Australia | Dec 01 2008
By Andrew Nelson
The latest 3Q data doesn’t bode well and an almost certain domestic recession is going to be compounded by a sharp fall in inflation and ongoing problems in the banking sector. At least that’s what Global Strategist and Managing Director of TD Securities Stephen Koukoulas thinks and he’s predicting the RBA will be forced to cut the cash rate towards 2.5% by the middle of 2009.
Commenting on his company’s TD Securities-Melbourne Institute Monthly Inflation Gauge for November, Koukoulas believes Australia’s CPI is likely to fall 0.45% in the December quarter. This would put the annual inflation rate at or below 2% in the March quarter 2009 and a rate below 1.0% by the second half of 2009. And this time around, decreasing inflation isn’t good news, as it is acting as a harbinger for even tougher times to come.
Koukoulas admits it is a bit early to be making firm and accurate predictions for the March quarter CPI, but he notes that recent commodity price trends suggest only a small rise for the March quarter. If that were the case, inflation will threaten to fall below the bottom of the RBA target band by late 2009.
This sharp fall in inflation in the months ahead, coupled with the continuing decline in global economic growth, falling commodity prices and weakening domestic demand will all help to bring about the significantly lower official rates Koukoulas is forecasting.
How?
Firstly, the RBA will keep cutting interest rates to ensure it stops what is quickly appearing to be free-falling inflation before it turns into spiralling deflation. It will take very low rates to work against deflation risks, which looks to be unfolding for the first time in the last 50 years or more.
Koukoulas reasons the central bank will also look to free up cash flows for those with high debt levels. This will help to get the borrowing costs of both households and corporates down to levels that allow for a more stable jobs environment and should offer support and hopefully increase both spending and investment.
The credit crunch put the clamps on credit growth, with personal credit and business borrowing leading the way down. Koukoulas says this is part of an inevitable and necessary de-leveraging process across the economy, with investors shying away from more debt, which isn’t helped by concerns about the outlook for house prices. Koukoulas notes real credit growth has slowed to almost zero, close to the lowest level in the last 25 years and he thinks it highly likely, if not certain, that real credit growth will weaken further.
On his numbers, even if about 90% of official rate cuts were passed through to end borrowers, variable mortgage interest rates would drop to around 5.0%. This is about 100bp below the low point of previous cycles. Given the severity of the problems confronting the economy, Koukoulas thinks this sort of stimulus seems about right, as it will also allow for some margin building and thus higher profits in the banking sector.
At the same time, wages growth will likely slow given expected increases in the unemployment rate given the current economic slow down. A sharp rise in unemployment coupled with a pronounced slowing in wages growth could deliver the necessary low inflation readings over the medium term.
At the same time, Koukoulas points out that business confidence is currently at record lows and is now entirely consistent with a recession. In fact, he notes the various recent ISM type surveys in Australia are at levels that are generally weaker than equivalent surveys in the US, suggesting a very clear downside to the Australian economy.
Consumer demand is also extremely weak and highly indebted households remain under pressure from the prior period of monetary policy tightening. Falling wealth from investment losses, a still very high debt servicing burden and emerging concerns about employment security will do little to help. Koukoulas notes consumer sentiment is now at similar levels to that of the last recession in the early 1990s and coupled with the limitations mentioned above, points to further weakness in consumer spending over the medium term.
Global conditions are as bad if not worse, which suggests very strongly that the commodity price cycle will weaken further. Koukoulas thinks that if falling commodities will severely undermine the terms and trade, this will bring down national income. In fact, if commodities keep falling at their current pace, the loss of income for Australia “will be huge”.