Australia | Jul 22 2008
By Chris Shaw
Given the high level of both nominal and real interest rates in Australia at present and with the fiscal policy setting slightly restrictive it is little surprise domestic economic activity levels are stalling, says TD Securities global strategist Stephen Koukoulas. He suggests a number of economic indicators are implying the economy is on the edge of a recession.
The only thing preventing the economy from fully sliding into a recession in Koukoulas’s view is the support being provided by the commodity price cycle, which leads him to suggest if or when this turns the economic environment could take a significant turn for the worse.
Already the numbers are showing Australians are finding the going quite tough at present, with tightening credit in the banking sector limiting the ability of both consumers and businesses to spend money, while the strength in the Australian dollar is severely limiting the level of non-resource exports.
With the global economy also slowing and so offering less support Koukoulas sees scope for Australian GDP growth to fall below 2% this year, while weak consumer sentiment suggests further falls in consumer spending, which is a concern given retail sales are already in recession as they have risen at less than the level of inflation so far this year.
Jobs growth has also softened in recent months and this should see unemployment slowly trend higher according to Koukoulas, though one positive is the tight job market has not spilled over into a breakout in wages growth. Despite this inflation is still a problem, though he suggests pressures here should slowly cool given the restrictive level of interest rates.
Putting all these factors together, Koukoulas argues the risks for the Australian economy, the Aussie dollar and interest rates are all skewed to the downside at present, as while a recession remains unlikely a return to a more neutral monetary policy setting should be expected.
This implies interest rates falling to levels of 5.5%-5.75% on Koukoulas’s estimates, though he notes if commodity prices turn down and the economy experiences a hard landing the cuts in rates could be more severe, which implies official rates below 5.0%.
Assuming his soft landing scenario plays out Koukoulas sees the Aussie dollar falling to around US$0.85, while a more protracted recession could see the currency back into the US$0.70’s range in his view. Either way Koukoulas suggests investors should be preparing for weak economic growth over the balance of this year and into 2009.