Economics: Issues

Global Markets Research

Issues

9 February 2015

Michael Blythe Chief Economist T. +612 9118 1101 E. [email protected]

Important Disclosures and analyst certifications regarding subject companies are in the Disclosure and Disclaimer Appendix of this document and at www.research.commbank.com.au. This report is published, approved and distributed by Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945.

The real economy ran in line with expectations in 2014, completing the 23rd year of uninterrupted economic growth.

The nominal economy, however, fell short of expectations and unemployment rose.

The task for the year ahead is to find more income and more jobs.

The challenge for policy makers is to support income and job initiatives in the short term while developing a credible exitstrategy for the medium term.

Australian economic outcomes in 2014 were in line with consensus did get it wrong was on the nominal economy. The expectation that commodity prices would move higher in 2014 proved wrong. Falling commodity prices weighed heavily on incomes and forecasts for nominal variables such as wages, interest rates and bond yields were well off the mark. Unemployment trended up and Australia is now in the uncomfortable position of having a higher unemployment rate than in the US and the UK!

So the key tasks for 2015 are to find some new sources of income and some new sources of jobs. Failure at either task will deliver worse economic outcomes than we currently expect.

The general theme underlying our forecasts is that key parts of the Australian economy will continue to move in diverging directions. The transition from the investment to the export phase of the resources boom will be in full swing, generating much of the necessary income. The transition from mining capex to other forms of construction activity should be in full swing, generating the necessary jobs. The various transitions will keep the economy difficult to read. But it should be a year of two halves. Below-trend growth in the first half should be followed by something closer to trend in the second half.

The risks and issues for 2015 revolve around:

Finding more income resource exports are the most obvious source, highlighting our exposure to commodities,China, the supply strategies of major producers and underlining the need to get t -9).

Finding more jobs construction (residential, non-mining and infrastructure) is the focus, emphasising the need for a-13).

Overcoming a variety of growth headwinds a seemingly endless list that includes an overvalued AUD, fiscal drag,dential policy , drought & El Niño, US interest-rate

-20).

Moving beyond construction building houses and office blocks gets us so far but other growth drivers need to kick in,meaning the domestic consumer and the emerging Asian middle income consumer have key roles to play (pp20-23).

Dealing with cyclical inflation issues and structural rigidities headline inflation ended 2014 below the bottom end of-3% target but a turn in cyclical price drivers like the AUD will have an increasing influence in 2015 and

inflation should end the year in the upper half of the band (pp23-24).

has given way to a rate cut and a new easing biasdrive the Budget and not offset revenue losses with new spending cuts is the right one in the short-term. But pressures are

Read on. Or click on the link below to some of the risks and issues in the year ahead for the Australian economy

Link to CBA's risks and issues video

Global Markets Research

Economics: Issues

9 February 2015

http://youtu.be/f5BE4cu4kpU

Global Markets Research | Economics: Issues

2

Rear window

continued through 2014. And the same bias is evident at the start of 2015.

This bias at the global level is understandable. Many countries and regions are still dealing with the difficult clean up from the Great Recession. And a range of geopolitical and geomedical issues became more prominent in 2014. But even here some perspective is required:

The major forecasting agencies have cutglobal growth forecasts:

- but the cumulative downgrade is modest compared with earlier years and the last published fore-casts for Australia were nudged up!

Earlier growth fears proved unfounded inmany cases:

- the US recovered strongly from some weather-related weakness;

- the Eurozone remains very weak but appears to have avoided a

- China achieved something close to the official growth target of 7½%.

Some perspective is also required when thinking about the starting point for Australia in 2015.

The Australian economy has just completedits 23rd year of continuous economicgrowth:

- this track record is unmatched in the post-Great-Recession era.

The imbalances that worry global investorsand the ratings agencies are manageableand our AAA rating looks secure:

- the budget deficit as a share of GDP is trending lower (even if not as fast as hoped);

- the current account deficit is at the bottom end of the range of the past thirty years (our medium-term call for a current account surplus (click here) remains intact); and

- the financial system remains in good shape.

Policy makers retain some firepower:

- the RBA has been able to cut interest rates and could do so again; and

- the Treasurer has the luxury of deferring fiscal consolidation and

the budget for a while.

The generational benefits of the resources

-6

-4

-2

0

2

-6

-4

-2

0

2

Apr'08 Apr'09 Apr'10 Apr'11 Apr'12 Apr'13 Apr'14

%%

For2009

Forecast made in:

Source: IMF

GLOBAL GROWTH FORECAST CHANGES(%pt change from initial forecast)

For2010

For2011

For2012

For2013

For2014

For2015

Upgrade

Downgrade

For2016

-3

0

3

6

-3

0

3

6

1960 1968 1976 1984 1992 2000 2008

% %

AUSTRALIA: ECONOMIC GROWTH(annual % change)

23 years

-9

-6

-3

0

3

-9

-6

-3

0

3

Sep-97 Sep-01 Sep-05 Sep-09 Sep-13

AUSTRALIA: KEY BALANCES(rolling annual total, % of GDP)

Currentaccount

Budgetbalance

(ex RBA capitaltransfer in 2014)

% %

-40

0

40

80

120

0

2

4

6

8

Dec-06 Dec-10 Dec-14 2007 2011 2015 2019

% of GDP

%

Australia

Cash Rates General Gov Net Debt

G-7

POLICY INDICATORS

Source: IMF/CBA

The tendency to seek the downside persists.

This tendency is understandable at

..but looks overdone from an Australian perspective.

https://www.commbank.com.au/content/dam/commbank/corporate/research/publications/economics/economic-issues/australia/2014/040214-Current_Account.pdf


3

boom and the Asian emergence continue:

- key commodity prices have fallen but the Asian middle income consumer is delivering other less-noticed benefits.

This perspective underlines why many Australian economic outcomes in 2014 were in

at the start of the year. Real GDP growth, for example, matched the consensus forecast, as did labour market outcomes.

Where the consensus did get it wrong was on the nominal economy. The expectation that commodity prices would move higher in 2014 proved wrong. Falling commodity prices weighed heavily on incomes and forecasts for nominal variables such as wages, interest rates and bond yields were well off the mark.

This nominal weakness and everything that hangs off it explains much of the gap between perception and the reality of Australian economic outcomes over the past year.

The task for 2015 finding more income and more jobs

Nominal GDP, the broadest measure of Australian income, grew by about 3¼% in 2014.This outcome matched that of 2012 and 2013 and capped off an exceptionally weak period of income growth.

Similar outcomes were last recorded at the height of the global financial crisis, the early 1990s recession and the early 1960s credit squeeze.

with labour market forecasts. But unemployment trended up, a marked contrast to the falls recorded in other countries. Some

Australian economic story. Australia is now in the uncomfortable position of having a higher unemployment rate than in the US (the global benchmark) and the UK (the old foe)!

If your only source of economic information on Australia was income and unemployment data you would probably conclude that we are in recession!

So the key tasks for 2015 are to find some new sources of income and some new sources of jobs. Failure at either task will deliver worse economic outcomes than we currently expect.

CBA & the consensus for 2015

The general theme underlying our forecasts is that key parts of the Australian economy will continue to move in diverging directions in 2015:

20

49

78

106

135

20

49

78

106

135


COMMODITY PRICE FORECASTS(RBA Non-Rural Index, USD)Index Index

Source: RBA, CBA, Consensus Economics Dec'13

consensusforecast

0

6

12

18

24

0

6

12

18

24

1960 1972 1984 1996 2008

%%AUSTRALIAN INCOMES

(annual % change in nominal GDP)

"Creditsqueeze"

Financial crisis

Early '90srecession

0

4

8

12

0

4

8

12

Jan 05 Jan 07 Jan 09 Jan 11 Jan 13 Jan 15

%%

UK

Eurozone

Source: CEIC

UNEMPLOYMENT RATE

US

Japan

Australia

0 2 4 6

Government(av next 2yrs)

CBA

RBA (midpoint)

OECD

IMF

Economist'sconsensus

AUSTRALIAN GROWTH FORECASTS(for 2015)

%pa

Trendgrowth(3%pa)

2015 should be another year of

largely met expectations in

were well short of the mark, especially commodity prices.

A nominal economy running at recession-type

jobless rate...

task for 2015 is to find more income and more jobs.


4

the transition from the investment to theexport phase of the resources boom will bein full swing, generating the necessaryincome; and

the transition from mining capex to otherforms of construction activity should be infull swing, generating the necessary jobs.

Varying views on the speed and success of these transitions explain the variation in growth forecasts for 2015. That said, the range for growth forecast (2½-3%) is quite narrow.

The various transitions will keep the economy difficult to read. But it should be a year of two halves. Below-trend growth in the first half should be followed by something nearer trend in the second half.

Our forecasts are shown in Table 1. We expect the economy to grow by 2.9% in 2015. Below-trend growth in the first half of the year means that the risk still lies with higher unemployment. But we expect the peak rate will be in the low 6 s . Wages growth should remain modest as a result. Nevertheless, a falling AUD means underlying inflation is more likely to end the year in the upper half of the -3% target band rather than the bottom. A stabilisation in AUD commodity prices and rising resource export volumes will underwrite a modest lift in nominal GDP growth. Less mining capex and more resource exports should favour a narrower current account deficit.

Our key forecasts are generally in line with the consensus (see Table 2). But relative to the consensus we see some upside risks on the growth front in 2015. These risks reflect our views of a successful growth transition and a smaller GDP growth threat from the mining

. Upside growth risks also mean upside risks to the low inflation consensus, especially given our below-consensus AUD forecasts. Nevertheless, inflation is unlikely to stand in the way of RBA rate cuts. From a market perspective our calls have longer-term rates and the AUD sitting below the consensus.

The LNG litmus test

The LNG story encapsulates many of the risks and issues facing the Australian economy. The huge expansion in LNG capacity pushed mining capex as a share of GDP up to 150-year highs. The completion of these plants over the next few years also accounts for much of the capex

economic growth. The shift from the construction to production phase highlights the need for more jobs industry figures suggest that the ratio of construction workers to operational workers is 10:1 (for WA LNG projects). Equally, LNG will be a major source of new income as exports ramp up. Australia

Table 1: Australia: CBA Key Forecasts

2013

(a)

2014

(f)

2015

(f)

Real GDP (%ch) 2.1 2.7 2.9

Unemployment rate (%)

5.7 6.1 6.0

Underlying CPI (%ch)

2.5 2.5 2.7

Wage Price Index (%ch)

2.8 2.6 2.7

Nominal GDP (%ch)

3.3 3.2 4.3

Current A/c deficit ($bn)

51.5 50.0 47.9

Table 2: CBA & The Consensus

Below At Above

Australian fundamentals

Growth

Growth risks

Inflation

Inflation risks

Unemployment

Current A/c balance

Global fundamentals

World

USA

Eurozone

China

Australian markets

RBA cash rate

Short end

Long end

AUD

0 25 50 75 100

Australia

Qatar

Africa

Indonesia

Malaysia

Other APAC

Other Mid East

Europe

Lat Am

Nth America

LNG: LIQUEFACTION CAPACITY(million tonnes pa)

Existing

Underconstruction

Source: BREE

Relative to the consensus, we see some upside risks to growth and inflation.

CBA economic forecasts.

ping the economy hard to read.

The LNG story captures many of the risks and issues facing Australia in 2015.


5

will become the largest producer of LNG over the next few years. The main export

the Asian economic story will intensify. So large are these exports that domestic supply shortages are possible, putting some pressure on inflation rates. The capital inflow financing LNG projects has been an important source of support under the AUD. But these inflows will recede as projects are completed.

Finding more income

The most obvious source of new income is the third wave of the resources boom the production and export phase. The income potential is certainly there. The latest official forecasts have the addition to resource export earnings building up over the next four years to around $50bn per annum (>3% of GDP).

Commodities have always been a significant source of income for the Australian economy. But it has always been a volatile income source. The close correlation between swings in the terms-of-trade (largely reflecting commodity prices) and the swings in income growth highlight the point.

Looking ahead, export tonnages will drive the income baseline. Commodity prices will drive the cycle around that baseline.

So the most important projection any forecaster has to make for 2015 is the direction of commodity prices.

The CBA Commodity Price Index fell sharply during 2014 but the component parts showed widely divergent trends. Some commodity prices actually rose during the year. The weakness was concentrated in the key bulk commodities and oil. Global commodity demand undoubtedly softened in 2014. But the wide divergence in price outcomes suggests supply factors were more important in some commodity markets (especially oil and iron ore).

(a) Prospects for commodity demand

Our global growth forecasts are shown in Table 3. Global growth outcomes disappointed in2014. But prospects for a return to trend look on firmer footings in 2015.

In the advanced economies, growth momentum in the US, UK and Canada is firmly established. And we see the risks in US economic growth as skewed to the high side. Prospects for growth in Europe and Japan remain lacklustre. But there is sufficient policy stimulus in place via a ramping up of QE initiatives to limit the downside.

The Emerging Market & Developing Economies (EMDEs) as a group are expected to grow at a

Table 3: CBA Global Growth Forecasts

2013

%ch 2014

%ch 2015

%ch

World 2.9 3.0 3.5

United States 2.2 2.2 3.2

Japan 1.6 0.6 0.6

Eurozone -0.4 0.7 1.1

United Kingdom 1.7 3.0 2.4

Canada 2.0 2.4 2.6

China 7.7 7.4 7.2

India 4.7 5.0 5.3

0

25

50

75

100

0

250

500

750

1000

1989 93 97 01 05 09 13 17 2021

KEY RESOURCE EXPORTSMt Mt

Ironore(lhs)

CBA(f)

LNG(rhs)

Coal(lhs)

-20

-8

4

16

28

-4

0

4

8

12


%%INCOME DRIVERS

(annual % change)

Income(nominal

GDP)(lhs)

Domesticfinal demandprices (lhs)

Terms-of-trade(rhs)

-60 -40 -20 0 20

CopperLead

AluminiumNickel

ZincIron Ore

GoldOil

Steaming CoalCoking Coal

WheatWoolBeef

SugarCotton

CBA Price Index

KEY USD COMMODITY PRICES(% change during 2014)

Global growth should pick up towards trend in 2015.

Resource exports are the most obvious source of new income.

Tonnages will drive the income

drive the cycle.

The most important projection any forecaster has to make for 2015 is the direction of commodity prices.


6

respectable pace but are unlikely to add much to global growth momentum. Greater divergence is probable in the BRIC economies within this grouping. Structural factors, such as slowing productivity growth, are impacting on these economies to varying degree. But country specific factors are also important (eg the impact of geopolitical tensions and lower oil prices on Russia, tighter financial conditions and subdued confidence in Brazil).

From an Australian commodity demand perspective, however, China remains paramount. China is a key player in many commodity markets and takes the bulk of Australian commodity production.

Our critical growth rate calculations where Chinese GDP growth sufficient to

support commodity demand sits at 6½% for 2015. The Chinese government is yet to announce a growth target for the year. But speculation centres around 7% (vs a target of 7½% in 2014). As the facing chart shows, such an outcome would be consistent with the downward demand pressures on commodity prices receding and stabilising.

CBA forecasts have Chinese GDP growth, at 7.2%, running comfortably above our critical rate calculations. Adding in other parts of the Asian growth equation and our forecasts have Asian growth momentum stabilising in 2015. This stabilisation should provide some modest assistance to commodity demand.

Lower commodity prices will impart a positive terms-of-trade shock to China and other parts of Asia (and advanced economies). Lower prices, especially oil, will also act to restrain inflation and allow policy settings to be more expansionary than otherwise.

Concerns about the downside to the China growth story were a feature of 2014. And these fears have carried over into 2015. There are some broad themes underlying these fears:

The data cannot be trusted. There is abelief that Chinese GDP data overstate thetrue growth rate. And a range of alternativereadings such as electricity use and railfreight do suggest a weaker picture. Butthe same logic of looking at alternativeindicators can be applied to commoditydemand. Australian exports to China(mainly commodities), for example, arerunning at record highs. Whatever the trueChina growth picture is, it is enough to takeall of our new commodity production.

Policy makers are reluctant to stimulate theeconomy. The belief is that Chinese policymakers are focused on economic reformand willing to accept slower growth as aresult. But a number of policy initiatives are

0

4

8

12

16

0

4

8

12

16

2003 2007 2011 2015 2019 2023 2027

% ch%ch

ActualGDP

growth

CHINA: GDP GROWTH(2003 prices)

Growth rates required to produce an equivalent

contribution to global growth

and commodity demand as achieved in

2011-12

-5.00

-2.75

-0.50

1.75

4.00

-40

-20

0

20

40

1980 1985 1990 1995 2000 2005 2010 2015

Change%pa

Commodityprices(lhs)

Developing Asia growth momentum*

(adv 1 year, rhs)*Source: IMF/CBA/RBA

ASIAN GROWTH & COMMODITIES(annual % change)

0

25

50

75

100

0

25

50

75

100

Jan 96 Jan 00 Jan 04 Jan 08 Jan 12

AUSTRALIA: EXPORTS TO CHINA(rolling annual total)

$bn $bn

40

45

50

55

40

45

50

55

Jan 05 Jan 08 Jan 11 Jan 14

%%

Non-manufacturing

Manufacturing

CHINA: PMI EMPLOYMENT

Source: CEIC

China remains the key to commodity demand.

We expect Chinese growth to run at rates providing some support to commodity prices.

We see fears about the downside to the China growth story as overdone.


7

rolling out. Interest rates have been cut, reductions in the reserve requirement ratio have occurred, the PBOC has boosted its standing lending facility (equal to a RRR cut), tax relief and other support for small and micro firms are in place and infrastructure spending is being brought forward. Some indicators suggest that the Chinese labour market is weakening. We expect further policy action in 2015 as a result. Chinese policy stimulus has traditionally favoured commodity-intensive activity.

Slowing domestic demand is an inevitablepart of the restructuring away frominvestment and towards consumption. Thefocus on the domestic economy has pushed the export sector into the background. But external demand remains an important source of growth. An upturn is underway in the US. Economic activity is

Trends in the new orders component of the US ISM, for example, indicate upside to Chinese exports to the United States. This US upside should provide an offset to any Chinese domestic weakness.

The focus on domestic risks brings the Chinese housing market into focus. House prices are falling in most Chinese cities. Falling prices indicate a mismatch between housing demand and supply. Falling construction is dragging on activity and commodity demand as a result. Residential construction accounts for about 30% of steel usage.

Price cycles are not unusual in Chinese residential property markets. There have been three episodes of falling prices in the past six years. These cycles generally result from policy changes designed to constrain or promote demand. They did not stop the Chinese economy from growing at a respectable pace.

The current downturn follows measures introduced in early 2013 to slow rapid price growth. These measures were successful perhaps too successful. They are now being reversed and housing risks should recede in 2015 as a result.

Chinese home buyer sentiment has improved and a lift in sentiment is typically followed by a turn in the residential price cycle.

Demand for housing will remain strong over the medium-to-longer-term given ongoing urbanisation.

(b) The influence of commodity supply

As noted, some commodity prices have fallen not just because of some demand weakness but because supply has been ramped up.

-80

0

80

160

240

-80

0

80

160

240

Jan 08 Jan 10 Jan 12 Jan 14

%CHINA: FAI RAILWAYS(smoothed annual % change) %

-46

-22

2

26

50

0

20

40

60

80


Index %pa

China: exports to US*(rhs)

US ISMnew orders

(adv 5 months, lhs)

*Source: CEIC

CHINA EXPORT INDICATORS

-6

0

6

12

-6

0

6

12


%pa%paCHINA: RESIDENTIAL PRICES

(newly built, 70 cities)

Source: Bloomberg

China forecast to

grow by 7.4% in 2014

China grows by 7.7% in

2012

China grows by 9.2% in

2009

-6

-1

4

9

14

11

13

15

17

19


%pa%

Residential prices(70 city newly built)

(rhs)

Planned to buy a new house in next 3 months

(adv 6 months, lhs)

CHINA: BUYING PLANS & PRICES

Source: CEIC

More policy stimulus

demand will help.

The housing market remains a risk to Chinese growth and commodity demand.

The cycle could turn in 2015.


8

The extra supply is an inevitable outcome of the global mining construction boom triggered by the earlier commodity price boom. The big price falls in bulk commodity and oil prices in 2014 coincided with a sharp pick-up in global production growth relative to recent years. Or followed an extended period of rapid production growth.

Lower oil prices receive most of the attention. But from an Australian perspective the iron ore story is critical. Iron ore mining accounts for 3.6% of GDP and 27% of exports.

Much of the extra iron ore supply that has depressed prices is sourced from Australia. There is more to come. BREE estimates that the three big domestic producers and the new Roy Hill project will add about 177Mt of iron ore to global production over the next three years.

The pressure on iron ore prices is set to continue. But this pressure need not be a threat to income. Australia occupies a very favourable position at the low end of the global iron ore cost curve. The major miners are focused on reducing costs further. Producers at the higher end of the cost curve are under severe pressure. The US Geological Survey suggests that up to 85Mt of iron ore production have already been eliminated. The Brazilian miner, Vale, has suggested that up to 220Mt of iron ore production will be uncompetitive if current prices persist in 2015.

Australian producers may end up with a lower cost base and a larger market share. This mix would be positive for Australian income growth.

The same price-supply dynamics are less favourable for Australian coal producers where the skew is to the high end of the global cost curve.

Lower oil prices will have diverging impacts on Australia incomes:

The main negative would be the threat toLNG prices. Asian LNG contract prices aretypically linked to the Japanese CrudeCocktail benchmark. This benchmarktends to follow the Brent oil price over time.But Australian contracts are based on an S-curve that sets a price floor and a ceiling.The aim as to reduce the impact of oil pricevolatility on LNG prices. The practicalreality is that sellers are protected when oilprices are too low. Operating costs arealso low. So rising LNG volumes willdeliver a substantial income boost.

The main positive is that petrol prices havefallen sharply. Household incomes may nothave changed. But disposable incomeshave lifted as petrol prices have fallen. Andbusiness costs are lower (including formining companies).

0 3 6 9

Hard coal

Iron ore

Crude oil

Average2009-13

2014(f)

SELECTED COMMODITIES(annual production growth)

%pa

0

40

80

120

160

0

40

80

120

160


USDUSD

Japan Crude Cocktail

LNG & OIL

Source: Bloomberg

Brent

100

115

130

145

160

100

115

130

145

160

Jan 12 Sep 12 May 13 Jan 14 Oct 14 Jun 15

c/lc/lAUSTRALIA: PETROL PRICES

Extra commodity supply is real issue for oil and the bulk commodities.

Iron ore supply will

miners have a low (and falling) cost base and could win market share.

The same dynamics are less favourable for coal.

Lower oil prices are a threat to LNG income but this threat looks manageable.


9

Second round effects are also important.Lower oil prices represent a transfer ofincome from oil producers to oilconsumers. This transfer should be a netpositive for global growth. The IMF, forexample, suggests that lower oil pricescould add up to 0.7-0.8% to global growthin each of the next two years. Asia is alarge net importer of oil. The region shouldshare a disproportionately larger share ofthe benefits. Any boost to Asian growth willhelp support commodity demand.

(c) The importance of currency moves

Supply and demand are the key price drivers. But currencies also matter. Most commodities are priced in USD. Commodities become more expensive as the USD rises to buyers in other currencies. And so USD prices tend to fall. We think we are in the early stages of a secular USD uptrend. So the USD trajectory will weigh on global commodity prices.

But what matters for Australian incomes is Australian dollar commodity prices. The flip side of a stronger USD is a weaker AUD. A lower currency will significantly buffer Australian incomes in 2015.

(d) The outlook for commodity prices

Our China/Asia views limits the downside to Australian commodity prices but rising supply and a stronger USD limits any upside. We expect the CBA Commodity Price Index to track sideways in USD terms during 2015.

But allowing for our fx views, local currency commodity prices are likely to trend higher.

(e) The implications for Australian incomes

The slight upward trajectory for commodity prices in AUD terms implies that the low point for this cycle in the terms-of-trade is not far off. Such an outcome would be consistent with the standard forecasting assumption that about half of the run up in the terms-of-trade will be ultimately retraced.

This half-retracement means that there is a permanent legacy from the earlier commodity-price-terms-of-trade boom. The level of incomes is nearly $3,000 per person per annum higher than otherwise.

Our forecasts for the terms-of-trade imply an ongoing but diminishing drag on income growth. This drag should have run its course by mid 2015 and a modest contribution to income growth is likely thereafter.

65

84

103

121

14070

75

80

85

90Jan 11 Jan 12 Jan 13 Jan 14 Jan 15

IndexIndex

USDIndex

(linverse, hs)

Commodityprices(rhs)

COMMODITY PRICES & THE USD

0

100

200

300

400

500

0

100

200

300

400

500

Sep 98 Mar 03 Sep 07 Mar 12

IndexIndex

USDIndex

AUDIndex

Source: CBA

CBA COMMODITY PRICE INDEX

CBA(f)

100

130

160

190

220

100

130

160

190

220

0 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60Qtrs from trough

TERMS OF TRADE CYCLES (trough=100) IndexIndex

Mar'99

Dec'71

Mar'87

Jun'61

Jun'94

Dec'68

Dec'78

50%retracement

-4

-2

0

2

4

6

-4

-2

0

2

4

6


%%

Periodaverages

CBA(f)

COMMODITY INCOME IMPACT(rolling annual total, % of GDP)

Source: CBA calculations

Lower oil prices are a positive for Asian growth and commodity demand.

A lower AUD will help buffer Australian incomes.

We suspect that the low for the terms-of-trade may be not far

incomes will fade during 2015.


10

Finding more jobs

The unemployment rate tracked around a relatively low 5¼% during 2011/12. But unemployment slowly trended higher since then and now stands at 6.1%.

This deterioration does not reflect job losses net jobs growth stands at around 340k since mid 2012. The problem is that the 11k average monthly jobs gain has fallen short of the 18k needed to prevent unemployment from rising.

The risk for 2015, however, is that the pace of job losses accelerates as the mining capex downturn gets into full swing.

Construction is the employment-intensive phase of mining activity. The close correlation between mining capex and the share of employment related to resource investment shown on the facing chart makes the point. As mining capex falls away over the next few years so will employment. These losses emphasise again the need to find more jobs as one of the key tasks for 2015 and beyond.

(a) Mining capex and jobs

The size of the fall in mining capex is the key to the extent of job losses. Again, the tendency is to take a pessimistic slant.

The assumption underlying official forecasts, for example, seems to be that the mining capex share of GDP will fall from the peak of 7½% all the way back to the long-run average of about

has also encouraged it to revise up its estimates of how far mining capex can fall.

estimates is equal to about 5½% of GDP.

But there some offsets that mean the true cliff is significantly smaller. These offsets include:

A bigger mining capital stock means alarger depreciation task and more capex tomaintain the stock of capital. The pick upin mining depreciation is >1% of GDP.

The east coast focus on coal seam gasrequires ongoing capex in drilling new wellsand so on.

More infrastructure spending is required.There is, for example, insufficient portcapacity to deal with increased bulkcommodity tonnages.

assumptions about the realisation of the pipeline would see a more modest and more drawn out decline in mining capex.

3.0

4.3

5.7

7.0

0

15

30

45

Jul-11 Jul-12 Jul-13 Jul-14

'000 %LABOUR MARKET INDICATORS

Required jobs growth

(lhs)

Trend jobs growth (lhs)

Unemploymentrate(rhs)

0

3

6

9

0

1

2

3

1989/90 1994/95 1999/00 2004/05 2009/10 2014/15

%%

Mining capex(% of GDP)

(rhs)

Jobs related to resource investment

(% of total employment)(lhs)

Source: CBA/RBA

MINING CAPEX & JOBS

0

2

4

6

8

0

2

4

6

8

1978 1983 1988 1993 1998 2003 2008 2013

%

Officialforecasts/ projections

MINING INVESTMENT(% of GDP) %

Pre-boomaverage

0

3

6

9

Capex peak

%

Long-runaverage

MINING CAPEX(% of GDP)

Source: CBA

Extradepreciation

Extra port spending

Potential miningprojects

"True" capexpothole

Unemployment has

because jobs growth lagged population.

Genuine job losses should pick up in 2015 as the mining capex downturn accelerates.

The more extreme estimates of the size of the mining capex

overdone.


11

Allowing for these offsets, we expect the decline in mining capex to peak at 3½% of GDP. This decline would translate through to job losses of up to 1½% of total employment.

(b) The growth transition and jobs

These potential job losses highlight why the risks are still skewed towards rising unemployment. And why policy makers are

The transition involves getting other parts of the economy moving to generate new jobs. But they need to be the right sort of jobs. The targeted areas are residential construction, non-mining business investment and public infrastructure. These activities have the greatest complementarity with the jobs ending in mining construction.

The evidence to date is encouraging. The lift in non-mining activity has more than offset the downturn in mining capex from an economic growth perspective. And job gains in construction-related areas have more than offset mining-related job losses.

The transition needs to continue during 2015. The fundamental drivers remain favourable. And we see the transition evolving in a favourable way.

Housing construction will continue responding to the demographics. The Australian population is growing at a solid pace. Adding close to 400,000 to the population each year implies a solid underlying demand for new housing.

The migrant intake accounting for more than half of population growth is skewed towards skilled migrants. The financial resources this group bring accentuate the construction impact of rising numbers.

Other supportive factors are at work:

New construction has fallen short ofdemand in recent years as the sectorcompeted for labour and materials withmining and infrastructure. There is asignificant pent-up demand for housing ofclose to 100,000 dwellings on ourestimates.

Rising prices increase returns and makenew construction more attractive toinvestors and make renovations moreattractive to existing homeowners.

Rising education-related visitor flows alsoadd to housing demand.

The Australian housing market is anattractive destination for global investors.The legislation should be channelling muchof this investment into new construction.

-2

0

2

4

6

-2

0

2

4

6

Dec-12 Jun-13 Dec-13 Jun-14

%pts

GDP(rhs)

Downturn in mining capex

(lhs)

GROWTH DRIVERS FROM MINING PEAK(cumulative contribution to GDP since end 2012)

Rise in resource exports

(lhs)

Other(mainly non-

mining)(lhs)

%

-50

0

50

100

Heavy Eng Const

Const Services

Exploration & other mining

services

MINING & CONSTRUCTION JOBS(change since mining peak end 2012)

'000

BulkCommodities

Mining

Non-mining building const

0

150

300

450

0

150

300

450

1949/50 1964/65 1979/80 1994/95 2009/10

POPULATION DRIVERS'000 '000

Netmigration

Naturalincrease

-100

0

100

200

-100

0

100

200


Demand

Supply

'000

Pent-updemand

Excesssupply

CBA: HOUSING DEMAND & SUPPLY'000

Potential job losses highlight why the growth transition must succeed.

Other forms of construction activity are lifting and further gains are likely in 2015.

Demographics and other factors favour residential construction.


12

ily adding to available supply. Prosper Australia, for example, has concluded that based on unusually low levels of water

is vacant or unused.

We put dwelling commencements in 2014 at around 193,000 and expect a similar outcome in 2015. Such outcomes would represent a significant improvement on the 150,000 average of the previous seven years.

A pick up in non-mining capex is also underway. But this pick up is less robust than that in residential construction. And the debate about this part of the growth transition continues. RBA liaison, for example, suggests that many firms are reluctant to lift capex until they perceive a genuine lift in demand.

Nevertheless, there are some encouraging indicators. These include:

A lift in commercial lending commitmentsthis lending is one of the key fundingsources for non-mining capex and isconsistent with an ongoing lift in spending.

The lift in commitments is flowing in tooutstandings. Growth in business credit isrunning at 4.6%pa, the fastest rate sinceearly 2009.

The ABS Capex Survey of spending plansfor the year ahead is signalling a (modest)lift in non-mining capex.

Indicators for those sectors not covered bythe ABS capex survey are picking up. Thenon-survey sectors include agriculture,health and education. Business investmentin these excluded sectors has been robustin recent years.

In contrast, public construction activity is yet to turn up. Infrastructure spending always involves long lags between plan and spend. But State and Federal governments are increasingly focused on the need to lift infrastructure spend.

The 2014 Budget provided for $28.5bn of infrastructure spending and an asset recycling scheme designed to encourage State and private sector involvement. Asset recycling initiatives where existing State assets are sold and recycled into new infrastructure with a 15% top up from the Federal government is proving attractive. Some estimates put the stock of commercially saleable assets at $100bn.

As with housing, the fundamentals favour rising business capex and infrastructure spending. The need to lift spending in these areas is pressing. The non-mining capital stock as a share of GDP is at the low end of the range of the past forty years. Similar comments apply to

130

150

170

190

130

150

170

190

1998 2002 2006 2010 2014

'000

Thou

sand

s

'000

Thou

sand

s

Average 2005-12 (ex 2010 stimulus

boost)

Boosted by government

stimulus package

DWELLING COMMENCEMENTS

CBA(f)

-35

0

35

70

-20

0

20

40

Jul-02 Jul-05 Jul-08 Jul-11 Jul-14

*Smoothed

%

Capex(ex mining)

(lhs)

Commercial lending*

(adv 5 mnths, rhs)

%LENDING & NON-MINING CAPEX

(annual % change)

-20

0

20

40

-20

0

20

40

Sep-88 Sep-93 Sep-98 Sep-03 Sep-08 Sep-13

%%

Non-residential

PUBLIC CONSTRUCTION WORK DONE(annual % chnage)

0

53

107

160

260

280

300

320

1976 1981 1986 1991 1996 2001 2006 2011 2016

%%CAPITAL STOCK(% of nominal GDP)

Mining(rhs)

Non-Mining(lhs)

Economic & social

infrastructure(rhs)

A modest pick up in non-mining construction is

infrastructure spending is yet to fire.

The non-mining and infrastructure capital stocks need to expand.


13

public infrastructure.

The areas policy makers are targeting also have the potential for significant 2nd-round effects.

The ABS, for example, estimates that every $1 spent on residential construction generates $1.31 worth of spending elsewhere in the economy. Retailing and consumer spending more broadly are the obvious beneficiaries. Spending in areas like hardware, building & garden supplies and furniture & floor coverings picked up significantly over the past year or so.

A wealth and confidence effect will also help. Housing is the major asset on household balance sheets. So rising dwelling prices are boosting the wealth of most households. Housing wealth has increased by around $640bn over the past eighteen months. Australian studies suggest that each $1 change in wealth moves consumer spending by 4-5¢. On these metrics the potential boost is around 3% of consumer spending.

The same should provide some support to consumer sentiment.

The focus on infrastructure spending can be seen as part of a global push championed by the G-20. The time is right for such a push because economic activity is subdued and borrowing costs are low.

Infrastructure spending boosts activity in the short term by lifting aggregate demand and in the longer-term by raising aggregate supply. IMF estimates show a 1% of GDP lift in infrastructure spending boosts output by 0.4% in Year 1 and 1.5% after four years.

Growth headwinds

Progress on the growth transition is succeeding to date. But a successful outcome over the longer haul faces a variety of headwinds that could slow or derail the process.

(a) An overvalued AUD

Policy makers have long feared that the strong Aussie dollar was weighing on significant parts of the non-mining economy and would impede the growth transition. The RBA is particularly vocal on the issue. They argue that the Aussie

a lower exchange rate is . RBA

Governor Stevens has indicated that he would like to see the AUD around USD0.75.

CBA models put AUD at USD0.82 and TWI=65, close to end 2014 levels. And CBA business surveys suggest that the AUD may not be as big a drag as feared.

The Compass, for

-10

-5

0

5

10

15

-10

-5

0

5

10

15


Furniture, floor coverings,houseware & textile goods

HOME IMPROVEMENT SPEND(annual % change)% %

Hardware, building & garden supplies

Totalretail

-400

0

400

800

1200

-400

0

400

800

1200

Mar-03 Mar-07 Mar-11 Mar-15

$bn $bn

Source: RBA

HOUSEHOLD ASSETS: HOUSING(annual change in value)

0.0

0.5

1.0

1.5

2.0

0.0

0.5

1.0

1.5

2.0

-1 0 1 2 3 4

%%

Year (t=0 is year of shock)

PUBLIC INFRASTRUCTURE IMPACT(output impact of 1% of GDP lift in spending)

Source: IMF

-40

-20

0

20

-40

-20

0

20


THE AUD(deviation from fair value)

TWI

USD

% %

Source: CBA estimates

Retailing and consumer spending should benefit.

Construction delivers significant 2nd round effects.

Infrastructure spending will help boost productivity growth.

The AUD may not be as big a growth headwind as feared.


14

example, AUD - where the least number of exporters and importers say they are uncompetitive - is USD0.90-0.94. By comparison, our 2012 research showed the sweet spot was considerably lower at USD0.80. The upshot is Australian businesses have adjusted to the higher exchange rate in the past two years.

This adjustment is a considerable achievement. And it explains why more than 80% of respondents to the CBA Future Business Index report that the AUD is not having an influence on labour hiring and capex plans.

The AUD fell sharply against the USD in HII 2014. And the fall is now evident on a trade-weighted basis as well. Further declines are likely in HI 2015. This fall will boost economic growth. But there is a risk of too much of a good thing. The lower AUD must also be factored into the inflation outlook.

The RBA suggests a 10% depreciation will:

stimulate GDP growth by ½-1ppt overtwo years; and

increase the year-ended inflation rateby ¼-½ppt each year for two years.

(b) Fiscal drag

Public spending was a drag on economic growth in calendar 2013 for the first time in fifty-two years. The policy intent was for fiscal consolidation to continue in 2014 and beyond. The May 2014 Commonwealth Budget, for example, proposed a raft of measures that would take a significant amount of spending out of the economic equation over time. The reality, however, is that the delays and compromises required to enact the measures has significantly reduced near-term fiscal drag. And after allowing for the likely rejection of other measures, fiscal settings should not impede growth in 2015.

The Treasurer has indicated that the Government will not attempt to offset revenue shortfalls with further spending cuts. This is the right response in the current environment.

(c) Missing animal spirits

A very risk-averse approach is evident in Australian business operations. The elevated levels of business cash on deposit and the focus on paying dividends and return of capital illustrates the point. RBA Governor Stevens

evident in the housing market would be welcome in some other sectors of the economy

Building confidence and translating confidence into action is not easy. But the necessary

0

25

50

75

100

0

25

50

75

100

0.50-0.60

0.61-0.70

0.71-0.80

0.81-0.90

0.91-1.00

1.01-1.10

1.11-1.20

0.50-0.60

0.61-0.70

0.71-0.80

0.81-0.90

0.91-1.00

1.01-1.10

1.11-1.20

Cum-ulative

%

Cum-ulative

%

Importers

The shifting "sweet spot"

May 2012 Survey September 2014 Survey

CBA AUD COMPASS: AUD & COMPETITIVENESS(at what AUD level are you uncompetitive?)

Exporters

-4

0

4

8

12

-4

0

4

8

12

14/15 15/16 16/17 17/18

$bn$bn2014 BUDGET: POLICY MEASURES

(impact of policy decisions)

As announced on Budget night

After allowing for other measures

likely to face Senate rejection

After allowing for Senate delays/

negotiations

0

10

20

30

40

0

10

20

30

40

Mar-88 Mar-93 Mar-98 Mar-03 Mar-08 Mar-13

% %NON-FINANCIAL CORPORATIONS

(bank deposits as % of financial assets)

40

45

50

55

60

40

45

50

55

60

Mar-14 Jun-14 Sep-14 Dec-14 Mar-15

%%

Costmanagement

Growthinitiatives

CBA FBI: BUSINESS FOCUS(% of respondents)

Source: CBA FBI

Businesses have adapted to a higher currency.

A lower AUD will help growth but inflation risks lift as well.

Necessary delays and compromises have reduced fiscal

allow the automatic stabilisers to work.

Risk appetite must return.


15

policy backdrop and fundamentals are in place.

There are some (tentative) encouraging signs. The CBA Future Business Index, for example, suggests have shifted focus to growth initiatives rather than cost management. A lift in new company registrations and patent applications also shows risk appetite returning.

(d)

The RBA message on house prices has evolved over time:

the initial view was rising prices are part ofthe policy transmission process;

they began warning in late 2013 that prices

and investor activity in Sydney and Melbourne is a concern.

House price growth in early 2015 is still running well ahead of incomes. But momentum has slowed as some elements of a natural correction came into play.

Rising prices are denting housingaffordability. The February rate cuts willprovide some buffer. But prices dominateand deteriorating affordability will dampeninterest from owner-occupiers.

Rising prices are reducing rental yields.Some renters have transitioned to owner-occupiers. More supply will come on-stream as residential construction lifts.Vacancy rates are rising and rental growthis slowing. Lower rates of return willdampen interest from potential investors.

Easing price momentum should see concerns

For a true bubble, rising prices need to be backed up by:

an acceleration in housing credit growthover a relatively short period;

an easing in lending standards; and

an expectation that dwelling prices keeprising.

Housing credit growth has picked up but remains at the low end of the range of the past three decades. There are few signs of a significant easing in lending standards. The share of lending made as low doc loans the closest equivalent to subprime lending is exceptionally low. House price expectations were rising but have now fallen back.

Nevertheless, RBA concerns about the level of investor interest are likely to remain in 2015.

-24

-12

0

12

24

-24

-12

0

12

24

Jan-98 Jan-01 Jan-04 Jan-07 Jan-10 Jan-13

DWELLING PRICES(8 capital cities) %%

Source: CBA/RP Data CoreLogic

Pricemomentum

Pricegrowth

0

3

6

9

0

3

6

9

Mar-90 Mar-95 Mar-00 Mar-05 Mar-10 Mar-15

VACANCY RATES & RENTS% %

Vacancyrate

(REIA measure)

Rentalgrowth

(%pa from CPI)

0

30

60

90

0

10

20

30


%%pa

Housingcredit(lhs)

HOUSING BUBBLE INDICATORS

House price expectations

(net % expecting higher prices, rhs)

New home loans with LVR>80%(% of total, rhs)

Low doc loans(% of total, rhs)

0

15

30

45

0

15

30

45

Jan-07 Jan-09 Jan-11 Jan-13 Jan-15

HOUSING LOAN APPROVALS(% of total)% %

First HomeBuyers

Investor

Otherowner-

occupiers

The RBA has moved

on the housing front.

Natural corrective

recede.


16

The investor segment is accounting for an unusually large part of housing activity at present. This investor interest is a rational response to the environment created by central banks. Central banks responded to the financial crisis by boosting liquidity and pushing

approach encouraged a search for yield, lifted risk appetite and boosted asset prices. Rental yields look attractive compared with other assets favoured by Australian investors.

The RBA was sufficiently concerned about these trends to come out in favour of using macroprudential tools. This shift is quite a radical departure from previous thinking that viewed such tools with suspicion. The RBA in its submission to the Financial System Inquiry, for example,

The banking regulator, APRA, has delivered a relatively restrained response. There are no changes to capital requirements or LVR restrictions at this stage. But APRA will further lift supervisory oversight and loan affordability tests. They will pay particular attention to higher risk mortgage lending. And growth in property investor loan portfolios above 10%pa will be an important risk indicator that may trigger further action (including consideration of individual Pillar 2 capital requirements).

housing contribution to the growth transition at the margin. But it is unlikely to derail the process.

Traditionally, investor activity was skewed towards the high end of the income and wealth range. But this time is different. There is a risk that the wrong group is being targeted. The counterpart to unusually high investor interest is unusually low first-home-buyer activity. It may

-home-buyers in normal circumstances. But affordability constraints mean they are entering the market as investors and taking advantage of the rental income and tax offsets before ultimately moving in. Surveys show a lift in the proportion of buyers who report that their first purchase was an investment property.

(e) Drought and El Niño

The farm sector is now a relatively small part of the Australian economy. But the swings in production have added and subtracted up to 0.4ppts from GDP growth over the past decade.

seasonal condi ureau of Meteorology is warning of borderline El Niño conditions. They expect El Niño-like impacts to continue. For Australia, this means drier and warmer than average weather is likely in many

0

3

6

9

0

3

6

9

Mar-03 Mar-06 Mar-09 Mar-12 Mar-15

%%

Sydneyrental yield*

Term depositspecial rate

Melbournerental yield*

RENTAL YIELDS(2 bedroom "other" dwelling)

*Source: REIA

0

25

50

0

25

50

1 2 3 4 5 1 2 3 4 5

%%

Share of investor housing

debt

Investors by income quintile

HOUSING INVESTOR INDICATORS(% of total) Source: RBA

Investors by net worth quintile

H/holds with investment

property loan

0

8

16

24

0

8

16

24

2009 2014

%%FIRST TIME BUYERS

(% buying an investment property)

Source: Mortgage Choice First Time Investor Survey

Ramping up macroprudential measures remains

targeting the wrong group.

Drought may weigh on agricultural production in some areas.


17

areas. Some regional areas are already experiencing rainfall deficiencies. There are some downside risks to farm production.

(f)

program towards the end of 2014. We expect the defining policy shift in 2015 to be the start of US interest rate normalisation.

Fed guidance is still for rates to remain low for some

.

Our forecasts have the Fed moving in mid 2015. But US labour market trends suggests the risks lie with an earlier move:

employment is growing rapidly and theunemployment rate is declining at thefastest pace in twenty years;

the unemployment rate is nearing the 5.2-5.5% range that the Fed nominates aslong-run equilibrium; and

the various measures of labour market

consistent with a lift in earnings growth.

The Fed is set to move in a different direction from other major central banks in 2015. The BoJ is ramping up its version of QE. And the ECB is taking further steps to broaden its QE initiatives. One outcome is a stronger USD, a trend we expect to continue.

Higher interest rates and a stronger USD pose some risks to the US growth outlook. But these risks should be counterbalanced by an improving US labour market, a lift in earnings growth, a consumer boost from lower oil prices and a lesser fiscal drag. One other outcome of monetary policy divergence is that lower bond yields in Japan and Europe have created

will help limit the upside to US bond yields during the Fed normalisation process and assist US economic growth.

The impact of fed funds normalisation on the rest of the world will depend on the rates trigger. Faster US growth would be a positive trigger if it boosted world trade and confidence. A rise in the US term premium, in contrast, would be a negative trigger if it boosted global risk premiums and volatility more broadly.

IMF spillover modelling suggests that a 100bpt rise in the US term premium (to near historical averages) would cut US and UK GDP growth by 0.6ppts relative to baseline and the rest of the world by 0.2ppts.

The impact of fed funds normalisation on

-5.0

-2.5

0.0

2.5

5.0

-5.0

-2.5

0.0

2.5

5.0

Jan 80 May 88 Sep 96 Jan 05 May 13

%%US UNEMPLOYMENT RATE

(annual change)

-70

-40

-10

20

0.0

1.5

3.0

4.5


EmploymentCost Index(%pa, lhs) Job openings

rate (lhs)

US EARNINGS & LABOUR SLACK

Source: Conference Board, NFIB, BLS

Net jobs plentiful (rhs)

Jobs hard to fill(scaled, lhs)

1

2

3

4

45

70

95

120

Jan 14 Mar 14 Jun 14 Sep 14 Dec 14

%

US 10-year bonds

(rhs)

Brent oil (USD, lhs)

USDindex(lhs)

MARKET INDICATORS

-0.75

-0.50

-0.25

0.00

0.25

-0.75

-0.50

-0.25

0.00

0.25

Yr0 Yr1 Yr2 Yr3 Yr4 Yr5 Yr6

%pts%pts

US and UK

*100bpt lift in term premium

IMPACT OF A TERM PREMIUM SHOCK*(ppts deviation from real GDP baseline)

Source: IMF Spillover Report 2014

Rest ofworld

Central banks will move in different directions in 2015.

We expect the Fed to start

interest rates by mid 2015.

Lower oil prices and a robust labour market should neutralise the growth threat from higher interest rates and a stronger USD.

Higher US interest rates could weigh on global growth.


18

Emerging Market & Developing (EMDE) economies would vary with economic fundamentals. The less damaging outcomes are likely in those EMDE economies with low current account deficits and low inflation rates because long-term yields should rise by less than elsewhere.

IMF spillover modelling suggests the peak impact on GDP growth for low deficit/low inflation economies is about 0.1ppts off baseline but for high deficit/high inflation economies the impact is about 0.4ppts.

Our risk indicator methodology rates a country against eight indicators (current account, foreign ownership of securities, foreign debt relative to fx reserves, inflation, budget balance, government debt, bank credit as a share of GDP and real GDP growth relative to its long-run average). The highest risk areas are

the Asian economies more important to Australia.

The bigger risk to Australia may come through exchange rates. The flip side of a stronger USD is a weaker AUD. But the full benefits to Australian growth from a lower AUD may be limited by policy moves elsewhere that weaken other major currencies. The QE ramp up in Europe and Japan, for example, will weigh on the EUR and JPY.

The Japanese Government Pension Investment Fund (GPIF the largest global pension fund) is lifting weights on foreign asset allocation from 27% to a target of 40%. Japanese life insurers may follow the GPIF lead. Any resultant capital outflows towards Australia could put some upward pressure on the AUD.

(g) Global deflation

A lingering concern about deflation risks was one fallout from the Great Recession. These concerns have ramped up recently as global growth concerns lifted, inflation rates slowed and oil prices started to fall.

Large output gaps and high unemployment rates are putting downward pressure on inflation. Nearly all industrial economies have a negative output gap at present. And the vast majority have very low inflation rates as a result. The 49% fall in oil prices in the second half of 2014 risks turning headline inflation rates negative.

Demand shortfall is an example of bad deflation:

it pushes down inflation expectations andlifts real rates; and

it pushes up the real value of debt.

-0.75

-0.50

-0.25

0.00

0.25

-0.75

-0.50

-0.25

0.00

0.25

Yr0 Yr1 Yr2 Yr3 Yr4 Yr5 Yr6

%pts%pts

HIgh current account deficit / high inflation

economies

*100bpt lift in term premium

IMPACT OF A TERM PREMIUM SHOCK*(ppts deviation from real GDP baseline)

Source: IMF Spillover Report 2014

Low current account deficit / lowinflation economies

0

7

14

21

28

3590

95

100

105

110

115

Feb-03 Feb-06 Feb-09 Feb-12 Feb-15

EUR Real Effective

ExchangeRate(lhs)

ECB Balance Sheet (%GDP)

(inverse, rhs)

ECB BALANCE SHEET & EURIndex %

GDP

0

25

50

75

100

0

25

50

75

100

1980 1985 1990 1995 2000 2005 2010

%%

% with a sub 2%pa CPI

% with a negative output

gap

OUTPUT GAPS & INFLATION(industrial economies)

Source: IMF

-1

0

1

2

3

4

-1

0

1

2

3

4

Jan-09 Jan-11 Jan-13 Jan-15

EUROZONE INFLATION(annual % change)% %

Eurozone Periphery

Eurozone Core

Eurozone Aggregate

ECB's 2%Inflation Target

High deficit / high inflation economies

in Asia.

Upside pressures on the AUD from central bank actions outside the US are the main threat to Australia.

Falling oil prices and ongoing negative output gaps have lifted inflation risks.


19

In contrast, lower oil prices driven by rising supply are an example of good deflation (other than for oil exporters!):

it boosts household disposable incomes;and

it cuts business costs.

Europe looks most at risk from deflation. The ECB is concerned about the unanchoring of inflation expectations and any second-round effects that may follow.

These concerns make a move to implement sovereign QE in Europe in 2015 more likely. The same concerns may speed up the start of

spending. Such shifts will help support growth.

EMDE economies will magnify the oil effect. Outcomes will vary between countries. Nevertheless, we expect the EMDE impact as a group to be more disinflationary than deflationary. EMDE currencies are weakening as the USD strengthens, offsetting some of the impact of lower oil prices. Some governments could take the opportunity offered by low oil prices to reduce or remove energy subsidies.

Deflation looks unlikely in the US. US inflation trends are dominated by services (75% of the CPI). Falling unemployment and tighter labour markets should feed into labour costs. And falling residential vacancy rates should boost shelter costs (42% of the core CPI).

There are implications for financial markets:

Low inflation and falling inflationexpectations may allow/encourage the Fedto defer interest-rate normalisation beyondour preferred mid 2015 start date.Commentary from key Fed officials,however, has tended to emphasise thegrowth stimulus from lower oil prices. We

impact on headline inflation rates.

Lower oil prices will pressure the financialposition of sovereigns, corporates andbanks exposed to the oil sector. High yieldenergy sector spreads and emergingmarket corporate spreads have widened.

Deflation, financial and economic risk effects will depend on whether the drop in oil prices is sustained or just a temporary blip.

The fall in oil prices is a supply-driven event. A lift in supply from unconventional sources, such as shale oil, has coincided with a strategic decision by the traditional swing producer, OPEC, to maintain production. And typically, supply cuts are required to lift prices.

Looking ahead, oil prices are below fiscal

1.5

2.0

2.5

3.0

1.5

2.0

2.5

3.0


EZ INFLATION EXPECTATIONS% %

ECB inflationtarget

Eurozone 5y/5y forward inflation

swap

3.0

4.3

5.5

6.8

8.0-1.0

0.5

2.0

3.5

5.0

Mar 00 Mar 03 Mar 06 Mar 09 Mar 12

%%pa

CPI Shelter Costs(lhs)

Vacancy rate(inverse)

(adv 2 qtrs, rhs)

US VACANCIES & SHELTER COSTS

80

100

120

140

160

80

100

120

140

160

Jan-14 May-14 Sep-14 Jan-15

IndexIndex

EnergyHigh Yield

EmergingMarket

CorporateHigh Yield

OIL & GLOBAL BONDS

Source: Bloomberg

Russia Government

Bonds

0

30

60

90

120

0

25

50

75

100

1969 1979 1989 1999 2009

Thou

sand

s

Production('000 barrels

per day)(lhs)

Price(USD per

barrel)(rhs)

OIL: PRODUCTION & PRICE

Source: Various

Europe looks most

policy effort is likely as a result.

Lower oil prices are an example of

Financial market pricing will be affected.


20

breakevens for most OPEC members and this may encourage some production cutback (equally, there is an incentive to pump more to offset lower prices). There are also some tentative indications that oil-related capex is being cut back. But such changes will take some time to affect supply in any meaningful way. The risk is that low oil prices persist for an extended period.

Geopolitics leads to the same conclusion. Saudi Arabia and other OPEC producers occupy the low end of the global costs curve. Some analysts are suggesting that the lack of

force other OPEC members to bear a greater share of the pain. Others suggest that OPEC is using its position on the cost curve to pressure higher cost producers elsewhere.

(h) Geopolitical and geomedical

Oil remains the major geopolitical issue facing the global economy in 2015. For much of 2014 the fear was that tensions in the Middle East and Ukraine/Russia would restrict oil supply and lead to higher oil prices. But the risk now comes from excess supply and low oil prices. Fiscal pressures, lower currencies and higher interest rates in affected countries can add to instability and shift global capital flows.

Geomedical issues re-emerged as a risk factor in 2014 with the Ebola outbreak in west Africa. Aside from the humanitarian tragedy, the risks from the Ebola outbreak are considered low:

the direct impact on global growth outsideof Africa should be low; and

the main economic danger to the globaleconomy is the fear of it rather than thedirect costs of the disease itself.

The SARS epidemic (2002/03) is one benchmark of possible geomedical effects. The impact on markets was relatively minor outside of the areas most affected (eg Hong Kong).

The main impact on Australian economy from SARS was via reduced tourism flows. Only a small proportion of tourists to Australia come from Africa each year.

Political dynamics will remain important in the Eurozone. The Greek election outcome has reignited fears of a Greek exit from the EZ. Elections in the UK, Spain and Switzerland are due later in 2015.

Beyond Construction

A broad range of construction-related activities should carry the Australian economy through the next couple of years. Based on CBA forecasts and the historical multipliers,

0

20

40

60

80

0 10 20 30 40 50 60 70 80

Average cost

($/bbl)

Production (mb/d)

OIL COST CURVE

Source: Energy Aspects

SaudiArabia

OtherOPEC

Russia

US(ex shale)

Kazakhstan/Norway

ChinaOther non-

OPEC

Mexico

Brazil

US shale

Canada oilsands

0 50 100 150 200

LibyaYemen

IranAlgeria

BahrainSaud Arabia

OmanIraq

AzerbaijanUAE

KazakhstanQatar

KuwaitTurkmenistan

USD per barrel

FISCAL BREAKEVEN OIL PRICES(for 2015)

72

83

94

105

116

126

137

148

159

78

82

86

90

94

98

102

106

110

Jan 14 Mar 14 May 14 Jul 14 Sep 14 Nov 14

Index

Index

MSCI WorldAirlines index

(lhs)

US consumer confidence

index(lhs)

EBOLA, MARKETS & THE ECONOMY

Source: University of Michigan

Peak Ebola fears

4

6

8

10

4

6

8

10

1974/75 1982/83 1990/91 1998/99 2006/07 2014/15

CONSTRUCTION(% of GDP)% %

The risk is that low oil prices persist for an extended period.

Low oil prices are a new source of geopolitical concern.

Construction can carry the economy for the next couple of years


21

construction job gains should outweigh mining construction losses.

But we cannot build evermore houses and office blocks indefinitely. Other sectors will need to make a contribution over the medium term. The main candidates are:

the domestic consumer (the largest part ofthe economy at 56% of GDP); and

the Asian middle income consumer.

(a) The Australian consumer

Consumer spending grew by about 2½% in 2014. This outcome was an improvement on the 1.7% rise in 2013. But it remains well below the pre-financial-crisis period where growth around 4%pa was seen as normal. The factors that produced that earlier period of robust growth sustained rises in wealth and leverage are unlikely to be repeated. Instead,

consumer spending ability will mainly reflect income trends.

The main or most variable drivers of disposable income are:

labour income;

social benefits;

taxes; and

interest rates.

Looking ahead, tax cuts, social benefit increases and rate cuts are off the agenda. The main swing variable is labour income. Labour income, in turn, reflects trends in jobs, job security and wages.

There was something of a vicious circle during 2014. Jobs growth short of labour-force expansion meant unemployment rose. Rising unemployment kept job security fears at elevated levels. And these fears kept a lid on wage demands. Household incomes grew only slowly as a result.

Households that are worried about job prospects also typically:

are less confident about the economicoutlook and less responsive to low interestrates;

want to save more and spend less; and

are reluctant to borrow and focus on payingoff debt.

So consumer outcomes in 2015 will depend on how the labour market evolves. The difficulties experienced by the statisticians in accurately measuring labour market trends have complicated the analysis. But a range of alternative indicators are consistent with a peak in unemployment and a lift in jobs growth

0

2

4

6

0

2

4

6

1995 1999 2003 2007 2011 2015

%%

Pre-financial-crisis average

Consumerspending

CONSUMER SPENDING(annual % change)

0 4 8 12

Labour income

Property income

Social benefits

Other income

Interest payments

Taxes

Other deductions

Disposable income

Increase in savings

Consumer spending

%pts pa

DISPOSABLE INCOME DRIVERS(annual contribution over decade to 2013/14)

-20

20

60

1001.0

2.3

3.7

5.0

Jul-98 Jul-01 Jul-04 Jul-07 Jul-10 Jul-13

EXPECTATIONS & WAGES

*Source: Melbourne Institute

%pa %

Unemploymentexpectations*

(net bal. exp. rise)(adv 12 months, inverse, rhs)

WPIprivate sector

(lhs)

-30

-15

0

15

- 2

0

2

4

Jul 06 Jul 08 Jul 10 Jul 12 Jul 14

Employment (lhs)

Labour hiring plans*(net % expecting a rise)(advanced 6 month, rhs)

%pa %

* Source: NAB Business Survey

EMPLOYMENT & JOB PLANS

NAB survey readings consistent with jobs

running at 2%pa or 19k per month

of growth are needed.

Income growth is the key to consumer spending.

Rising unemployment and rising job fears have weighed on incomes and spending appetite.

So consumer outcomes in 2015 will depend on how the labour market evolves.


22

during 2015. The jobs component of some business surveys, for example, is pointing to jobs growth of around 19k per month. That growth would stabilise unemployment.

A structural drop in labour-force participation will help contain unemployment over time. As the population ages, the proportion of the population at the high end of the age range increases. Increased longevity is accentuating the trend. These older groups have lower participation rates. They are neither working nor looking for work they are retired. Unless there is an offsetting increase in participation by younger age cohorts, the aggregate participation rate will decline over time.

There would also be a positive spinoff to job

need an unemployment rate of 6¾% to validate the concerns. We expect the peak to be somewhere in the low 6 s .

A reduction in job fears would encourage less savings, more borrowing and help the consumer part of the growth equation.

Other factors will assist the consumer activity in 2015. These factors include:

Lower petrol prices are adding tot

around $20bn on petrol in 2013/14. So the drop in petrol prices from the 2013/14 average of 152.4c/l to 108.6c/l at the end of January 5.8bn (equal to 60bpts worth of rate cuts).

The lower AUD is redirecting someconsumer spending from offshore backonshore. And may encourage morespending by foreigners in Australia.

We expect consumer spending growth to push towards 3%pa in 2015.

(b) The Asian middle-income consumer

One of our enduring medium-term themes is the belief that an expanding middle-income population will underwrite growth in Asian consumer demand. There are plenty of opportunities for the Australian economy if we have the wit to grasp them.

We are in the middle of a decade where the middle income group in the Asia-Pacific region is moving from ½bn people to 1¾bn people.The number of consumers in China and the rest of Asia with money to spend is growing at a rapid rate. The historical experience is that middle income consumers want:

larger and better quality housing;

more and better quality food;

more consumer durables;

3.00

4.25

5.50

6.75

8.00

-30

0

30

60

90


Index %

Unemploymentrate (rhs)

Job concerns*(net % exp

unemp. to rise)(adv 12 mnths, lhs)

*Source: Melbourne Institute

UNEMPLOYMENT & JOB SECURITY

GFCperiod

120

160

200

240

120

160

200

240

Jan-05 Jan-08 Jan-11 Jan-14

H'HOLD PETROL SPENDING$ permonth

$ permonth

-30

-15

0

15

30

45

-20

-10

0

10

20

30


%%

"Offshore" consumer spending*

(lhs)

TWI(adv 5

months, rhs)

OFFSHORE SPENDING & THE AUD(annual % change)

* Consumer goods imports + tourism

debits

0.0

0.5

1.0

1.5

0.0

0.5

1.0

1.5


Mn

Thou

sand

s

Mn

Thou

sand

s

China

India

SHORT TERM OVERSEAS ARRIVALS(rolling annual total)

NewZealand

Japan

UK

Measurement issues mean job trends are uncertain but a range of indicators are pointing to some improvement.

An expanding middle income group will under-write Asian consumer demand.

Lower petrol prices and a lower AUD will assist domestic consumer activity.


23

more education services; and

more holidays.

The Asian demographics also involve an aging population. And again experience tells us that older consumers have certain needs notably:

health; and

financial services.

The rising demand for consumer durables, learning and holidays is a source of new growth in Australia for areas such as manufacturing, education and tourism. The general perception that Australia is little more than a quarry with a farm attached conceals the reality that tourism is our 3rd biggest export earner and education is the 5th.

services means we are well placed to take advantage of the aging trend.

The same income growth will assist LNG demand and price. The bigger LNG markets are those economies at the higher end of the income range.

Australia has recently negotiated free trade agreements with our three biggest trading partners China, Japan and South Korea. Components of these agreements, especially

shift towards more consumer-driven growth.

Inflation: cyclical vs structural

The last published data showed inflation running at 1.7% at the end of 2014. The dramatic slowdown is courtesy of lower petrol prices. But within that headline result lies two quite different trends:

a cyclical component sitting comfortably-3%pa target; and

a structural component stuckuncomfortably above target.

The main cyclical drivers are labour costs and the AUD. The structural drivers reflect influences on some parts of the CPI that do not respond to the business cycle and are beyond

Examples of these structural influences include: the ageing population and new technology costs boosting health charges; government revenue needs boosting government charges (eg tobacco excise and petrol excise rates); and education preferences and work requirements boosting school fees and childcare costs.

Cyclical components account for 75% of the CPI basket. Structural items are the other 25%.

Looking ahead, structural inflation is likely to

AUS

CAN

CHN

FRADEU

HKG

INDIDN

ITA

JPN

KORMYS

NZLNTL

PHL

SGP

THL

GBRUSA

VTN

0%

25%

50%

75%

100%

0 10 20 30 40 50Income per capita ('000)

PENSION COVERAGE(of working age population)

Source: OECD

0

300

600

900

1200

0

300

600

900

1,200

0 9,000 18,000 27,000 36,000

Mcm/capita

GDP/ capita

NATURAL GAS CONSUMPTION(1965-2012)

China

EU

Japan

Mcm/ capita

0

2

4

0

2

4


CONSUMER PRICES(annual % change)% %

Headlineinflation

(exc GST)

Underlyinginflation

-4

0

4

8

12

-4

0

4

8

12


CONSUMER PRICES(annual % change)% %

Other Goods & Servicesinc volatile

items

Market Goods & Servicesex volatile items

Cyclical

Structural

There are opportunities for the non-mining economy if we have the wit to grasp them.

Weak cyclical price drivers are offsetting structural price rigidities.

Inflation is at the bottom end of the

-3% target.


24

remain around 4%pa and is a source of upside risk in the inflation outlook. Cyclical drivers are more diverse. Petrol prices will remain restrained. Growth in labour costs will probably remain subdued. But leading indicators are starting to turn. The AUD has fallen sharply and we expect a move lower in HI 2015. In the end, cyclical inflation is more strongly correlated with the currency than labour costs. So cyclical inflation is a source of upside risk.

We expect inflation rates to end 2015 in the upper half of the RBA s 2-3% target band.

The removal of the carbon tax helped reduce CPI growth in QIII 2014. And the expectation built into official forecasts is that there is more to come. But estimates that the tax removal will ultimately cut the headline CPI by 0.7ppts look too optimistic. So there are upside risks to official inflation forecasts.

There are some indications of lifting inflation outside the CPI as well. Prices in the stronger parts of the economy are growing more quickly. Building output prices, for example, are growing at 3.0%pa, the fastest rate in three years.

The RBA in 2015

2014 in both word and deed. The cash rate sat at a record low of 2½% through 2014.

This stability theme was expected to continue through 2015 as well.

In what has become a regular end-of-year interview with the Australian Financial Review, RBA Governor Stevens revealed that his focus

The Governor also indicated that the Bank s forward guidance would be adjusted before any shift in policy direction.

From that perspective, the decision to cut interest rates following the RBA Board meeting in February was surprising.

We suspect that currency risk in a world where many central banks were (unexpectedly) cutting interest rates was the key. The RBA stressed in February that a lower exchange rate is likely to be needed to achieve balanced growth in the economy . The risk was that by not following other central banks the RBA would surrender some of the recent AUD depreciation as interest-rate differentials widened.

RBA Governor Stevens nominated USD0.75 as his desired level for the currency. It appears

provide a buffer against lower commodity

-1.0

0.5

2.0

3.5

5.0-30

-15

0

15

30Sep-03 Sep-06 Sep-09 Sep-12

% %

TWI(inverse, lhs)

"Cyclical"inflation

(rhs)

"CYCLICAL" INFLATION DRIVERS(annual % change)

Wage Price Index

(rhs)

0

2

4

6

8

77

79

81

83

85


CAPACITY PRESSURES%pa %

Source: NAB

Labour costs (lhs)

Capacity utilisation

(adv 8 mnths)(rhs)

1.50

1.75

2.00

2.25

2.50

2.75

3.00

1.50

1.75

2.00

2.25

2.50

2.75

3.00

1 m 3 m 5 m 7 m 9 m 11 m 13 m 15 m 17 m

%OIS CASH RATE PRICING

%

Source: Bloomberg

Current(early February)

1 yearago

3 monthsago

1.5

3.5

5.5

7.5

1.5

3.5

5.5

7.5

-12 -6 0 6 12 18 24 30Months from last cut

HOW LONG AT THE TROUGH?(Australian cash rate since 1990)% %

1993

1997

2001

2009

2012

CBA(f)

Cyclical inflation is more strongly correlated with the currency than labour costs and is set to rise as the AUD falls.

We expect inflation to end 2015 towards the top end of the target.

was a persistent RBA theme that delivered

in 2014.

So the February rate cut was a surprise .


25

prices.

The RBA repeatedly indicated in 2014 that it would prefer any additional stimulus to the economy came from a lower AUD rather than lower interest rates. The fear was that lower rates would just feed into house prices and rising household leverage. One key change is that the RBA is promoting macroprudential measures to take the heat out of key parts of the housing market. This shift appears to have given the RBA greater confidence to cut rates.

More broadly, the RBA s decision to extend forecasts for below-trend growth has seen the Bank adopt a more pessimistic labour market outlook. Trends in unemployment are a critical input into the monetary policy equation. The disinflationary influence of lower oil prices then allows policy makers to consider additional stimulus.

One risk is whether further cuts would be helpful to confidence? The sharp drop in consumer confidence and pull back in business confidence in the first half of December reflects in part the rate cut speculation that surfaced at the time. It appears that households and

economic news. So produce the confidence and stability the RBA favours.

Nevertheless, it seems likely that the RBA will move to lower rates again over the next few months. We see the terminal cash rate at 2%.

The low point is set to remain in place for an extended period. The winding down of the terms-of-trade and credit booms of earlier years that boosted activity and repeated.

Any tightening cycle when it comes should be fairly modest and drawn out. The neutral policy rate is now probably closer to 3½% rather than the 5-6% that was regarded as the norm.

Financial markets in 2015

Many of the forces that drove financial market outcomes in the past few years will continue in 2015. But some new forces will come in to play.

Policy interest rates will remain low and central bank balance sheets will remain large. Risk appetite and the pursuit of yield will continue. Sensitivity to event risk will remain. And pricing in many markets remains susceptible to shifting fundamentals and the reduced capacity and appetite of market makers to accommodate risk-off events. A discussion of the volatility fundamentals can be found here.

What will change in 2015 is a growing

Table 4: CBA Interest Rate Forecasts (%)

Cash rate 2¼ 2 2 2

90-day bills 2.3 2.1 2.1 2.2

3-yr bonds 2.0 1.9 2.0 2.1

10-yr bonds 2.9 2.9 3.0 3.1

Au 3-10 curve 90 100 100 100

Au-US 10yr spd 30 20 25 30

Au 3-yr swap 2.60 2.85 2.95 3.05

Au 10-yr swap 3.25 3.40 3.45 3.50

US 10-yr bonds 2.60 2.70 2.75 2.80

1.5

3.7

5.8

8.0

2.0

3.8

5.7

7.5

Jan 97 Jan 00 Jan 03 Jan 06 Jan 09 Jan 12 Jan 15

%%

3yr bonds(lhs)

Cashrate(rhs)

CASH RATE & BOND YIELDS

10yr bonds(lhs)

Neutralcash rate

(rhs)

17

20

23

26

0

4

8

12

Jan-95 Jan-99 Jan-03 Jan-07 Jan-11 Jan-15

% of GDP%

Globalsavings

(rhs)

G-7 policyrate (lhs)

RBAcash rate

(lhs)

POLICY INDICATORS

Source: IMF/RBA/CBA

0

12

24

36

48

60

0

12

24

36

48

60


ECB

Fed

BoE

% %

CENTRAL BANK ASSETS(% of GDP)

BoJ

Many of the forces shaping financial markets in 2014 will continue into 2015.

The neutral cash rate is 3½%.

Further rate cuts could damage confidence, something the RBA wants to avoid.

Nevertheless, we put the cash rate low at 2%.

Concern about upward pressure on the AUD was probably a key driver.

https://www.commbank.com.au/content/dam/commbank/corporate/research/publications/economics/economic-issues/australia/2014/231014-Volatility.pdf

https://www.commbank.com.au/content/dam/commbank/corporate/research/publications/economics/economic-issues/australia/2014/231014-Volatility.pdf


26

divergence between the major central banks.

US interest-rate normalisation is set to begin in HI 2015. The ECB and BoJ are still aiming to ramp up their balance sheets.

Market pricing will adjust to these divergences. So the risks lie with higher US and Australian bond yields. But there are some limits to the upside. Downward pressure on yields elsewhere, low inflation and growth and deflation fears will impose some restraint.

Our interest rate forecasts are shown in Table 4 Great Policy Divergence

and implications for financial markets can be found here.

The same policy divergences are central to our currency forecasts as well.

our belief that the USD is now established on a secular uptrend. The US will be the stronger advanced economy in 2015 and will benefit from an oil driven boost to the terms-of-trade.

The flip side of a stronger USD is weakness in the other major currencies. And some country specific factors are likely to accentuate the divide.

The AUD, for example, is finally catching up with the fundamentals. Lower commodity prices, a falling terms-of-trade and narrower interest-rate differentials underpin our forecast for the AUD at USD0.73 by mid 2015.

The AUD is also likely to struggle against the JPY, EUR, GBP and NZD over the first half of 2015 for similar reasons.

Elsewhere, the disappearing Japanese current account surplus and GPIF-led capital outflow will weigh on the JPY. The large UK current account deficit (5.6% of GDP) will weigh on the GBP. And the same commodity pressures will weigh on the NZD.

Our currency forecasts are shown in Table 5 and more detail on our fx views can be found here for the majors and here for Asian currencies.

A peek at 2016

The downturn in mining capex will remain a feature of the economic landscape in 2016. Equally, the offsets through resource exports and non-mining construction (including public infrastructure) will continue.

Our preliminary forecasts have GDP growth averaging out at a trend-like 3% in 2016. The global economy should also be back at trend growth.

Table 5: CBA Exchange Rate Forecasts

vs USD:

AUD 0.78 0.73 0.76 0.77

EUR 1.23 1.20 1.19 1.17

JPY 120 125 128 130

CNY 6.05 6.00 5.95 5.75

vs AUD

JPY 93.6 91.3 97.3 100.1

EUR 0.63 0.61 0.64 0.66

GBP 0.50 0.48 0.49 0.50

60

70

80

90

100

110

60

70

80

90

100

110

-6 11 28 45 62 79 96 113 130 147 164Months from peak

US REAL BROAD TWI(peak=100) IndexIndex

PeakMar-85

PeakFeb-02

US REAL BROAD TWI(peak=100) IndexIndex

PeakJan-70

Source: FRB/JP Morgan

40

67

93

120

80

120

160

200


THE AUDIndex Index

*Source: RBA

Terms of trade

(rhs)

RealTWI*(lhs)

Our preliminary forecasts have GDP growth averaging out at a trend-like 3% in 2016.

But the rising divergence in central bank activity will increasingly impact on markets.

The AUD.

Bond yields.

https://www.commbank.com.au/content/dam/commbank/corporate/research/restricted/fixed-income/debt-updates/2014/101214-Outlook_2015.pdf

https://www.commbank.com.au/content/dam/commbank/corporate/research/restricted/foreign-exchange/market-views-and-recommendations/2014/181214-Revisions.pdf

https://www.commbank.com.au/content/dam/commbank/corporate/research/restricted/foreign-exchange/market-views-and-recommendations/2014/181214-Forecast_changes.pdf

https://www.commbank.com.au/content/dam/commbank/corporate/research/restricted/foreign-exchange/market-views-and-recommendations/2014/181214-Forecast_changes.pdf


27

2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2010 2011 2012 2013 2014 2015 2016(a) (a) (a) (a) (f) (f) (a) (a) (a) (a) (f) (f) (f)

Economic Activity

Private final demand 4.4 6.0 2.1 0.9 1.2 1.6 2.6 5.5 4.5 1.0 1.1 1.3 1.8Of which: Household spending 3.7 2.5 1.9 2.2 2.6 3.1 3.2 3.1 2.5 1.7 2.5 2.9 3.1

Dwelling investment 3.8 -2.9 -3.8 5.1 6.5 4.1 4.8 1.8 -6.1 0.2 8.1 5.7 2.1Business investment 9.0 24.3 4.1 -5.0 -5.5 -4.5 0.1 19.0 15.8 -1.5 -5.5 -6.0 -3.0

Public final demand 1.7 2.4 -0.2 1.5 0.7 1.4 6.5 0.2 3.2 -1.5 1.7 1.5 1.3Domestic final demand 3.7 5.1 1.6 1.0 1.1 1.6 3.5 4.3 4.2 0.4 1.3 1.3 1.7

Inventories (contrib to GDP) 0.4 0.0 -0.1 -0.3 0.3 0.2 0.4 0.4 0.0 -0.4 0.1 0.2 0.1GNE 4.1 5.1 1.5 0.8 1.4 1.8 4.0 4.6 4.2 0.0 1.3 1.6 1.8

Exports 0.9 5.0 6.0 5.8 6.4 8.0 5.8 0.1 6.0 6.2 6.5 6.6 8.5Imports 10.3 11.6 0.7 -2.1 0.4 1.6 15.2 11.0 6.3 -1.9 -0.8 0.6 3.1

Net exports (contrib to GDP) -1.7 -1.4 1.0 1.6 1.2 1.4 -1.5 -2.1 -0.2 1.6 1.5 1.3 1.3GDP 2.3 3.7 2.5 2.5 2.5 3.2 2.3 2.7 3.6 2.1 2.7 2.9 3.0

Prices & IncomesCPI 3.1 2.3 2.3 2.7 1.7 2.6 2.9 3.3 1.8 2.4 2.5 1.7 3.1

Underlying CPI 2.6 2.3 2.3 2.6 2.4 3.0 2.8 2.6 2.1 2.4 2.5 2.7 3.1WPI 3.8 3.7 3.2 2.6 2.5 3.0 3.4 3.8 3.6 2.8 2.6 2.7 3.2

Nominal GDP 8.6 5.6 2.2 4.1 2.6 6.1 7.8 7.1 3.3 3.3 3.2 4.3 6.2Real h/hold disposable income 5.0 3.8 0.7 1.6 1.8 2.5 2.7 4.5 2.0 1.5 1.5 2.1 2.7

Labour MarketEmployment 2.4 1.2 1.2 0.8 1.3 2.0 2.0 1.7 1.2 1.0 1.0 1.7 2.0

Unemployment rate 5.0 5.2 5.4 5.8 6.2 5.9 5.2 5.1 5.2 5.7 6.1 6.0 5.7

External AccountsCurrent Account: $bn -44.2 -50.2 -59.3 -47.5 -53.9 -35.9 -48.3 -42.4 -64.0 -51.5 -50.0 -47.9 -26.9

% of GDP -3.1 -3.4 -3.9 -3.0 -3.3 -2.1 -3.6 -2.9 -4.3 -3.3 -3.1 -2.9 -1.5


28

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In Hong Kong: The contents of this document have not been reviewed by any regulatory authority in Hong Kong. You are advised to exercise caution in relation to the offer. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. The provision of this document to any person in the Hong Kong does not constitute an offer of securities to that person or an invitation to that person to acquire, apply, or subscribe, for the issue of, or purchase, securities unless the recipient is a person to whom an offer of securities may be made in Hong Kong without the need for a prospectus under section 2 and the Seventeenth Schedule of the Companies Ordinance (Cap. 32 of the Laws of Hong Kong) (“Companies Ordinance”) pursuant to the exemptions for offers in respect of which the minimum consideration payable by any person is not less than HK$500,000 or its equivalent in another currency. Neither this document nor any part of it is, and under no circumstances are they to be construed as, a prospectus (as defined in the Companies Ordinance) or an advertisement of securities in Hong Kong. The products have not been, nor will they be, qualified for sale to the public under applicable Hong Kong securities laws except on a basis that is exempt from the prospectus requirements of those securities laws. Minimum Investment Amount for Hong Kong Investors: HK$500,000

In Hong Kong for Equities: This document is distributed in Hong Kong by, and is attributed to, Commonwealth Bank of Australia, Hong Kong Branch (“CBAHK”), which is a registered institution with the Hong Kong Monetary Authority to carry out the Type 1 (Dealing in securities) and Type 4 (Advising on securities) regulated activities under the Securities and Futures Ordinance. Investors should understand the risks in investments and that prices do go up as well as down, and in some cases may even become worthless. If you have any queries concerning this document, please contact CBAHK’s registered representative, James Barratt (T. +612 9117 0109 and E. [email protected]).

In the USA for products other than Equities:

The Bank is authorized to maintain a Federal branch by the Office of the Comptroller of the Currency. This document is made available for informational purposes only. The products described herein are not available to retail investors. NONE OF THE PRODUCTS DESCRIBED ARE DEPOSITS THAT ARE COVERED BY FDIC INSURANCE. This product is not suitable for investment by counterparties that are not “eligible contract participants” as defined in the U.S. Commodity Exchange Act (“CEA”) and the regulations adopted thereunder; or (ii) entities that have any investors who are not “eligible contract participants.” Each hedge fund or other investment vehicle that purchases the products must be operated by a registered commodity pool operator as defined under the CEA and the regulations adopted thereunder or a person who has qualified as being exempt from such registration requirement. CBA cannot execute swaps with any US person unless our counterparty has adhered to the ISDA Dodd Frank protocol.

This report was prepared, approved and published by Global Markets Research, a division of Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945 (the “Bank”) and is distributed in the United States by the Bank’s New York Branch and its Houston Loan Production Office. If you would like to speak to someone regarding securities related products, please contact Commonwealth Australia Securities LLC (the “U.S. Broker–Dealer”), a broker–dealer registered under the U.S. Securities Exchange Act of 1934 (the “Exchange Act”) and a member of the Financial Industry Regulatory Authority (“FINRA”) at 1 (212) 336-7737. The information contained herein is not intended to be an exhaustive discussion of the strategies or concepts mentioned herein or tax or legal advice. Investments and strategies are discussed in this report only in general terms and not with respect to any particular security or securities transaction, and any specific investments may entail significant risks including exchange rate risk, interest rate risk, credit risk and prepayment risk among others. There also may be risks relating to lack of liquidity, volatility of returns and lack of certain valuation and pricing information. International investing entails risks that may be presented by economic uncertainties of foreign countries as well as the risk of currency fluctuations. Investors interested in the strategies or concepts described in this report should consult their tax, legal or other adviser, as appropriate. This report is not intended to provide information on specific securities. The Bank’s New York Branch and its Houston Loan Production Office provides its clients access to various products and services available through the Bank and its affiliates.

In the United States, U.S. brokerage products and services are provided solely by or through the U.S. Broker-Dealer. The U.S. Broker-Dealer is a wholly-owned, but non-guaranteed, subsidiary of the Bank, organized under the laws of the State of Delaware, U.S., with limited liability. The U.S. Broker-Dealer is not authorized to engage in the underwriting of securities and does not make markets or otherwise engage in any trading in the securities of the subject companies described in our research reports.

All Investors:

All investors: Analyst Certification and Disclaimer: Each research analyst, primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the report. The analyst(s) responsible for the preparation of this report may interact with trading desk personnel, sales personnel and other constituencies for the purpose of gathering, synthesizing, and interpreting market information. Directors or employees of the Group may serve or may have served as

http://www.research.commbank.com.au/


29

officers or directors of the subject company of this report. The compensation of analysts who prepared this report is determined exclusively by research management and senior management (not including investment banking).

Unless agreed separately, we do not charge any fees for any information provided in this presentation. You may be charged fees in relation to the financial products or other services the Bank provides, these are set out in the relevant Financial Services Guide (FSG) and relevant Product Disclosure Statements (PDS). Our employees receive a salary and do not receive any commissions or fees. However, they may be eligible for a bonus payment from us based on a number of factors relating to their overall performance during the year. These factors include the level of revenue they generate, meeting client service standards and reaching individual sales portfolio targets. Our employees may also receive benefits such as tickets to sporting and cultural events, corporate promotional merchandise and other similar benefits. If you have a complaint, the Bank’s dispute resolution process can be accessed in Australia on phone number 132221 or internationally 61 2 98417000.

Unless otherwise noted, all data is sourced from Australian Bureau of Statistics material (www.abs.gov.au).


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Research

Commodities Telephone Email Address

Vivek Dhar

Tobin Gorey

Mining & Energy Commodities

Agri Commodities Strategist

+613 9675 6183

+612 9117 1130

[email protected]

[email protected]

Economics Telephone Email Address

Michael Blythe

Michael Workman

John Peters

Gareth Aird

Diana Mousina

Chief Economist

Senior Economist

Senior Economist

Economist

Economist

+612 9118 1101

+612 9118 1019

+612 9117 0112

+612 9118 1100

+612 9118 6394

[email protected]

[email protected]

[email protected]

[email protected]

[email protected]

Fixed Income Telephone Email Address

Adam Donaldson

Scott Rundell

Philip Brown

Alex Stanley

Tariq Chotani

Tally Dewan

Head of Fixed Income Strategy

Chief Credit Strategist

Senior Fixed Income Strategist

Fixed Income Strategist

Credit Strategist

Securitisation Analyst

+612 9118 1095

+612 9303 1577

+612 9118 1090

+44 20 7710 6994

+612 9280 8058

+612 9118 1105

[email protected]

[email protected]

[email protected]

[email protected]

[email protected]

[email protected]

Foreign Exchange, Interest Rates and International Economics Telephone Email Address

Richard Grace

Jarrod Kerr

Elias Haddad

Joseph Capurso

Peter Dragicevich

Andy Ji

Chief Currency & Rates Strategist, Head of International Economics

Senior Interest Rate Strategist

Senior Currency Strategist

Senior Currency Strategist

Senior Currency & Rates Strategist

Asian Currency Strategist

+612 9117 0080

+612 9303 1766

+612 9118 1107

+612 9118 1106

+44 20 7710 5603

+65 6349 7056

[email protected]

[email protected]

[email protected]

[email protected]

[email protected]

[email protected]

Delivery Channels & Publications Telephone Email Address

Monica Eley

Ai-Quynh Mac

Internet/Intranet

Information Services

+612 9118 1097

+612 9118 1102

[email protected]

[email protected]

New Zealand Telephone Email Address

Nick Tuffley

Nathan Penny

Christina Leung

Chris Tennent-Brown

Jane Turner

ASB Chief Economist

Rural Economist

Economist

Senior Economist

Senior Economist

+649 301 5659

+649 448 8778

+649 301 5661

+649 301 5660

+649 301 5853

[email protected]

[email protected]

[email protected]

[email protected]

[email protected]

Sales

Institutional Telephone Equities Telephone

Syd FX

Fixed Income

Japan Desk

Melb

Lon FX

Debt & Derivatives

Credit

HK

Sing

NY

+612 9117 0190

+612 9117 0341

+612 9117 0020

+612 9117 0025

+613 9675 6815

+613 9675 7495

+613 9675 6618

+613 9675 7757

+44 20 7329 6266

+44 20 7329 6444

+44 20 7329 6609

+852 2844 7539

+65 6349 7074

+1212 336 7750

Syd

Asia

Lon/Eu

NY

+612 9118 1446

+613 9675 6967

+44 20 7710 3573

+1212 336 7749

Corporate Telephone

NSW

VIC

SA/NT

WA

QLD

NZ

Metals Desk

Agri Desk

+612 9117 0377

+612 9675 7737

+618 8463 9011

+618 9215 8201

+617 3015 4525

+64 9375 5738

+612 9117 0069

+612 9117 0145

mailto:[email protected]









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