situation that simply couldn’t be allowed to exist without some policy action. This means the next RBA forecasts for underlying inflation on May 9th will be important as if the outlook is again for inflation to be above its target range assuming no change to policy then rates will have to go even higher.
Evans argues those in the market starting to price in rate cuts by the end of 2008 have it wrong and rates will stay elevated for some time given the inflationary pressures, which will also support the Australian dollar. His view is the weakness post the latest rate hike was simply a market reaction and so will prove only temporary, the bank expecting the dollar to hit 96c against the US dollar in coming months and to continue trading in the mid-US90c range until well into 2009.
For the US dollar the bank sees weakness continuing until mid-year prior to a small bounce on the back of better economic data in the third quarter. This bounce is not expected to last long though as the bank expects data to indicate the US economy will remain weak in 1H09 and this will see new selling pressure hit the greenback. Only when the US housing market shows signs of recovery, expected in 2H09, will the US currency bounce for real.
Underlining the secular nature of the downtrend in the currency the bank notes most actively traded currencies have gained against the greenback this year, this despite each currency’s economy having markedly differing fundamentals with respect to terms of trade, interest rates and domestic demand.
According to senior international economist Huw McKay this means other currencies are likely to end the year at substantially different levels to where they are now, with the bank’s estimates calling for the US dollar/euro rate to hit 1.60 against almost 1.54 now, the yen to move below 100 against 102 now and the Canadian dollar to appreciate by around 10% from its current level of around 99c.
For the EU and UK the bank notes while economic growth is slowing there is still some resilience, though the European Central Bank’s hawkish outlook on inflation will eventually relent and rates will come down as they already are in the UK. As economist Andrew Hanlan points out, this will represent a shift in emphasis from controlling inflation to supporting growth.
Japanese headline growth in the fourth quarter was surprisingly strong but McKay doesn’t see this as necessarily sustainable, as the data remain mixed and the trend is in fact softening. With few signs of sustained inflationary pressures and labour market conditions less tight than a year ago his expectation is for the Bank of Japan to remain on the sidelines in terms of changes to interest rates.
New Zealand’s Reserve Bank is also expected to remain on hold as while inflationary pressures remain the bank notes the weak housing market and the cloudy global growth outlook will necessitate a more cautious approach. Chinese economic growth is tipped to slow in the March quarter due in part to the bad weather experienced across much of the country, while the impact on food and fuel prices means inflation is likely to push higher in the June quarter.
This implies a slowing in growth for 2008 as a whole, though McKay expects still robust growth of around 10% for the year given domestic demand, consumption and investment should stay firm.
For oil prices the bank sees scope for prices to remain elevated, as while OECD demand is slowing thanks primarily to weaker US demand the emerging economies have stepped in to fill this void and will continue to do so, especially as the supply side response should be limited enough to see the market tighten further.