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Australia and NZ - Weekly Prospects 15 Sept 08

Australia and New Zealand - Weekly Prospects

• The RBA Governor's testimony last week reaffirmed our view that officials are in no hurry to ease policy. We forecast another 25bp cut to the cash rate target by year end, but the chances of a cut in October fell following the slew of upbeat economic data last week. The RBA will be on hold unless, of course, there is an unanticipated financial markets event that abruptly changes sentiment. The upbeat data last week included a bounce in retail sales, a spike in consumer sentiment, and an unexpected fall in the jobless rate. This week sees the release only of second tier economic data, but the RBA releases the minutes of the September Board meeting, at which officials elected to cut the cash rate for the first time since late 2001. Also, the RBA's Glenn Stevens delivers a speech and answers questions from the floor on Wednesday.

• The RBNZ cut the official cash rate 50bp on Thursday, an unexpectedly large rate cut owing, in our view, to the Bank's growing concern over the deteriorating global economic and financial outlook. In doing so, the RBNZ announced a downgrade to its annual 2008 GDP growth forecast to just 0.3%, with household consumption the biggest drag. This week sees the release of the Q2 current account deficit data in an otherwise quiet schedule. We are sticking with our view that the RBNZ will cut the cash rate twice more this year, but by only 25bp each time.

• The linkage between global financial market movements and macroeconomic performance is complex, as market moves both reflect current conditions and shape future outcomes. In this regard, the broadening weakness in global growth is now reverberating through markets across the globe. Downward motion in global equity and commodity markets is now firmly established. Interest rates are also falling - in part because of shifting expectations about the balance of risks between growth and inflation and the likely direction of monetary policy. While market developments reflect current economic weakness, their influence on future activity is less obvious. The rapid descent of oil and agricultural commodity prices is a strong positive for growth, as it restores purchasing power to beleaguered households in oil-importing nations. In addition, the US Treasury's plan to shore up the GSEs and purchase agency-sponsored mortgage-backed securities is likely to push mortgage interest rates lower.

• Tempering any optimism from these market movements is the chill of rising risk aversion. In the industrial world, credit spreads have continued to widen on the back of growing concern about the health of financial institutions. Emerging economies also are experiencing this chill in the form of reduced net capital inflows. The decline in EM equity prices significantly exceeds that in the developed world so far this year. This marks a sharp reversal from the outperformance of EM equities in the early stages of the credit turmoil. Likewise, EM corporate borrowing rates and spreads have climbed in recent months. Increasingly, the deceleration in capital inflows is taking a toll on EM fx rates.


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