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Australia and NZ - Weekly Prospects 24/11/08

Australia and New Zealand - Weekly Prospects

• The RBA Board minutes last week showed that in early November, the Governor proposed that Board members make a choice between a 50bp and 75bp cut to the official cash rate. They opted for a 75bp move, despite an official recommendation for "only" a 50bp rate cut. Speeches last week, however, by the RBA Governor and Assistant Governor shed little light on the RBA's policy intentions. The main highlight this week will be the 3Q business investment survey. We expect firms to have scaled back their spending plans in the 3Q survey - it already was clear then that firms were finding it more difficult to raise the capital necessary for spending.

• In New Zealand, after data last week showing that producer price inflation eased in 3Q, the RBNZ should report this week an easing in inflation expectations in 4Q. Our forecast calls for headline CPI growth to be beneath the RBNZ's 1-3%oya target range by the end of 2009; this should pave the way for more assertive policy easing. We look for a 100bp rate cut in the OCR in December and a terminal cash rate of 3.25% by end-2009. The NBNZ business confidence survey this week will likely show that confidence remained weak in November, owing mainly to the significant deterioration in the global economic outlook and poor conditions in global financial markets.

• In gauging the intensity and duration of the global recession, we are keeping one eye fixed on the data flow and the other on financial market conditions. Looking at the recent developments in each of these areas sends a disturbing message. The data flow is tracking our current quarter forecast that global GDP and industrial production will contract at a 2% and 8% pace, respectively, this quarter - in both cases the sharpest declines since the early 1980s. However, a continued slide in business surveys in November - notably the Euro area PMI, and US surveys of homebuilders and regional manufacturers - suggest that growth momentum will continue to weaken into year end. This message is reinforced by the recent surge in US jobless claims, which points to job losses exceeding 300,000 for November.

• While deflation has risen as a medium-term risk facing the Fed, there already has been an appreciable move down in core inflation from its peak. This was underscored in October, with sizable falls in both the US and UK core readings reported last week. These moves fan speculation that the global economy's rapid decent into recession may be accompanied by a rapid tilt into deflation. To be sure, falling demand and resource utilization are expected to generate significant disinflation. However, the recent slide in core inflation is not likely to be sustained, and near-term fears of deflation are overblown. Both the sudden rise in developed market core inflation earlier this year as well as the more recent sharp decline have mirrored this year's commodity price moves. While evidence of commodity price passthrough to core inflation has typically been difficult to find, the correlation has jumped markedly in recent years, reflecting changing pricing behaviour in response to the sustained, strong gains in oil and agriculture prices.


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