Australia and NZ - Weekly Prospects 10 June 08
Australia and New Zealand - Weekly Prospects
• Australian economic data were mixed last week. GDP growth surprised on the upside, the current account and trade deficit narrowed more than expected, and retail sales unexpectedly contracted in April. The RBA's decision to leave interest rates steady was, however, widely anticipated. This week brings the release of more key domestic indicators, including home loans, consumer confidence, and employment. These indicators will probably signal that domestic demand has eased further in 2Q. Home loans are expected to fall again in April, consumer confidence is set to rise only mildly in June, and employment growth is expected to moderate in May.
• In New Zealand, the highlight last week was the RBNZ's monetary policy statement, which signalled that the Bank may lower the OCR later this year. The RBNZ left rates steady as expected, amid rapidly slowing economic growth and elevated inflation, but we maintain our forecast that the RBNZ will cut the OCR 25bp in October and December, and again in 1Q09. This week's retail sales data should confirm that consumer spending remains subdued under the weight of record high interest rates.
• The ECB signaled that it is willing to raise rates in order to ensure that inflation expectations remain contained. Anchoring inflation expectations is central to every central bank's mission, but it is hard to think of a recent occasion in which a major central bank has tightened policy from a point of rest against the backdrop of a deteriorating growth outlook. In taking this action, the ECB is breaking new ground and challenging our view that central banks would "talk loudly and carry a small stick" through the end of this year.
• Our forecast for Fed policy already incorporates much of this thinking. Unlike in the past three recession episodesâ€”when the Fed waited until the US unemployment rate had fallen for 12 months (June 2004); 20 months (February 1994); and 16 months (March 1984)â€”we expect the Fed this time to begin normalizing policy 3-6 months after the US labour market finds its footing. In our forecast, this places the start of the tightening process in 2Q09. We have not until now seriously considered the possibility that the Fed could choose to take a limited step while the economy is still weak but displaying a lower profile of downside growth risk.
• The emerging economies have released a wave of upside May inflation surprises, including in Asia. This week's reports are likely to show that China was an exception. The forecast calls for inflation of 7.7%oya in May, down from 8.5% the previous month. Key is that food inflation, which hit 22%oya in April, finally appears to be coming down, based on our tracking of daily and weekly food price indices. Food price inflation should trend lower in coming months and headline inflation should follow, but only to a point: as headline inflation subsides, the government is expected to resume its price liberalization reform drive later in the year.