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Australia and NZ - Weekly Prospects 19 May 2008

Australia and New Zealand - Weekly Prospects

* The flow of Australian data slows to a crawl this week, with only the consumer confidence reading (delayed to include reaction to last week's Budget) and the RBA's Board minutes likely to trouble the scorers. Last week's Budget was aimed at curbing inflation, but is likely to add to inflation pressure in the near term by pushing up prices for private health care and luxury cars. The RBA Governor's speech last week signalled clearly that the RBA will not be easing policy any time soon; our view is that the RBA is on hold, but the risk is that a further rate hike may be necessary. The tax cuts granted in last week's Budget could fuel a boost in household spending later this year, and the terms of trade bonanza (we forecast a 28% rise from here) will continue to support investment and employment.

* In New Zealand, the data last week showed that retail sales values slumped in March, and also fell sharply in volume terms over 1Q. Thus, as expected, private consumption will be one of the main drags on economic growth in the March quarter. Still, with significant price pressures in the pipeline - producer prices spiked in 1Q - we maintain our forecast that the RBNZ will not start easing policy until October. We will watch closely the Federal Budget this week. The Budget, to be delivered on May 22, will deliver generous personal income tax relief, which should help consumer spending post a modest recovery in 2H08.

* During 2H07, financial markets cowered in the face of a correction in US housing and credit markets that looked all too much like a 1930s horror movie. But as time has progressed, it has become clear that there is another equally powerful threat to global economic stability. For five years, a powerful set of reflationary forces - emanating largely from Asian demand and policy dynamics - have promoted strong global growth and firming pricing power. Reflation has been a significant positive force in the expansion, but global resource utilization and commodity prices have reached levels that are producing a sustained move upward in global inflation. How this epic battle between King Kong (the downturn in the credit cycle) and Godzilla (the upturn in global price pressures) unfolds is the key outlook issue.

* Central to the 2009 outlook will be how much steam this period of subpar global growth takes out of the inflation engine. With expectations for a modest rebound in activity along with high utilization rates and accommodative policy stances, we do not believe that Godzilla will be defanged. In short, we think that the imagery for next year will continue to be better described in terms of a Japanese monster movie than Goldilocks, or other fairy tales. Recent strong reports of 1Q GDP help explain the surprising strength of commodity prices. With global growth widely expected to move below trend as the year began, a significant leg down in commodity prices might have been expected, particularly for oil and base metals, which are the most sensitive to global demand. The realization that global activity instead remained near its trend pace last quarter - with strength concentrated in emerging markets - helps explain why this did not happen.


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