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Australia and NZ - Weekly Prospects 22/09/08

• Economic data was pushed to the back-burner last week as the turmoil in global financial markets attracted most attention. In Australia, the only data of note was 2Q dwelling starts, which dropped another 3.7%q/q, after a 1.0% fall in 1Q. There was, however, plenty of central bank communication, including the RBA minutes from the September Board meeting, at which officials trimmed the cash rate for the first time since late 2001. Also, there was a keenly awaited speech by Governor Stevens, which indicated that the RBA remains in no rush to lower the cash rate. It still is too early to revise down our Aussie GDP growth forecasts on the back of the market turmoil but, clearly, the downside risks have intensified.

• In New Zealand, we almost certainly will get confirmation this week that the Shaky Isles' economy has slipped into recession. GDP growth on Friday probably will be negative, the second straight contraction, following the 0.3%q/q drop in 1Q. This helps to explain why the RBNZ cut the overnight cash rate by an unexpectedly large 50bp the previous week. We expect a 25bp rate cut in October although, given the instability in global markets, the odds of a second 50bp move are rising. Last week, the current account deficit unexpectedly blew out to NZ$3.9 billion as the goods deficit dropped back into deficit.

• A tumultuous week in global financial markets began with the US Fed and Treasury appearing to draw the line on the use of public funds to support teetering financial institutions. It ended with the unveiling of a sweeping plan that will entail a large injection of public funds into the financial system. This enormous policy shift is a response to aftershocks resulting from the Lehman Brothers bankruptcy filing, which sent the message that no institution is "too big to fail." These included: the seizing up of short-term money markets in the face of uncertainty about counterparty risk, the threat of the collapse of AIG and other financial institutions as the flow of private capital turned off, and the growing contagion of the crisis to credit and equity markets around the world. The speed by which US policymakers moved this week is impressive and offers hope that the risks to the financial system may now be genuinely fading. However, some further damage has likely been inflicted on an already fragile economic landscape.

• By lowering risks of financial instability, the risk to US public sector finances are being raised substantially. It is impossible to accurately gauge the ultimate cost of new initiatives to the taxpayer at this stage. However, the total net issuance of public sector debt in the coming fiscal year - to fund a large deficit and the purchase of distressed assets - is likely to approach $1.5 trillion, about 10% of US GDP. How much of this borrowing is ultimately funded by asset sales will depend in part on how quickly the housing market stabilizes and how well the economy performs.


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