Australia NZ Weekly Prospects 25 August 2008
Australia NZ Weekly Prospects 25 August
Last week's minutes from the RBA's August Board meeting reaffirmed our expectation that the RBA will cut the cash rate on 2 September. RBA officials now place significantly more emphasis on the downside risks to growth than the upside risks to inflation. By presenting an unexpectedly nuanced assessment of the growth and inflation dynamics, however, the minutes indicate that there remains "considerable uncertainty" about the outlook and that there are "powerful forces pulling in opposite directions." Indeed, an extended period of official rate cuts is not a "done deal". Data this week probably will show that demand for credit remained subdued in July, but that firms boosted their business investment spending in 2Q, after an unexpected contraction in 1Q. The investment spending pipeline should remain impressive.
In New Zealand, the 2Q PPI print indicated that pipeline price pressures remain significant; this increases the risk that RBNZ officials may rethink the length and depth of the easing cycle on which it recently embarked. Our forecast calls for a gradual and steady decline in the OCR to 6.25% by mid-2009. Inflationary pressures remain at large, however, and data this week should show that inflation expectations, measured by the RBNZ, remained elevated in 3Q, with business managers expecting inflation to be at the top end of the RBNZ's 1-3%oya target range in two years' time.
Global growth turned sharply weaker around midyear and there are good reasons to expect growth to remain subpar for some time. There is significant pressure on European and Asian firms to cut back in response to a profit margin squeeze and an unwanted rise in inventories during 1H08. What's more, there is little in the way of global policy stimulus to cushion the blow. Tight credit conditions are offsetting the beneficial effects of the past year's 200bp drop in global real policy rates. Fiscal policy remains modestly accommodative, largely driven by EM governments. But the principal policy dynamic currently at work is the fading of the benefits from US tax rebate checks at a time when incomes are being compressed by high inflation. This week's July personal income report should show a second straight fall in real consumption, pointing to the first quarterly contraction by US consumers since 1991.
UK GDP growth stalled in 2Q, but what's alarming is the message on demand growth. Private consumption, and business and other investment each fell, and the 3.5% annualized rate of decline in domestic demand matched lows not seen since the depths of the early 1990s recession. Although some of the weakness in 2Q consumption was payback for 1Q strength, the trajectory of retail sales into 3Q and the forthcoming increases in energy bills point to continued consumption weakness.
Households may come under added pressure from a weaker labour market, as recent indicators suggest that the corporate adjustment is spreading from capex to employment. While the magnitude and longevity of the spike in CPI inflation remain a concern for the MPC, the severity of the downturn in demand reinforces the case for a rate cut this November.