March quarter 2002 December Quarter 2004 ANZ …Australia and New Zealand Banking Group A.B.N. 11...

Australia and New Zealand Banking Group

A.B.N. 11 005 357 522

March quarter 2002 December Quarter 2004

ANZ Economic Outlook

This publication was finalised on 18 October 2004

Economics on the Web View Economics@ANZ research and commentary on-line by going to http://www.anz.com/go/economics. NZ economic researchcan be accessed online at http://www.anz.com/nz/tools/economic.asp. For your economic consultancy needs please call David de Garis on 03 9273 1995

Inside

International outlook • High and rising oil prices have been the main challenge to world economic growth this year. We continue

to expect that current prices will not be sustained and that the probability of an oil-induced global recession - meaning world growth of less than 2% - remains slim. page 2

Asian outlook • Economic growth in East Asia is projected to slow from 7½% in 2004 to 5¼% in 2005. This moderation

partly reflects slower growth in China but also the negative impact of higher oil prices. Critical for Asian economic prospects is global demand, given the importance of exports to the Asian economies. page 8

Australian outlook • The Australian economy is well placed to extend its record of 13 years of uninterrupted growth, with both

domestic demand and exports now providing support for growth. Inflation is accelerating and with the likelihood of a property market crash remote, interest rates are likely to rise. page 12

New Zealand outlook • The New Zealand economy continues to surprise on the upside although strong economic growth has

come with a sting in its tail, with inflation rising across a range of gauges. The RBNZ is expected to raise the official cash rate once more in October and another rate rise is possible later this year. page 16

Financial markets • The surge in the price of oil has gripped the market’s attention and participants are betting that oil prices

will remain well above the long term average for an extended period. Higher oil prices have halted in recent months the rise in world interest rates that had been evident from earlier this year. page 19

Household debt – safe as houses • Household debt levels in Australia have risen dramatically over the past decade, buoyed by a marked

reduction in interest rates, solid growth in household incomes and a sustained boom in house prices. However the need for household balance sheet ‘correction’ is not yet clear-cut. page 23

Financial markets forecast table page 26

Economic forecast table page 27

Gross Domestic Product

% ch 2002 2003 2004(f) 2005(f) 2006(f) United States 1.9 3.0 4½ 3½ 2¾ Eurozone 0.9 0.6 1¾ 2 1¾ Japan -0.3 2.5 4¼ 2¼ 1¾ Australia 3.9 3.0 3¾ 3¾ 3½ New Zealand 4.3 3.4 4¼ 2½ 2¼ China 7.8 9.1 8½ 6 7½ Other East Asia 4.7 4.2 5½ 4¼ 5 South Asia 4.6 6.7 6¾ 6¼ 6½ South America -0.8 1.7 5 3½ 3½ E.Europe & Russia 3.8 5.7 6 4¾ 4¼ World 2.7 3.8 5 3¾ 3¾

ANZ ECONOMIC OUTLOOK 2

International outlook Oil-induced recession a low probability High and rising oil prices have been the main challenge to world economic growth this year, continuing to increase even as oil supply has risen and projections for global oil demand have been trimmed. The spot crude price (West Texas Intermediate) reached a record level of $55/barrel in October to stand nearly 80% higher than a year ago. As prices have shot above our target range, we have marginally revised down our forecasts for world economic growth next year. Real GDP growth is now forecast to be 3¾% next year, down ¼ pc point from that forecast three months ago. This may seem a fairly modest reduction in expected global growth considering how sharply the oil price has risen of late. However, we continue to expect that current prices will not be sustained and that the probability of an oil-induced global recession - meaning world growth of less than 2% - remains slim.

World oil prices close to peaking

15

20

25

30

35

40

45

50

55

60

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

US$/bbl

2002

2003

2004

Brent crude oil price

Source: Datastream We have modified our oil price assumptions and now expect an average price for 2004 of $40/barrel, up from an expected average of $37/barrel 3 months ago and a 2003 average of $31/barrel. We continue to expect prices to retreat from current highs by the end of the year - as the political risk premium dissipates and demand growth decelerates - albeit more slowly than we expected 3 months ago. Market data confirms that even with recent supply disruptions, oil supply was running ahead of demand in Q2 and crude oil inventories have moved back into long- term ranges. We are now assuming a slightly higher average oil price in 2005 of $34/barrel (up from $29/barrel back in June) but a decline from 2004 levels nonetheless. We acknowledge the oil price is unlikely to fall back to the old OPEC target range of US$24-28/barrel and

that the new equilibrium price is probably in the $30-$40/barrel range given the lack of meaningful spare capacity. Importantly the expected fall in average crude prices between 2004 and 2005 has not changed dramatically (given the higher 2004 base) and this will have an offsetting positive impact on growth next year. It is also important to note that our world GDP forecasts have been influenced by factors aside from oil. For example, upside surprises to actual growth outcomes in the US, the offsetting impact of stronger than expected growth in China on Japanese and Asian growth expectations and, for Australia, the higher oil price impact is largely offset by additional fiscal stimulus during the recent election campaign. Higher oil prices and production has also lifted real GDP growth in 2004 for most oil-producing countries in the Middle East and elsewhere. This means that in the absence of higher oil price impacts, we could have been raising our 2004 and 2005 world GDP estimates compared with three months ago. We concede that things would look very different if the rally in oil prices continued for a few more quarters. For example, if oil prices continued to follow the trend that has prevailed since July, they would rise above US$75/barrel by mid-2005. The odds of a global recession would then be much higher. Most economies still fundamentally sound It is important to consider the context in which the current oil shock is being felt. Prior to the 1991 oil price spike, world GDP growth had slowed from its 1988 peak for 3 successive years and was just 2.7% in calendar 1990. In the current cycle, world growth has peaked (or passed its acceleration phase), but is still close to 5% and policy settings and interest rates remain stimulatory. This raises the likelihood that any oil-induced output loss will result in a dip in growth not outright recession. In the US, previous oil price shocks were associated with recessions largely because the US was already in the process of stalling. That is not the case this time. Interest rates remain historically low and the wider economy, remarkably resilient. Indeed, in a recent speech, Fed Chairman Greenspan said ‘The impact of the current surge in oil prices, though noticeable, is likely to prove less consequential to economic growth and inflation than in the 1970s. So far this year, the rise in the value of imported oil- essentially a tax on U.S. residents-has amounted to about 3/4 percent of GDP. The effects were far larger in the crises of the 1970s.’ Indeed ANZ

3 ANZ ECONOMIC OUTLOOK

expects US growth to moderate from 4½% in 2004 to 3½% in 2005 (See page 4). According to the International Energy Agency, the Euro zone is the most vulnerable of G3 economies to higher oil prices, given its reliance on oil imports, closely followed by Japan with its efficiency in oil usage partly offsetting its dependence on imported oil, whereas the UK and Canada are both net oil exporters. Asian economies are likely to suffer the biggest negative impact as they tend to have larger industrial sectors and are less efficient users of oil.

Growth in global oil demand

North America20%

Europe8%

China32%Others

40%

China is one of the world’s most inefficient energy users and last year accounted for one third of the growth in global oil demand. Partly reflecting the likely negative impact of higher oil prices on the Chinese economy, ANZ retains a ‘below consensus’ call for Chinese growth of 6% in 2005. Consensus forecasts are still for around 7-8% growth in 2005 while the 2004 outcome looks set to be close to 9% despite measures introduced to cool the economy. Other risks loom We have been arguing for some time that the critical imbalances in the current accounts of the world’s major regions are unlikely to be corrected without some further adjustment in currency markets. Current account imbalances in the global economy are now the largest in modern history. The largest deficits are in Anglo-Saxon economies, primarily the US but also the UK and Australia, matched by surpluses in East Asia and the Euro zone and oil exporting nations. The US dollar has depreciated by 10% since early 2002 but resistance by many Asian countries to letting their currencies appreciate against the US$ has to date prevented a more significant decline. The US dollar has largely traded sideways through 2004 as US corporate recovery, expectations for higher US interest rates and higher oil prices (oil revenues tend to be channelled into US assets) attracted sufficient capital to fund the deficit at largely unchanged interest and exchange rates.

Major current account balances

-600

-400

-200

0

200

400

600

96 97 98 99 00 01 02 03 04 (f) 05 (f)

US EU 6 Asian countries Other developing countries

US$bn

Source: IMF. 6 Asian countries include Japan, China, Korea, Taiwan, Hong Kong, Singapore

But the US deficit has continued to grow and is now close to 6% of GDP. Imports are now 50% larger than exports which means that so long as the US economy continues to grow faster than its main trading partners, the deficit is unlikely to narrow and will most likely get even larger. History suggests these imbalances will only be addressed by a further decline in the US$. However, the failure of the US$ to continue its fall this year and for the external deficit to register any meaningful improvement raises questions about the appropriate remedy this time round. The US deficit (and strong dollar) have been caused largely by weak demand in the rest of the world (Europe and Japan) plus huge growth in foreign exchange reserves in East Asian countries and, more recently, the rise in oil-producing country surpluses, which have been heavily invested into US markets. Hence, depreciation of the US dollar may not be as effective on its own this time as it was in the mid 1980s. A rise in the currencies of Europe and Japan would hinder their ability to generate stronger economic growth relative to the US. The US clearly needs specific demand management policies including higher interest rates and a reduction in the budget deficit so as to reduce the rate of growth in imports relative to exports while Japan and Europe need measures to boost their domestic demand. Asian countries also need to carry lower reserves or invest more in their own economies or destinations outside the US. It is difficult to know what the trigger will be for this or the likely timing. With a reduction in the surpluses of oil exporting countries also likely next year as oil prices decline, there could be less capital flowing into the US to fund the deficit and we continue to expect higher Treasury yields and further US$ weakness as a result. Karen Pringle, Chief Economist (Acting) 03 9273 6251


US outlook remains positive Negative real short-term interest rates throughout much of the past 2 years have provided a major boost to private sector demand, underpinning a rapid acceleration of economic growth in 2003-04. Over the year to June, real GDP expanded by a solid 4.9%.

US economy is still growing strongly

0

1

2

3

4

5

6

95 96 97 98 99 00 01 02 03 04

ann.%ch.

Source: Datastream, Economics@ANZ

US real GDP and GNE

GDP

Gross national expenditure

And despite the clear risks posed by high oil prices, the outlook for the US economy remains positive. Recent data have generally supported the Federal Reserve’s assertion that the mid-year economic slowdown (due largely to higher gasoline prices) was temporary and that, more recently, the economy has regained some ‘traction’. Higher crude oil and gasoline prices adversely impacted consumers through the middle of the year and growth in real private consumer spending slowed sharply from an annualised rate of 4.1% in the March quarter to just 1.6% in the June quarter. But the wider economy has, to date, been remarkably resilient. Even with the ‘soft patch’ in consumer spending, June quarter GDP registered near-trend annualised real growth of 3.3%. Growth in housing investment (+16.5%) and total business investment (+12.4%) partially filled the void left by slower consumer spending. Furthermore, were it not for a marked deterioration in net exports, GDP growth would have registered an above-trend 4.4%. Since then, despite continued high oil prices, real personal consumption expenditure has rebounded growing at an annualised rate of 4% in July and August. Combined with strong growth in non-defence capital goods orders and housing starts, and a smaller negative contribution from net exports, this should ensure a solid rebound in September quarter GDP growth to somewhere near 4%.

Real personal consumption spending rebounds

0

1

2

3

4

5

6

Jan Feb Mar Apr May Jun Jul Aug

ann. % ch.*


*annualised qtr on qtr growth (2 mth smoothed)

But with oil prices hovering between $US50-55/barrel in past weeks and refined product prices again moving higher, the momentum in household spending may be difficult to sustain into the December quarter. However, our economic forecasts are predicated on a marked pullback of crude oil prices over the coming year to $US36/barrel by mid-2005. This will lift consumers’ real purchasing power, hence any slowdown in consumer spending in the December quarter should be short-lived. The US economy is currently in far better shape to absorb higher oil prices than in earlier oil price crises. The economy had already slowed sharply prior to each of the earlier oil price shocks (1973, 1979 and 1991) and was therefore more vulnerable. With US GDP still at an early stage in the recovery cycle and with growth currently running hot, the economy is much better placed to absorb any hit from higher oil prices. Nonetheless, we do expect US GDP growth will moderate from 4½% in 2004 to 3½% in 2005, in part, due to higher oil prices and the removal of the large fiscal and monetary stimuli of recent years. After recovering strongly in the 3 months to May, the labour market has been disappointing with private sector employment growth averaging just 65,300 in the past 3 months. However, the hurricanes in September clearly adversely affected the most recent payrolls outcome. Underlying labour market indicators remain strong and we continue to expect a solid rebound in employment growth in coming months. While job creation has been weak, growth in total hours worked has been more robust, rising at an annualised rate of 4.1% in the past 3 months. This strong underlying labour demand will eventually spill over into higher employment growth. While lingering doubts remain over the ability of US households to maintain the spending momentum built up over 2003-04, no such concerns exist in the


corporate sector. Corporate profitability and cash flows remain buoyant and the outlook for capital spending is positive.

Corporate America is booming

-30

-20

-10

0

10

20

30

40

50

00 01 02 03 04

% p.a.

-20

-15

-10

-5

0

5

10

15

00 01 02 03 04

% p.a.


Non-defence capital goods orders excl. aircraft

Corporate profits (economic post tax)

Real private equipment investment rose sharply (+13.9%) over 2003-04, and growth in non-defence capital goods orders in July and August point to further strength in equipment investment in the September quarter. Despite recent growth, non-residential building and construction activity remain near record lows as a share of GDP and we expect a solid cyclical recovery to extend into 2004-05. Strong momentum has also continued in the housing market with both starts and permits running at a 2 million annual rate. Core consumer price inflation has been remarkably subdued in recent months. After accelerating in the first half of the year, both the core private consumption deflator and the core consumer price index have essentially been unchanged in July and August, prompting a reduction in inflation expectations and a marked rally in bond prices. Upstream price pressures are a risk to inflation

1.0

1.5

2.0

2.5

3.0

3.5

94 96 98 00 02 04-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0ann.% ch. ann.% ch.

Core CPI vs. core PPI (finished)

Core PPI (finished goods) 6

mths forward)

RHS

Core CPI

1.0

1.5

2.0

2.5

3.0

3.5

94 96 98 00 02 04-10

-8

-6

-4

-2

0

2

4

6

8

10ann.% ch. ann.% ch.Core PPI (interme

diate goods)

12 mths forward)

RHS

Core CPI

Source: Datastream,Economics@ANZ

Core CPI vs. core PPI (intermediate)

However, upstream price pressures remain strong and continue to foreshadow a rebound in core consumer prices in the coming six months. To date, surprisingly strong productivity growth and substantial excess productive capacity have kept unit labour costs and inflation well contained, preventing upstream price pressures flowing through to final consumer prices. But steadily diminishing excess capacity and weakening productivity growth are likely to push unit labour costs higher. Combined with the lagged impact of the weaker US dollar on import prices, this will push core inflation closer to 2% by early next year. As a consequence, US bond markets look extremely vulnerable. The Fed has now hiked interest rates 3 times, lifting the fed funds target to 1.75%. For an economy that has grown by 4.9% over the previous year, this is still an incredibly loose stance of monetary policy and a renewed upturn in inflation in coming months will see bonds sell off sharply and maintain the Fed on it’s steady path towards neutral official interest rates. Strong domestic US growth combined with weak demand from its major trading partners has driven the US trade deficit and current account to record levels. Higher oil prices have been a major contributor to the widening trade deficit and a prospective retracement of oil prices offers some hope for improved trade outcomes. However, with growth in Western Europe forecast to remain anaemic and Japan expected to slow sharply, the US current account will be a growing concern in 2005. This leaves the US increasingly dependent on foreign capital flows and is likely to place further downward pressure on the US dollar. In addition to a widening external deficit, the market appears to have become overly complacent about the Federal budget deficit. The latest Congressional Budget Office report foreshadowed a marked reduction in the budget deficit in fiscal 2005 to 2.8% of GDP (down from 3.7% in 2004). However, the recent extensions of various tax relief bills and a likely increase in spending on defence and homeland security suggest any improvement may be less marked. Both the Republicans and the Democrats have promised to halve the deficit within 5 years. This will, however, prove a difficult task, as the rapidly ageing population will raise the US dependency ratio placing downward pressure on labour force growth and personal taxation revenues while at the same time boosting health expenditures. With demographics working against it, the US must somehow lift the taxation share of GDP above its current low levels, while at the same time reining in public expenditure. Paul Braddick, Senior Economist (03) 9273 5987


Euro area growth remains sluggish Real GDP growth in the euro area slowed slightly in Q2, with a quarterly rise of 0.5% after a 0.6% increase in Q1. The modest rise was sufficient to raise GDP growth over the year from 1.3% to 2.0%, the fastest for over 3 years. Net exports were responsible for about three-quarters of the quarterly rise in GDP in Q2; there were small increases in private consumption and fixed investment, largely offset by a decline in inventories.

Slow GDP growth in the euro area

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1999 2000 2001 2002 2003 2004

% change from year earlier

Source: Eurostat

% change quarter-to-quarter

GDP growth in Germany continues to lag that of most of its euro area partners. Average GDP growth in Germany averaged just 1.3% per annum during 1996-2003, well below average growth of 2.0% in the euro area and 2.2% in France, the second largest European economy, over this period. Germany’s poor performance has continued with GDP growth unlikely to exceed 1½% this year, while growth in France is forecast to be around 2½%. There are few prospects of any significant improvement in economic activity in the euro area over coming quarters. The international economic environment is not expected to be as favourable in 2005 so the recent strong performance of exports is likely to slacken. The long period of low euro interest rates is a positive influence and if expectations that oil prices will decline from current high levels over the next few months are met then stronger domestic demand should make up for any loss of momentum from net exports. GDP growth in the euro area is forecast to improve slightly to around 2% in 2005, but if oil prices remain at elevated levels then there is a significant risk that growth next year will fail to meet this year’s lacklustre pace. Unemployment has been steady at 9% over the past few months, up from around 8% in 2001, with unemployment around 4-5% in some smaller economies, such as Austria and Ireland, but around 10% and 11% respectively in Germany and Spain.

Germany’s fiscal deficit is again expected to breach the 3% limit specified by the EU’s Stability and Growth Pact in 2005. In contrast, the French government expects next year’s deficit to be slightly below the 3% ceiling, for the first time since 2001, with faster economic growth producing better-than-expected tax receipts. The European Commission has put forward proposals to reform the Pact, which would take account of levels of public debt in determining how quickly individual countries with ‘excessive deficits’ would have to correct the problem. The reforms are opposed by the ECB, which is concerned that weaker fiscal rules could have a detrimental impact on the euro and its efforts to hold down inflation. Headline inflation in the euro area has dipped from 2.5% in May to an estimated 2.2% in September, but remains above the ECB’s 2% ceiling. The ECB has expressed concern about upside risks to inflation, but there are no signs that high oil prices are feeding through to wages so the ECB is expected to continue to hold its main refinancing rate at 2% for a few more months until the outlook for growth, both within and beyond the euro area, becomes clearer. However, the current level of euro interest rates is very accommodative and a series of modest interest rate rises is expected during 2005. The euro has recently regained some ground against the US dollar, rising above US$1.24 in early October, after trading in a narrow US$1.20-1.23 range for most of August and September. ANZ expects further euro gains over the next few months, a consequence of our expectation of general US dollar weakness. UK economic growth is set to slow The UK economy grew by 3.6% in the year to Q2, the strongest annual increase since mid-2000, and is set for full-year growth of around 3½% in 2004. The Bank of England responded to strong economic growth, a tight labour market, and concerns about the possible over-heating of the housing market by raising its repo rate on five occasions between November 2003 and August 2004 from 3.5% to 4.75%. There are growing signs that the economy is set to slow modestly over coming quarters and the prospect of further interest rate rises has receded although the possibility of a final 25 basis points rise in the repo rate to 5.0% within the next few months is still considered close to 50%. The Bank of England is paying particularly close attention to housing market data and has noted that recent signs that the housing market was cooling raise the possibility of a more abrupt correction to house price inflation than had been expected as recently as June 2004. Barry Coulthurst, Senior Economist (03) 9273 5417


Is Japan’s fairytale over? Japanese economic growth slowed sharply from a 6.3% annualised pace in the March quarter to just a 1.3% annualised pace in the June quarter. Shrinking public final demand together with a drawdown in inventories were the major factors behind these softer than expected results. However, both of these are actually welcome developments, and suggest that the Japanese economy is a little stronger than the ‘headline’ numbers suggest. Indeed, even though consumer spending, business investment and exports did all ease a little, Japanese private final demand – the driver of any sustainable economic recovery - continues to grow well above trend, rising at a healthy 3.1% annualised pace in the June quarter. While June quarter GDP was disappointing, a slower pace of growth is to be expected as Japan enters a more mature stage of the business cycle. Certainly, it does not mean that Japan’s recent success story is about to come to an end. After all, the 6%+ annualised pace of growth that was recorded earlier in the recovery was never going to be a sustainable rate for any mature economy especially not Japan given it’s rapidly aging population. Nevertheless, while prospects for continued growth are solid, the risks facing the Japanese economy have heightened in recent months. The most immediate risk is posed by higher oil prices. At over US$50/barrel, oil prices are now more than US$15/barrel higher than our forecast three months ago. Japan is the world’s third largest oil consumer (after the US and China) and is almost wholly dependent on oil imports to satisfy demand. However, while a heavy consumer, Japan is also a world leader in terms of energy efficiency with per capita oil consumption amongst the lowest in the developed world. This helps to limit the damage to Japan from higher oil prices. The International Energy Agency estimates that a sustained $10/barrel rise in oil prices will knock 0.4 pc points from annual growth in Japan, a bigger impact than in the large oil producing United States (-0.3 pc points), but smaller than the Euro area (-0.5 pc points) and non-Japan Asia (-0.8 pc points). Hence, to the surprise of many commentators, Japan is much better placed than many other oil-importing nations to face rising oil prices. Nevertheless, the impact is still distinctly negative and the recent rise in oil prices has caused us to downgrade slightly our forecasts for Japanese growth in both 2004 and 2005. Developments in China, which is now Japan’s second biggest export market, is another major risk. To date, even though the Chinese economy is starting to show signs of slowing, Japanese exports to the region are holding up well. Japan’s main exports to China are machinery goods used in the intermediate

production process. Hence, with the slowdown in China expected to deepen over 2005, demand for these intermediate imports will also eventually pull back, in turn softening an important source of Japan’s recent export, and ultimately economic, growth. While firm demand from Japan’s biggest trading partner, the US, should hold up some exporters, a slower China (and the risk of a hard landing) is a significant challenge for Japan. Despite these risks, the latest indicators suggest that Japanese economic growth should bounce back in the September quarter. A stronger labour market, which has seen the job offers to applicants ratio tick up a 10-year high, combined with a hotter than usual summer, has seen household spending on retail sales turn up in recent months. A competitive yen and continued solid global demand is also keeping exports well supported. All of this has seen industrial production regain momentum and business confidence rise.

Prospects solid, Chinese exports holding up TANKAN and GDP growth

Source: Bank of Japan, Japan Cabinet Office, Datastream

-4

-3

-2

-1

0

1

2

3

4

5

6

98 00 02 04-60

-50

-40

-30

-20

-10

0

10% yearly change Index

GDP (LHS)

Tankan business conditions (RHS)

Japanese exports to China

200

250

300

350

400

450

500

550

600

650

01 02 03 04

Yen bn

The clearest indicator yet that the recovery is far from over has been provided by the Bank of Japan’s closely watched Tankan survey. This survey of business conditions, which tracks Japanese GDP growth, shrugged off the heightened risk environment to tick up into positive territory for the first time in 13 years in the September quarter. The survey also contained a welcome upward revision to expected capital spending in the year ahead. Nevertheless, there was a slight downgrade to the Tankan survey of future conditions, suggesting that Japanese economic growth has now passed its peak. Overall, we still expect the Japanese economy will grow by around 4¼% in 2004 before softer export growth causes a slowdown to 2¼% in 2005 (which is still above the 10-year average). As these rates of growth are still well above Japan’s potential economic growth rate (around 1¼% per annum), deflation should continue to slowly ease. Katie Dean, Economist (03) 9273 6286


Asian outlook Mixed signals on the Chinese economy There is mixed evidence on the effectiveness of the efforts to cool the economy. The growth of loans outstanding has slowed significantly, to 11.7% over the year to August, down from a peak of 23.9% a year earlier. The slowdown in other variables is much less significant, especially in view of the volatility in the monthly data. Over the year to August, retail sales rose 13.1%, the value of industrial output 31.7%, fixed investment 26.3%, and imports 35.5%. While all of these growth rates are below recent peaks, they are still at levels that suggest demand is stronger than the authorities would like. Significantly, inflation has risen above 5% despite numerous controls on prices and tariffs. Output and prices rising strongly in China

0

5

10

15

20

25

30

35

40

1999 2000 2001 2002 2003 2004-3

-2

-1

0

1

2

3

4

5

6% change over year(smoothed)

Value of Industrial Output (LHS)

CPI (RHS)

% change over year(smoothed)

The authorities are also sending mixed signals on their assessments: while in recent months there have been numerous confident statements from officials that the controls are working, they appear to have been contradicted by a hawkish statement by Premier Wen in mid-September. Wen said that the controls need to remain and hinted that there could be further tightening. Two weeks later, the State Development and Reform Commission raised its official growth projection for this year to 9% - almost identical to last year’s 9.1%. China’s imports from Asia have boomed in recent years, and there is understandable anxiety in the region about the risk of a hard landing in China. The policy measures are targeted at investment spending, so countries such as South Korea and Japan, which supply capital goods, machinery and industrial equipment, have most to lose.

Chinese imports boosting Asia

-30

-20

-10

0

10

20

30

40

50

60

1999 2000 2001 2002 2003 2004

% change over year (smoothed)

Imports from Asia

Exports to Asia

The risk of a hard landing is connected with the time lag between policy action and its impact on the economy. Perhaps enough has already been done to slow growth to 7% next year. If so (and it is impossible to know) then if the current strength in the economy and upward pressure on prices persuades the authorities to tighten further, it would raise the probability of a hard landing. ANZ is maintaining its 2005 forecast of 6%, suggesting a moderate undershoot. Hong Kong builds momentum The economy experienced very strong growth of 12.1% over the year to Q2 2004. While this partly reflects the low SARS-affected base in Q2 2003, it is also driven by very strong domestic demand in recent quarters. The strength of the economy is reflected in a decline in the unemployment rate, which had risen substantially between early 2001 and mid-2003. The latest figure, for August 2004, is 6.8%, compared with a peak of 8.7% in July 2003. Similarly, the value of retail sales, which had stagnated for so long, is buoyant, having risen 10.7% over the year to July. Another sign of strong domestic demand is the end of deflation. The CPI is now running above year-earlier levels, showing a change of +0.8% over the 12 months to August. An important driver of Hong Kong’s economy is the strong growth in China, especially in the neighbouring Pearl River Delta. If China slows sharply, the shock will be felt in Hong Kong, for example through lower spending by mainland visitors to the SAR. The impact would, however, be ameliorated by continued growth of Chinese exports shipped through Hong Kong, which are driven by world demand, not the state of China’s economy.


Solid growth outcome for Singapore The Singapore economy posted very strong growth of 12.5% over the year to Q2 2004, after a 7.5% rise over the year to the first quarter. Growth was propelled by robust external demand particularly for electronics and pharmaceuticals as well as base effects from the SARS-induced weakness in economic activity in Q2 2003. Advance estimates for Q3 2004 indicate growth of 7.7% compared with the same period in 2003. Full-year growth is expected to exceed 8% for the first time since 2000. A slower, albeit healthy, growth rate of 4½% is forecast for 2005 coming off a strong base as well as a moderation in external demand. Annual inflation has crept up this year to average 1.6% during January-August compared with 0.4% for the same period in 2003. Higher food and oil prices and the GST increase will continue to fuel price pressures but inflation remains relatively benign.

The changeover in political leadership proceeded smoothly, with BG Lee Hsien Loong assuming the post of Prime Minister on 12 August from Mr Goh Chok Tong. No dramatic shifts in macroeconomic policy are expected. The new administration continues to face long-term economic challenges, which include attracting high value-added investment in the face of competition from China and India, maintaining export competitiveness and addressing a declining birth rate. South Korea’s economy is peaking … The South Korean economy grew by a slower-than-expected 5.8% over the year to Q2 2004 dragged down by sluggish domestic demand and softer export growth. Exports have been the main engine of growth over the past five quarters. However, an expected slowdown in external demand, particularly from China and the US which are Korea’s top two export markets, and more subdued global demand for electronics goods, have raised the urgency to revive domestic demand. Accommodative fiscal and monetary policies have been adopted with the overnight call rate at a record low of 3.5% and the government introducing income tax cuts and abolishing some special consumption taxes. However, the rapid acceleration in household credit in recent years has left households with large debt service payments. In addition, annual inflation edged up to 4.8% in August - the highest rate since July 2001 – before easing to 3.9% in September, and unemployment was 3.6% in August compared with 3.3% in January. … and Taiwan’s may be too Taiwan’s recovery in mid-2003 was export driven, but in the first half of 2004 it became more broadly

based, with both private consumption and investment spending acting as drivers. Growth over the year to Q2 2004 was 7.7%, boosted also by the low SARS-affected base in Q2 2003. ANZ has revised up the forecast for the full year to 5¼%. However, there are early signs that the economy may be starting to lose momentum. The composite leading indicator peaked in April and eased by 3% in the subsequent three months. The unemployment rate, which declined moderately in the second half of 2003, has shown signs of levelling off in recent months. The latest reading, 4.7% in August, is well above the 3% which was considered the norm in the late nineties. Food and oil prices have boosted consumer price inflation to its current level of 2.8%, but a strong rise in the PPI (up 11.4% over the year to September) suggests more upward pressure in the pipeline, and inevitably, an increase in interest rates. In contrast to these negative signals, exports and export orders are still trending upwards, so any slowdown should be muted by positive contributions from net exports. ANZ expects growth to ease to 3½% next year. With the controversy over the March presidential election at last subsiding, political parties are gearing up for the legislative election due to be held on 11 December. The two major opposition parties are considering a formal merger. Polls show the governing Democratic Progressive Party in the lead. Political and economic change in Malaysia Prime Minister Abdullah Badawi, who consolidated his political authority when the ruling coalition secured a strong victory in elections in March 2004, suffered a setback within the ruling United Malays National Organisation in September, when elections for party positions produced victories for politicians who may not provide strong support for his drive against corruption. Former Deputy Prime Minister Anwar Ibrahim was released from prison in September 2004 when the Federal Court overturned his conviction for sodomy. However, Anwar failed in his attempt to make an early return to politics when the Federal Court upheld his conviction for abuse of power that bans him from political office until 2008. Malaysia’s economy is a major beneficiary of global recovery and grew by 8.1% over the year to Q2 2004, the strongest increase since 2000. A modest slowdown is expected over the next 12 months as global economic activity slows, but medium-term economic prospects are being bolstered by moves to tackle corruption, reform the civil service, and adopt an open-bidding system for government contracts and privatisation. Prime Minister Abdullah has also called for a gradual easing of the Bumiputra affirmative action policy, that favours ethnic Malays in gaining access to higher education and public


sector jobs, in order to bolster the country’s international competitiveness. The 2005 budget, unveiled in September 2004, contained no changes to corporate or income tax rates. The budget envisages a reduction in the Federal government budget deficit, from 4.5% of GDP this year to 3.8% in 2005. The gradualist approach to reducing the budget deficit takes account of the expected economic slowdown in 2005, but the medium-term commitment to reducing the deficit was reiterated and will be assisted by the introduction of a good and services tax in January 2007 to replace existing sales taxes. Inflation remains low at 1.4% over the year to August and official interest rates have been held steady although modest increases are likely in 2005. The series of economic reforms is reinforcing expectations that the ringgit peg to the US dollar will eventually be replaced by a more flexible exchange rate system. There are no signs that such a move is imminent, but this prospect will increase if the US dollar resumes its decline or China moves to a more flexible exchange rate policy. GDP growth has slowed in Thailand Annual real GDP growth has slowed from 8.1% over the year to the final quarter of 2003 to 6.2% in the period ending Q2 2004 as Thailand has suffered several setbacks including outbreaks of bird flu, political unrest in the south, and the detrimental impact of high oil prices. The authorities have warned of a long fight against bird flu which could take 3-5 years to eradicate. A tightening of bank regulations on credit cards and property lending is also having a dampening influence on growth. Real GDP growth is expected to be under 6% this year, a disappointing outcome given Prime Minister Thaksin’s earlier confidence that growth would reach 8%. Recent problems have adversely affected the popularity of the prime minister, but he is still expected to be comfortably re-elected in the general election which is likely to be held in January 2005. Inflation has risen from a low of 1.2% in January to 3.1% in August, with the authorities responding by raising the official 14-day repurchase rate from the unusually low level of 1.25%, to 1.50% in August. Further modest interest rate rises are likely over coming months, but they are not expected to match the pace of interest rate rises in the US and consequently will not provide much support for the currency. The baht has depreciated modestly against the US dollar since April 2004 and is forecast to remain in a narrow range against the US dollar over the next 12 months.

A sharp rise in inflation in Vietnam Inflation has risen sharply from less than 3% at end-2003 to 10.1% in September, the fastest since 1995. The strong increase is largely due to higher food prices, which account for almost half of the price basket and which rose by 17% in the year to September, partly due to the adverse impact of bird flu. The central bank raised compulsory reserve requirements in mid-2004 in response to rapid credit growth and rising inflation, and the government is making spending cuts and suspending some infrastructure projects in an attempt to curb inflation. Government ministers have been told to try to curb price increases by state-owned companies. The gradual depreciation of the dong against the US dollar has continued, but the pace of depreciation has declined in recent years amounting to around 1.5-2.0% annually in 2002 and 2003 and less than 0.8% in the first 9 months of 2004. Slightly faster depreciation of the dong is expected over the coming year as the authorities will be keen to maintain export competitiveness with the current account deficit forecast to rise to around 5% of GDP this year despite the beneficial balance of payments impact of high oil prices. The economy grew by 7% in the first half of 2004 and a target of 8.8% growth has been set for 2005. This appears optimistic given the prospect of a less favourable international economic environment in 2005 and rapid inflation in Vietnam. Over the longer-term, there is concern that electricity generating capacity may not keep pace with rapid growth in demand, with the state-owned supplier warning of power shortages if an ambitious programme to build over 30 new power stations by 2010 is delayed. Inflation danger in Philippines GDP expanded by a strong 6.2% over the year to the second quarter. The components of aggregate demand were well balanced and there was a reversal of the previous quarter’s big build-up of inventories. This suggests that the economy has some momentum, and ANZ has boosted its full year growth forecast to 4¾%. Recent history in the Philippines shows that inflation can rise sharply and necessitate significant tightening of monetary policy. The CPI has risen rapidly this year. The latest figure, for September, is 7.2% higher than a year earlier, driven mainly by energy costs and depreciation of the peso. There is public antagonism against rising costs of fuel and transport. In the past, the government has ameliorated the impact by the use of subsidies, but


this has contributed to the country’s unsound fiscal position. The IMF has urged the government to take a more aggressive approach to reducing the deficit, by raising taxes, improving compliance and reducing inefficiencies in the public enterprises which are a drain on the public purse. The government, for its part, believes that rapid reform is simply not politically feasible for various reasons including public opinion, vested interests and obstructionist politicians. In the meanwhile, the authorities will need to find an appropriate balance of fiscal and monetary tightening that will stifle inflation and minimise the impact on the poor. Further delay risks a more painful adjustment in the future. Less political uncertainty in Indonesia In the country’s first direct presidential elections, the leader of the Democratic Party, Susilo Bambang Yudhoyono, won a convincing victory. The relatively smooth election process, with parliamentary elections in April, presidential polls in July followed by the run-off on 20 September, underscores significant democratic progress in Indonesia. Expectations are for the new administration to pursue reform and act more decisively to tackle corporate governance issues and security concerns, in a bid to improve the economic and investment environment. However, given that Dr Yudhoyono’s party has only a small representation in parliament, he faces a challenging task of securing support for policy measures. That said, his clear mandate should provide him with some authority to effect change. Real GDP grew by 4.3% over the year to the June quarter, with domestic demand driving the Indonesian economy. However, growth in private and government consumption was slower than expected. Despite a pick-up in global economic growth, exports have been sluggish. For the first eight months of 2004, exports were up by only 5.5% in US$ terms, due in part to competitive pressures. Real GDP is projected to expand by 4½% in 2004. A slightly quicker pace of 4¾% is expected for 2005 with election uncertainty having abated. The rupiah fell sharply in reaction to the Jakarta blast on 9 September but quickly recovered some ground. The medium term outlook is more positive as political uncertainty subsides and macroeconomic policy management helps to lift sentiment.

Economic growth in Asia % ch. 2004 (f) 2005 (f) 2006 (f) China 8½ 6 7 Hong Kong 7 2¾ 3 Indonesia 4½ 4¾ 5¾ Malaysia 7 6 5 Philippines 4¾ 3¼ 4¼ Singapore 8¼ 4½ 5¼ South Korea 4¾ 4 5½ Taiwan 5¼ 3½ 3¾ Thailand 5¾ 5 5¼ Vietnam 7¼ 6¾ 7 East Asia* 7½ 5¼ 6½ (ex China) 5½ 4¼ 5

* weighted GDP at PPP exchange rates

The oil price risk Sustained high oil prices represent a risk to economic growth. The IMF has produced estimates of the impact after one year, of a US$10/barrel increase in the oil price. For Asian countries, the impact on growth ranges up to a subtraction of 1.8 pc points from growth in the case of Thailand. Even Malaysia, an oil producer, would suffer a negative impact, of 0.4 pc points. Our forecasts for 2005 have generally been reduced over the past three months. In aggregate, for the Asian countries in the table above, excluding China, the revision is from 4¾% to 4¼%. Oil prices have been only one factor; other factors acting on domestic demand have been more important in some individual countries, particularly South Korea and Thailand. Against this, the world economy has held up surprisingly well, and for some Asian countries, (Hong Kong, Taiwan, Malaysia) we have revised 2004 growth upwards. Next year, on our projections, the world economy will still be growing at a respectable 3¾%. This will help to sustain growth in Asian countries, many of which are heavily dependent on exports. The real danger that expensive oil holds for Asia is not the direct effect, but the indirect impact which would arise if it causes a more marked slowdown of the global economy, thus undermining the demand for Asian exports. Bernie Shuttleworth, Senior Economist (03) 9273 6123


Australian outlook

Economic growth to continue Australian economic growth moderated in the first half of 2004, growing by only 2.9% (on an annualised basis) following a very strong second half of 2003 when the economy grew by 4.8%. However economic growth was still a healthy 4.1% over the year to the June quarter, a legacy of persistent economic expansion. Underlying this was a continuation of the story that has supported Australia’s recent economic performance. Ongoing strength in the domestic sector, and a commensurate increase in imports to satisfy this increased demand offsetting some of the agriculture led export recovery. Net exports again subtracted from growth in the June quarter, though only a modest 0.1 pc point (cf 1.3 pc points in the March quarter). This brings the tally of negative net export contributions to three years, a new record. While the external sector drags its feet, the domestic sector has done more than its fair share to fuel economic expansion. Domestic demand recovered from a soft patch in the March quarter, led by continued strong household consumption and business investment. Dwelling investment growth moderated in the June quarter, consistent with a slowing in building and finance approvals.

There’s still room for economic optimism

-5

-3

-1

1

3

5

7

9

00 01 02 03 04 05

% point contribution to growth from year earlier

Exports

Domesticdemand

Imports

-1

0

1

2

3

4

5

00 01 02 03 04 05

% change

Annual change

Quarterly change

Sources: ABS; Economics@ANZ

Economic growth Sources of growth

While the first half of 2004 has been soft relative to recent performance, it is not yet time to despair. The two interest rate increases implemented by the RBA in late 2003 have done their intended duty and moderated the housing market, and consequently some segments of the economy. Although some partial indicators such as retail sales and employment growth both paused a little in recent months other indicators have remained positive. Consumer confidence is at a decade high, businesses continue to view economic conditions as favourable, the ‘at risk’ housing sector is showing

signs of stabilising and the laggard in the growth equation, exports, is now benefiting from a healthy global economy. In addition, the economy will receive support from the tax cuts and family payments handed out under the 2004-05 Budget. Furthermore, policies announced in the election also promise some additional fiscal stimulus over the coming years. However, there is a material risk that persistently high international crude oil prices, which have averaged more than US$40/barrel since July, will limit some of these positive influences. ANZ research1 suggests that a sustained US$10/barrel increase in oil prices will subtract approximately 0.3 pc point from GDP growth. Indirect effects such as higher oil prices denting world economic growth also have consequences for Australia’s exports and hence economic growth. Sustained high oil prices is a key risk to the outlook. On balance, Australian economic growth looks set to accelerate over the coming year, from 3½% in 2003-04 to 3¾% in 2004-05. Some rotation in the sources of growth is expected with exports making a larger contribution while some modest easing in domestic demand growth occurs. Public spending is also expected to make a positive contribution. Strong economic growth will keep labour demand buoyant with the unemployment rate expected to average 5½% in 2004-05. More fiscal stimulus on the agenda? In the 2004 Federal election the incumbent Liberal – National coalition was re-elected with a clear majority. The Coalition also increased the number of seats in the Senate, meaning that the freshly re-elected government will now have more wide ranging abilities, than in their previous term, to pass policies through to their fruition. In the lead up to the election the Coalition made policy announcements totalling some $8.5bn over almost four years in addition to $5.1bn fiscal stimulus announced between the May Budget and Pre-Election Fiscal and Economic Outlook (PEFO). Although only a small portion of this will be spent in this financial year, coupled with the Budget this amounts to a fiscal stimulus equivalent to around 1% of GDP in 2004-05. Not only has the federal budget reaped the benefits of solid economic growth, so have individual States. State coffers are very healthy from strong GST revenue, and also own tax collection (eg stamp duty

1 Hay, Melanie, ‘The impact of oil on the Australian economy’, ANZ Economic Research, 1 September 2004


on residential property). Robust economic activity has seen State governments acquire a penchant for spending and with several State elections scheduled before the end of 2006, the scope and possibility exists for additional fiscal stimulus.

State elections and budget positions Operating surplus ($mn) Next

election 2003-04 2004-05(f) 2005-06(f)NSW Mar ‘07 1,291 836 1,111 VIC Nov ‘06 545 505 531 QLD Feb ‘07 646 454 473 SA Feb ‘06 264 116 118 WA Feb ‘05 207 243 224 TAS Jul ‘06 100 (45) 22 NT Aug ‘05 49 (12) (31) ACT Oct ‘08 18 (17) (73) Source: Access State Budget Monitor, June 2004. Export growth to affect some rebalancing Net exports have subtracted from economic growth for three continuous years. A long stretch by any one’s imagination, but there are two sides to the story: weak exports and strong imports. While exports have rebounded from their drought stricken lows, imports have also been very strong, commensurate with a strong domestic economy.

Exports are recovering

10

15

20

25

30

35

40

45

50

90 92 94 96 98 00 02 04

$(000)

Resources

Other

Rural


Export volumes Commodity prices

60

70

80

90

100

110

120

90 92 94 96 98 00 02 04

IndexBase metals

Rural

Within the export sector it was expected that the resources sector would make the most inroads in volume of exports, however this has not yet taken place. One of the reasons has been capacity constraints, which should diminish as record levels of investment in recent years comes on stream. Mining related exporters have enjoyed record prices for many base metals and bulk commodities associated with limited supply and burgeoning demand. Although economic growth in Australia’s major trading partners has likely peaked, a gradual moderation in their economic growth is still consistent with ongoing demand for Australia’s exports of resources. So with demand holding up

and new capacity coming on stream to service this, the prospects for resource exports are positive. Another export sector to have recovered is services. There has been a rebound in tourist arrivals since the SARS and Iraq war induced slump and despite ongoing concerns about terrorism, visitor arrivals into Australia have picked up nicely. Since the sector contributes almost a quarter of all export revenue, health of the services sector is essential to a good export performance. The Tourism Forecasting Council2 is expecting inbound tourism to step up in 2005 and 2006, rising by 6¾% and 6½% respectively. The prospects for services exports are therefore quite bright.

Exports of services expected to pick up

-10

-5

0

5

10

15

20

90 92 94 96 98 00 02 04 06

Annual average % change

Servicesexports

Touristarrivals

19

20

21

22

23

24

25

90 92 94 96 98 00 02 04

%, 4 qtr moving average

Sources: ABS; Economics@ANZ; *Tourism Forecasting Council forecasts.

Services share of export returns

Tourist arrivals* and services exports

However not all segments of exports are performing to their potential. Relative to the mining and agricultural sectors’ prospects, manufacturing has remained in a state of apathy. Even with global growth at the strongest rate in twenty years and the currency coming off its early 2004 highs, manufacturing exports have failed to make significant inroads. This has been due in part to the currency remaining close to US$0.70, above which manufacturers report as ‘uncompetitive’ and also because some manufactured items may have been directed to the domestic market to feed elevated domestic demand. On balance, increased rural, resources and services exports will likely contribute positively to economic growth over 2004-05. Domestic sector fundamentals sound The underpinnings of the domestic economy remain sound. Consumer confidence is at decade highs reflecting a sub-6% unemployment rate for more than 12 months, income gains and wealth gains via both housing and financial assets. On top of all this, households have received income tax cuts and

2 Tourism forecasting council, ‘Inbound Tourism Forecasts - 2004 to 2013’, April 2004


higher family payments from the 2004-05 Budget. It’s not all positive though, oil prices have risen biting into discretionary spending, but at about 3½% of disposable income the impact will likely be limited unless prices remain high for a significant period. One of the cornerstones of spending increases has been gains in household wealth, but as the housing market slows these gains will be more limited. Furthermore, the current level of household debt servicing requirements mean that interest expenses will effectively constrain spending to a certain extent. As such household consumption is expected to moderate over coming years. The housing cycle will also likely fare well. The RBA’s two interest rate increases implemented in late 2003 have had the desired impact in taking the heat out of the housing market. While the speculative element in the investor-borrowing segment appears to have subsided, there is still significant interest in the owner-occupier segment and activity in the sector. Residential construction activity is expected to face only a modest downturn, with underlying demand conditions supporting activity and the current large backlog of ‘pipeline’ work which will also effectively moderate any slowing in the residential construction cycle.

Building activity holding up

0

2

4

6

8

10

12

95 96 97 98 99 00 01 02 03 04

$bn

Investor

Owner-occupier

Source: ABS

Finance approvals Building approvals

2

3

4

5

6

7

8

9

10

11

12

95 96 97 98 99 00 01 02 03 04

Number (000)

Other

Houses

Businesses have just come off a bumper profit reporting season and their balance sheets are looking very healthy. Although many businesses have already initiated significant capital expenditure programs there are still many sectors within the economy facing capacity constraints. In order to alleviate this businesses are likely to further increase investment spending, albeit not with the same tenacity as in recent years. Business investment growth is expected to remain solid at 7¼% in 2004-05 a modest temperance from 8¼% in 2003-04. Most sectors of the Australian economy are still firing, but with a lesser potency than recent experience.

Labour market still healthy Labour market performance softened over the June quarter with only 13,400 jobs created in those three months. But employment growth bounced back with a vengeance in the September quarter creating 71,400 jobs. Even with the ‘soft patch’ in the June quarter, the unemployment rate has been below 6% for more than twelve months and 60% of the working age population is currently in employment, confirming a strong labour market.

Labour market still strong

5

6

7

8

9

10

11

90 92 94 96 98 00 02 04

%

1990's average


Unemployment rate Employment to population ratio

55

56

57

58

59

60

61

90 92 94 96 98 00 02 04

%

1990's average

Pervasive employment growth in recent years has resulted in a perceptibly tight labour market. Indicators of labour demand such as the ANZ Job Ads survey has remained at a level consistent with ongoing employment growth of around 20-25,000 per month. Although employment growth of such a level has not been consistently realised, this reflects increased effort by employers to recruit from a diminishing labour supply pool. Intensifying recruitment search combined with a diminishing labour supply pool has led to some delays in matching labour demand and supply and surveyed measures of skilled labour shortage have ticked up. One of the contributing reasons has been geography. Australia’s fastest growing states have been Queensland and Western Australia. While Queensland has been able to attract population increases through interstate and international migration, WA has not yet been able to draw on a large enough supply of mobile labour. However, with businesses demanding labour and some willing to offer higher wages to attract workers, current vacancies will be filled. If wages are high enough, labour mobility will eventuate. On an industry basis retail and, related to that, wholesale and transport sectors have had output growth unmatched by employment growth. This suggests that there is room for employment growth in those sectors. Also, the construction sector is increasingly constrained by shortages of suitably


qualified labour, which is hindering job creation. The finance and insurance sector is reportedly looking for new staff and continued business sector strength will support employment in business services. Business hiring intentions are overwhelmingly positive and consistently reflected by a range of surveys, although realisation of these intentions have been limited due to reported shortages of skilled labour. Businesses have seen profits rise strongly recently and this increases their ability to fulfil these hiring intentions, by offering higher wages if needed.

Emerging labour shortages to pressure wages

50

70

90

110

130

150

170

95 9697 98 99 00 0102 0304

Index

Professionals

Trades

Sources: DEWR; NAB; ABS; Economics@ANZ

Vacancies Skilled labour shortages and wages

1

2

3

4

5

6

98 99 00 01 02 03 04 050

2

4

6

8

10

12

14

16%

Average weeklyearnings

(left scale)

Labour shortage,fwd 7 quarters(right scale)

% change fromyear earlier

With the Australian economy expected to grow above trend through 2004-05, hiring will remain solid, albeit to a lesser extent as the pace of economic expansion eases. As such, we expect employment growth of 2% in 2004-05 pushing the unemployment rate down from 5¾% in 2003-04 to an average of 5½% in 2004-05. We expect the unemployment rate to trough at 5¼% in mid 2005 before gradually ticking up to 6% by end of 2006. Upside inflation risks Australia’s inflation rate was right in the middle of the RBA’s 2-3% band in the June quarter at 2.5%. This was an acceleration from 2% in the March quarter and the risks to inflation appear tilted to the upside in the medium term. The inflation dampener of recent years, an extended decline in prices of imported goods related to an appreciating A$, has largely come to an end. Furthermore, domestic price pressures are already running at their highest levels in over a decade and are likely to remain intense in a robust macroeconomic environment. With continued economic growth expected to force the unemployment rate below current 23-year lows, skills shortages are emerging across a range of industries placing upward pressure on wages adding to inflationary pressures. One-off factors such as tariff reductions for clothing and motor vehicles in the new year will mitigate some of these upward

inflationary pressures in the short term. Overall risks to prices are tilted on the upside and we expect underlying inflation will accelerate from 2% currently to around 2¾% by the end of 2005. Interest rates need to rise When the RBA raised interest rates in late 2003, there were a few key drivers of the monetary tightening policy. These included the improving international economy, strong domestic economy, a frenetic housing market leading to unsustainable credit growth and upside inflation risks in the medium term. Since then a number of changes have occurred in the Australian economy. The two interest rate increases in late 2003 have effectively taken the heat out of the housing market. House prices have plateaued in the Melbourne and Sydney markets. Furthermore, runaway credit growth in the more speculative residential investor segment has moderated appreciably.

Inflationary pressures to lift interest rates

4.0

4.5

5.0

5.5

6.0

6.5

98 99 00 01 02 03 04 05

%

Cash rate

-1

0

1

2

3

4

5

6

7

9596979899000102030405

Annual % change

Underlyinginflation

Headline inflationrate

Sources: DEWR; NAB; ABS; Economics@ANZ

Inflation Interest rates

RBA’starget band

The domestic economy had moderated in the first half of 2004, but with significant fiscal stimulus through tax cuts announced in the 2004-05 Budget and election promises totalling some 1% of GDP, a rebound is expected. Returned intensity in the domestic economy will lead to further domestic inflationary pressures and with the currency having come off its highs in early 2004, the risks to inflation will be weighted on the upside. The labour market is tight and there are wage and price inflation risks associated with that. Although official measures of wage inflation have not yet ticked up significantly, there is a very real threat of inflationary pressure from this source. The RBA will need to raise rates and we expect two 25 basis point increases by mid-2005. Shaz Eaqub, Economist (03) 9273 4060


New Zealand outlook Strong growth comes with a sting The New Zealand economy continues to surprise on the upside. Surging growth in the first quarter of 2004 has been followed up by an above-trend (potential) 0.9% rise in the second quarter. Annual growth has risen to 5.7%, and growth for the past five years has averaged just below 4.0%. Encouragingly, growth over the past few months has taken on a broader base, with improved export performance and surging business investment in response to capacity constraints. But strong economic performance has come with a sting in its tail. Inflation is rising across a range of gauges. The headline rate has increased to 2.5%, non-tradable inflation is running at close to 5%, inflation expectations are ticking up and wage pressure is percolating from a tight labour market.

Output gap remains inflationary

-6

-5

-4

-3

-2

-1

0

1

2

3

4

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Output Gap (%)

Sources: NZIER, Statistics New Zealand

Rising inflation pressure is a reflection of excess demand. Accentuating this picture are rising cost-push influences such as oil and unit labour costs. Growth in demand has exceeded the economy’s capacity to supply (potential growth rate). The economy has opened up a positive (inflationary) output gap of around 1.5%. Such a strongly positive output gap means growth needs to slip materially below trend (which we put at 3%) for the next two years to remove excess demand pressure and shift the output gap broadly back to zero. At this level, growth in demand is matching supply, there is no excess pressure on resources, and inflation typically sits around the middle of the 1-3% policy band. This ‘reality’ sets the scene for a moderation in activity over the coming two years, either through

the natural forces shaping the business cycle, or fostered via a monetary response from the Reserve Bank. The risks While performance has been strong, there are cracks appearing in the economic foundations as forces shaping the business cycle wax and wane. Broadly speaking, the doomsayers are pointing to four areas that have the potential to stifle prospects. A high New Zealand dollar. Across most benchmarks the NZ dollar is 10% to 20% overvalued, and implies export competitiveness has been significantly eroded. Based on the previous relationship with monetary conditions, growth could be expected to slow sharply in 2005. On the previous two occasions the New Zealand dollar pushed above 65 on trade-weighted-basis, the economy fell into recession two years later.

Monetary conditions likely to cool growth

Source: Economics@ANZ; Statistics NZ

-3

-2

-1

0

1

2

3

4

5

6

7

8

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05

0

500

1000

1500

2000

2500

Annual average % change

GDP (LHS)

Monetary Conditions (advanced 6 qtrs,

RHS)

Index

Surging international oil prices. Net oil imports total $ 1.3 billion (0.9% of GDP). The recent surge in oil prices - if sustained - has the potential to knock at least 0.5% off growth, through a combination of weaker global demand, and higher input costs. Receding migration. The annual net migration gain has eased from 42,000 (more than 1% of the population) to 19,000 (just under 0.5%). Student inflows from China – a key source of immigration – are slowing sharply. Historically, previous periods of strong net inwards migration have been followed by an exodus. Easing housing market activity. House sales have eased during the course of 2004 and dwelling consents are softening. Moreover, across most valuation benchmarks (i.e. price-earnings ratios,


ratio of house prices to income or combinations of income and yield) the property market is overvalued. A speculative element in some segments of the market implies the market may be vulnerable to a correction, which in turn will flow-on to durables spending and employment prospects. Such a combination implies natural business cycle dynamics will foster the desired slow-down in activity and the Reserve Bank must remain mindful of the downside risks facing the economy. Nevertheless, growth has a solid footing While these factors are raising the risk profile on a sharp moderation in activity – particularly following such a strong surge over the past year, they need to be assessed with caution. Buoyant commodity prices are supporting the export sector. Exports account for around 30% of New Zealand’s GDP, with close to half commodity based. As such, the country’s economic fortunes are closely aligned to international soft commodity movements. A sharp recovery in international prices for New Zealand’s agricultural commodities in 2003 and 2004 remains a key influence on momentum for the New Zealand economy as we move towards 2005.

World commodity prices at record highs

Source: Economics@ANZ

80

90

100

110

120

130

140

150

160

86 88 90 92 94 96 98 00 02 04

Index (July 1986=100)

NZ$ prices

World prices

The surge in commodity prices during the past two years is the result of a combination of tight supplies (partly as a result of the lingering influence of drought in Australia) and improving demand. It has been characterised by a sharp turnaround in dairy prices to their highest level since 1996, aided by prices for lamb and beef pushing to record levels. These are the mainstay of New Zealand’s commodity exports, but have been supported by a range of commodities.

The ANZ International Commodity prices index sits 24% above its decade trend, and rural incomes remain above average. Incomes are being squeezed in some sectors of the export community which have not enjoyed the cushion afforded by record commodity prices, such as forestry and manufacturing. But record prices for lamb, beef and dairy (highest since 1996) are supporting the mainstay of New Zealand’s commodity exports. Moderating global growth, waning supply side influences and the removal of BSE related trade restrictions are expected to see commodity prices soften over 2005. But equally, supply and demand fundamentals are supportive of a relatively positive outlook. A high terms of trade is insulating the economy from high oil prices. Strong global demand has underpinned higher oil prices. This favourable demand backdrop has also supported soft commodity prices. Collectively, New Zealand’s terms of trade – what we receive for our exports relative to what we pay for imported goods – remains at a historically high level and a key shock absorber dampening the effect of high oil prices on the economy. Migration is merely receding towards it long-run average. Relative job prospects are the key determinant of migration flows. Previous migration exoduses have been strongly driven by poor domestic job prospects. Interestingly, this implies migration is a consequence of economic developments as opposed to the primary cause of it. Current tightness in the New Zealand labour market and skill shortages implies emigration will remain relatively subdued and supportive of net migration trends. Nonetheless, with a large population of foreign students now reaching graduation, in combination with weak inflows, deteriorating migration trends remains a material risk. Housing market activity is easing rather than plunging. While the housing market has turned, the overall level of activity remains high and continues to put pressure on resources. Migration and interest rate developments are of secondary importance to job prospects, and the labour market remains tight. While the New Zealand housing market has followed the global housing upswing, the length of the cycle has been shorter (3-4 years compared to 5-6 around the globe). The NZ housing market is not as extended as global counterparts according to gauges such as the ratio of house prices to income. Non-residential


investment looks set to partially fill the void vacated by the housing market as 2005 progresses. Business investment is contributing to a broader base. Business investment is being fuelled by strong profitability and equity market performance within the corporate sector. In addition, the New Zealand Institute of Economic Research's September Quarterly Survey of Business Opinion revealed that firms' investment intentions remain strong in the face of intense resource pressures. Collectively, this leaves us reasonably sanguine regarding economic prospects, even though some key pillars of economic support are dissipating. Moreover, at this juncture, there is an array of forces that imply a lengthened economic cycle. Fiscal policy is moving to an expansionary stance, with the first tranche of targeted spending to low-middle income families due in December, and subsequent increases each six months. Additional infrastructure spending has been pledged in road and energy – both areas that have become bottlenecks to economic growth. Collectively, fiscal policy will be delivering an impulse in the order of 0.5% of GDP over the coming 2 years, with the potential for this to rise to 1% of GDP as election vote-winning comes to bare. What is more, business cycles seldom die and we are mindful that the economy has a fair head of steam. The combination of low unemployment and consumer spending is fostering a cycle of economic success. But business cycles can be murdered by bad policy. So will the moderating expansion phase be moderate enough? While the scene is set for a moderation in activity over the coming months, questions surround whether the pace of deceleration will be sufficient to dampen inflation pressure before it becomes embedded in inflation expectations. While the full impact of the 125 basis points of hikes delivered so far this year has yet to impact on economic activity, monetary policy has yet to extend to a materially restraining stance.3 On balance, we expect the Reserve Bank to raise the official cash rate once more in October and the risk profile is pointed towards a successive hike late in the year. Strictly speaking monetary policy looks to be running concurrently with current indicators. 3 The neutral official cash rate is generally thought to sit around 5.75-6%. At current levels (6.25%), monetary policy remains close to neutral.

But given existing resource pressures, potential for a lengthened economic cycle, and inflation risks, it is hard to quibble. While not our core scenario, there is potential for an over-extended tightening cycle if inflation concerns weigh heavily within the Reserve Bank’s reaction function. While we are mindful of the oscillating path monetary policy has followed over the past five years, such a path reflects the vulnerabilities of being a small trading nation and risks that have buffeted the economy Moreover, interest rate volatility is preferable to swings in real economic variables.

A further interest rate rise is likely

4.0

4.5

5.0

5.5

6.0

6.5

7.0

99 00 01 02 03 04 05

% per annum

90 day bank bills

OfficialCash Rate

Sources: RBNZ; Reuters; Economics@ANZ

An over extended cycle is likely to foster a sharp easing in activity from early 2005. But in that situation, expect the currency to react accordingly – shifting from a yield to a growth related theme, and a degree of monetary policy back-tracking from mid-year. Let the good times roll There is enough growth in the bag for growth to push towards 5% in 2004. Beyond that we expect momentum to moderate towards 2.5%. While this represents a sharp moderation, it needs to be put in perspective. At the trough in the economic cycle, economic growth will be matching New Zealand’s 20 year average. Amongst international counterparts, this will be better than the UK and Europe, but below Australia and the United States. Under-performance against the Australian and United States economy should eventually invoke a self-correcting response from the New Zealand dollar, which by 2007 should help eventually return economic growth towards its trend rate of 3%. Cameron Bagrie, Senior Economist (NZ) (++644) 802 2212


Financial marketsOil dominates world markets The surge in the price of oil has gripped the market’s attention. So far this year, the price of West Texas Intermediate crude oil has averaged $US39.5/barrel4, up from $US31/barrel in 2003. Crude oil has risen through $US50 to new nominal records, rising to $US55/barrel5 in the first part of October. Short-term supply concerns dominated market news, such as the spate of hurricanes affecting US production in the Gulf of Mexico, but the market remains concerned about longer-term availability of oil in a global economy that is growing at its strongest pace in two decades. Oil market participants are betting that a combination of continued shortages and strong demand will underpin the price of oil at well above its long term average both in nominal and real terms for an extended period. Valued in today’s prices, the price of oil has averaged $US35/barrel since 1960. The futures market for West Texas Intermediate crude oil has priced in an average price of around $48-49/barrel for 2005 and 2006 before reverting closer to (but still above) its long term average, with the market expecting a price of around $40/barrel in the last four years of this decade.

Oil prices, WTI, real (August 2004) prices

These elevated oil price expectations have halted in recent months the rise in medium to longer term world interest rates that had been evident from earlier this year. The US Federal Reserve, the Bank of England, the Swiss National Bank and the Bank of Canada and the Reserve Bank of New Zealand have raised their respective target short term interest 4 Spot futures contract price, average of daily closes Source: Reuters 5 To 18 October

rates in recent months, but corresponding medium to long term interest rates have either been steady or fallen. In part this bond market rally has been associated with a preference by investors for ‘safe-haven’ government bonds as a form of investment in times of geo-political uncertainty as well as the market’s expectation that the higher price of oil will in time slow economic growth in the major industrial economies. In contrast to the two major ‘oil price shocks’ of the 1970s, this episode has not heralded market fears that a new wave of global inflation is about to be unleashed.

US bond yield and oil prices

10

20

30

40

50

60

Sep-01 Jan-02 Jun-02 Oct-02 Mar-03 Aug-03 Dec-03 May-04 Sep-04

2

3

4

5

6

US$ per barrel US 10y yield, inverted scale

US 10y bond yield (rhs)NB: inverted scale

West Texas crude, $US, bbl (lhs)

Inflationary expectations remain subdued. For example, the long term inflation rate priced in to the US Treasury bond market over the next decade has been remarkably stable through the course of this year, despite signs of much stronger growth and the immediate spur to inflation created by the rise in the price of oil and some other input costs. After bottoming at a 10 year expected inflation rate of 1.7% in mid 2003 when the market was most concerned with the fear of deflation arising in the US, that expected rate has remained at 2¼-2½% through this year; in early October that priced in rate was 2.3%6. The US bond market therefore does not expect that the current run up in the price of oil spells a particular on-going risk for US inflation over the period ahead. Comments from speeches made by members of the US Federal Reserve suggest a similar thinking. In large part this will reflect the flexibility and competitiveness of the US economy and the now well-anchored price stability objective of the US Federal Reserve.

6 That compares with the latest August CPI that was 2.7% or 1.7% on an underlying (excluding food and energy) basis.

Note: Shaded areas denote years in which OECD economic growth was less than 2½% pa. Sources: Datastream; IMF; Economics@ANZ.

0

10

20

30

40

50

60

70

80

90

100

70 75 80 85 90 95 00

US$ per barrel(West Texas Intermediate)

(In August 2004 dollars)

Spot price


While a higher oil price is pushing up the price of related energy prices for consumers and business, it is acting as a ‘tax’ on personal income (and thus consumption) and business profitability in the oil consuming economies. The higher the price of oil, the lower the expected growth rate, other factors remaining the same. Higher oil prices are thus a double-edged sword for central banks; they push up inflation but also dampen prospects for continued strong global economic growth. ANZ expects that in time – within a 6-12 month horizon - there will be a significant decline in the price of oil below what is currently priced in to current futures markets. This view stems from a realisation that economic forces themselves will see both demand and supply adjust to the currently high price of oil but also that the price has been bid up by speculation. The higher price of oil reflects not only a tight balance between the supply and demand for oil but heightened sensitivity of oil prices to any news that could be interpreted as possibly adversely affecting oil output. This has been evidenced by a higher than normal exposure to rising prices by the speculative community through oil derivative markets. Should such positions unwind, there will likely be some corresponding pull back in oil prices. There is evidence that while demand for oil has been rising strongly, this has been matched by rising supply.

Oil market speculative positioning

-80000

-60000

-40000

-20000

0

20000

40000

60000

80000

100000

Mar-83 Mar-87 Mar-91 Mar-95 Mar-99 Mar-03-10

0

10

20

30

40

50

60

WTI oil (rhs)

CFTC oil non-comercial positions,long +, short -, lhs

Source: Bloomberg.

Of course, forecasts for the price of oil will have a large bearing on the economic landscape and therefore the outlook for financial markets. The higher the price of oil assumed or forecast, the lower that world and Australian interest rates are likely to prevail. A higher price of oil, or signs that a retracement is still some way off would be a factor that would influence not only the deliberations of the

US Federal Reserve (and other major central banks) but the Reserve Bank of Australia. For example, were the ‘soft patch’ in the US economy to carry through for a longer period, it’s likely that the Fed would pause in their path of lifting the Fed funds rate to a more realistic rate. A more tempered rate of world economic growth would also be grounds for the RBA to reflect on prospects for less upside to Australian exports and related investment, taking the edge off Australia’s economic prospects. Recent Fed speeches have espoused the view that the US economy appears to have stabilised and that the Fed’s Open Market Committee will continue for now on its path of ‘measured’ rate rises. The market is not so sure; with oil prices at over $50/barrel, Eurodollar futures have priced in the expectation that the funds rate will rise to around 3% by the end of next year. That implies that at around one meeting in two over the course of the next 12 months, the Fed will pause on its path of raising interest rates to less accommodative levels. Fed- more rate rises for now ANZ expects that the Fed will continue to lift its funds rate at each of the next two meetings on November 10 and the final meeting on December 14. That would take the funds rate to a slightly positive real rate, with nominal interest rates at 2.25% by the end of the year and underlying consumer inflation running at around 1¾% by year end. Thereafter, our forecast for the Fed funds rate is contingent on the forecast for the price of oil. There is the real risk that unless the price of oil stabilises or retraces in the next few months that the Fed will exercise more caution as far as monetary policy is concerned and take a pause in the first half of 2005. The Fed’s own econometric model of the US economy estimates that for a permanent increase in the price of oil cumulating to $10/barrel over four quarters will increase CPI inflation in the first year by 0.5%, but that effect will then dissipate. The growth effect however accumulates from –0.2% in the first year to –0.4% in the second year. US$ outlook: yield support vs structural headwinds Our baseline forecast for the price of oil envisages a pull back over the next few quarters to around or below its long term real average by the end of 2005. The US Fed funds rate is forecast to rise to around 3½-4% by the end of 2005, a forecast that is at or above current US interest rate futures market pricing. In the absence of any structural headwinds, that would suggest an upbeat outlook for the US$


over the next year. Over the same period, the European Central Bank is expected to lift their repo rate to 3.0% from 2%, while the Bank of Japan is unlikely to move away from its policy of quantitative easing and zero interest rates until 2006. However, we continue to retain a defensive view over the outlook for the US$ because of its continuing high external current account deficit and internal government deficit. Such concerns have not adversely affected the performance of the US$ over the past few months; rather it has been variable interest rate expectations that have had the most influence over the US$. Our expectation is that the US current account deficit will average 5¾% of GDP in 2005, the same as in 2004, a deficit that will continue to require large reliance on inward capital flows. We would highlight the first half of 2005 as a time when concerns over the US external deficit might arise again. The Fed is set to pause in its program of monetary tightening at either of its February 2 or March 22 meetings at a time when the ECB will likely be acting to lift its repo rate toward a more normal level. There is also some event risk associated with the upcoming US Presidential election to consider. First, any change in Administration, were it to occur, might engender some short term uncertainty in US investment markets, including the US$. In the lead up to the election – with polls currently showing a close contest between President Bush and Mr Kerry – market could well price in some uncertainty risk associated with a change in Administration. As far as the Federal deficit is concerned, both have promised to take steps to reduce the Federal Government’s deficit in coming years and and on that score there might be little to distinguish the two. The market would also be paying close attention to any new appointment affecting US economic policy such as a new Treasury Secretary, were Mr Kerry to be elected. In short, over the short term horizon, we expect that the US$ will remain relatively well supported. The EUR/US$ is not expected to move above $1.25 between now and the end of the year. Thereafter, some depreciation in the US$ remains in prospect; over the course of 2005, the Fed’s ‘major currency’ US$ index is expected to ease, an easing that will be giving some support to other major currencies, including the A$. As far as the Australian dollar is concerned, while oil prices have risen, so have other commodity prices, including gold and base metals, adding supporting the Australian dollar. Base metal prices – a barometer Australian export and fundamental currency health - have been pushing toward their

highs reached earlier this year, notwithstanding the recent sell-off. The increases in such industrial commodity prices reflects as much about the upbeat nature of the global economic cycle. Indeed, ANZ continues to expect that the global economy will record growth of 3¾% in 2005, after growth of around 5% this year, which is still above the average growth rate of around 3½% since 1970. Other diagnostics on the health of the global economy do not point to any near term risk of global risk aversion. (It has been such measures of global uncertainty that plagued the A$ during the Asia crisis and the global economic downturn in 2001.) The VIX Volatility Index – a market estimate of future volatility has been around 15 in recent weeks, symptomatic of low levels of risk, well below peak levels of 45 observed in 1998 and 40 in 2002. Based on ANZ’s global economic forecasts for the period ahead, ‘fair value’ for the A$/US$ is currently around the 0.73 level7. That fair value is not expected to change significantly over the next 6 to 12 months. A$/US$ now the 4th most traded currency pair

30

20

11

45

43

2

28

17

14

54 4

32

0

5

10

15

20

25

30

35

EUR/

USD

USD/J

PY

GBP/U

SD

AUD/U

SD

USD/C

HF

USD/C

AD

EUR/

JPY

EUR/

GBP

Apr '01Apr '04

Source: Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity surveys in April 2001 and April 2004, Bank for International Settlements.

The A$/US$ continued to ‘range trade’ through most of the September quarter in a $0.685-0.725 range, weighed down at times but some softness in Australian domestic economic indicators and the likelihood that the RBA’s monetary policy would remain on hold. Toward the end of September and in early October, the Aussie was testing the high end of its range, supported by higher commodity prices and some ebbing in support for the US$. Looking through the inevitable day-to-day and week-to-week volatility in the foreign exchange market, the outlook remains positive for the Aussie

7 One standard deviation of this estimate is around US$0.04, with the result that there is a two thirds chance that the estimated rate is within a 0.69-0.77 range.


dollar through 2005. Little change is expected between now and the end of this year with an upside bias in prospect in the first half of 2005. In part this 2005 outlook reflects some prospective softness in the US$, but also an overly sanguine view of the RBA cash rate currently embodied in Australian interest rate markets. The RBA is expected to lift the cash rate in 2005, quite likely on two occasions. In the lead up to those announcements, ANZ expects that the RBA will move to a more formal tightening bias in the lead up to the end of this year. For the remainder of this month and into early November, the key domestic data will be the upcoming September quarter CPI and GDP reports. While neither of these reports would themselves be a trigger for RBA policy action, they would be sufficient to conform that the economy is continuing to grow at a solid clip at a higher rate of capacity utilisation, pressuring the price of labour and business costs. The September quarter CPI is expected to reveal a headline rate of 2.7%, up a touch from 2.5% in the June quarter. In part this reflects the impact of higher petrol prices that will also feed through in the December quarter. Underlying measures of CPI inflation – that exclude some more volatile prices such as petrol prices - are expected to be lower on a year-ended basis at 2¼-2½% but will signal that the low point in inflation is passing. Recent employment data and business surveys suggest that the economy’s momentum will be sustained through the end of 2004 and into next year. Anecdotal reports suggest that (skilled) labour shortages remain a barrier to output expansion and that recent wage rises have been at a higher rate than has been evident in the aggregate data on wage costs to the middle of the year. Even allowing for the minimum wage rise that ANZ estimates could add around 0.5 percentage points to wages growth in this half year, other wage agreements point to some wage acceleration. The RBA will be watching the next set of wages data due November 17 very closely. There is also the risk that the stimulus from the May Budget will add to the economy’s momentum in the near term. Recent retail trade data have been disappointing of late and might be evidence that some rise in household saving is taking place. To some extent that might be true. But even assuming

that private consumption grows at a much more moderate 1.0% per quarter over the next year implies that the economy would be continuing to grow at over 4% in the absence of any policy action from the RBA to contain pressure on resources and inflation. The next major Monetary Policy Statement is due from the RBA on November 8. We doubt that this policy Statement would signal a rate rise by the end of this year. Rather, ANZ expects that the RBA would be outlining a view that with the housing market on track for a ‘soft landing’, other growth spurs – including business investment and government spending and signs that the dwelling investment cycle would bottom in the middle of 2005 – will be acting to support growth through 2005 and into 2006.

A$ yield outlook

Sources: Reuters, Economics@ANZ

ANZforecasts

4.0

4.5

5.0

5.5

6.0

6.5

00 01 02 03 04 05

Cash rate

OIS implied pricingas at 13-Oct

%

Domestically, the September employment report was a big wake up call for markets. After averaging monthly employment growth of 14,000 in the six months to August, down from 25,000 in the six months to March, the 63,500 employment rebound in September confirmed the still firm state of both the domestic economy and labour market. Our expectation is that firm labour demand continues exerting pressure on Australian wages, a key watershed for RBA monetary policy. ANZ continues to expect that the RBA will hike rates in the first quarter of 2005, a move far from fully priced in by A$ interest rate futures. David de Garis, Senior Treasury Economist (03) 9273 1995


Household debt - safe as houses Household debt has risen sharply Household debt levels in Australia have risen dramatically over the past decade, buoyed by a marked reduction in interest rates, solid growth in household incomes and a sustained boom in house prices. These factors have combined to reduce households’ traditional debt adversity, driving a structural shift in household balance sheets. Over the decade to June 2004, total household debt grew by an average 14.7% per annum, far outstripping average growth in household disposable incomes of just 5.4% per annum. This has pushed the aggregate household debt-to-income ratio to record levels, prompting many analysts to predict a looming household debt crisis that could potentially bring Australia’s 13 year period of uninterrupted economic growth to an end.

Household debt has risen to record levels…

405060708090

100110120130140150160170180190200

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Australia

Source: ABS,Datastream, Economics@ANZ

% of disposable income

US

Debt to income ratios

UK

Neth.

The debt-to-income ratio for Australian households has risen from well below international benchmarks for developed economies in past decades to around the level of other English-speaking countries. Over the past 15 years, Australian households have emerged from a position of being ‘under-geared’ (due to a debt-averse culture, financial market regulation and the availability of ‘vanilla-only’ financial products) to one where they are now far more comfortable with higher levels of debt and where financial service providers are offering significantly more product flexibility. Household debt servicing still comfortable However, the need for household balance sheet ‘correction’ is not yet clear-cut. In fact, despite a record household debt-to-income ratio, we believe the household sector can comfortably accumulate

further debt in coming years, providing economic conditions remain stable. Ongoing household income and employment growth remain the keys to the sustainability of household credit growth. In isolation, gross debt-to-income ratios offer little insight to assessing the vulnerability of the household sector and can provide a misleading view, as they take no account of changing debt-servicing costs or household sector asset accumulation. In this context, debt-service and household gearing ratios are much more appropriate and useful metrics – both of which present a far more sanguine view of household financial positions. While household debt-to-income ratios have risen to record levels, the debt-servicing burden for the total household sector remains below the peak reached in 1989-90 (when variable mortgage rates hit 17%).

…but debt servicability remains comfortable

5

6

7

8

9

10

11

12

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Household

Source: ABS, RBA, Economics@ANZ


Personal i.e. HH excl. unincorp.

Debt service ratios

Rising house prices have boosted net HH assets Moreover, buoyed by rising house prices, net household assets have grown considerably, averaging annual growth of 13% over the past 5 years. Hence, while moving higher, the aggregate household-gearing ratio8 remains broadly in line with international benchmarks. It has been argued that gearing ratios present an overly optimistic picture of the household sector’s net asset position due to the potential for sharp falls in house prices. However, unlike other asset markets, downward corrections in aggregate Australian house prices are extremely rare and have only occurred in very special circumstances i.e. deep 8 Household debt to net assets


economic recessions accompanied by sharp increases in interest rates and high unemployment (eg 1982-83, 1990-91). We believe a buoyant economic outlook combined with solid housing market fundamentals virtually preclude significant falls in aggregate house prices in this cycle. A large proportion of the rise in household debt-to-income has been a perfectly rational response to the structural downward shift in interest rates experienced since the early 1990s. Significant economic reform and 13 years of positive and relatively stable economic growth and low inflation have not only lowered interest rates but have also increased confidence that interest rates will remain comparatively low and stable. Combined with surging asset prices, this has substantially increased households’ propensity to borrow. ..and we’re also undergoing a cultural evolution Traditionally, the debt-holdings of householders followed a fairly predictable pattern over their life-cycle, with debt levels jumping sharply in the household formation/expansion life stages and then being unwound gradually in preparation for retirement. While the purchase of a home remains the biggest financial investment in one’s lifetime, financing patterns surrounding and following such a purchase are changing, being facilitated by more flexible mortgage products and a preparedness to use equity in the home to fund either consumption or other investments. This implies a clear shift in the typical pattern of household debt behaviour over the life-cycle, with debt holding at higher levels for longer periods on average and displaying larger swings. Products such as home equity loans, interest-only loans and loans with redraw facilities are helping to ‘institutionalise’ this way of financing one’s journey through life. The trend is evolutionary as the ‘old school’ of borrowers makes way for a less debt-averse set of borrowers. Until this cultural shift has ‘washed through’, structural increases in aggregate household debt are likely to continue. A slowing in house prices and the consequent tempering of expectations for future growth will serve to slow debt accumulation and soften to some extent the momentum of the structural shift we have seen in recent years. The implication is that we can expect household debt to continue growing faster than income growth for quite some time (although the premium will be much reduced for the rest of this decade). Some reversion to incomes growth can be expected

towards the end of this decade or early next decade as the demographic ‘drag’ from baby boomer retirements, becomes a primary driver. This cultural shift in the use of debt will also present unprecedented challenges for householders as they progress towards retirement and for financial service providers. From the household perspective, one can expect wholesale re-structuring of financial and residential portfolios towards the end of one’s working life. Financial service providers must be innovative enough to ensure the transition is a smooth one. Can households lift debt levels higher? Data on the distribution of household debt-servicing ratio (DSR) underscores why we have seen such a significant structural increase in household sector gearing in recent years. Unpublished Household Expenditure Survey data for 1998/99 shows that over 6.3 million households (out of 7 million households) had debt service ratio of under 16%9 while 5 million had a DSR of under 8%. Excluding the over-55s (who traditionally have a natural aversion to gearing up but who are less likely to be so in the future), leaves around 4 million households with a DSR of less than 16% and 3.3 million households with a DSR of less than 8%10.

Amazing capacity to lift debt a few years ago

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Zero < 4 < 8 < 12 < 16 < 20 < 24 < 28 < 32 > 32

O-54 years old

Source: ABS HES 1998/99, Economics@ANZ

million households

Over 55 years old

Morevulnerable

Lessvulnerable

Debt servicing ratio

Solid growth in debt levels is clear testament that this capacity has been exploited. We believe there is further scope to increase debt levels despite the personal DSR already surpassing levels reached in the late 1980s11. To determine how much further

9 includes owner-occupied, investment housing, alterations and additions debt , car loans and credit cards 10 Unfortunately, results from the 2003-04 Household Expenditure Survey will not be released until 2005 11 The household debt-servicing levels recorded in the late 1980s are often cited as a ‘financial stress’ benchmark. Recession in the early 1990s had little to do with household sector balance sheets. It just so happened that the personal sector DSR landed at that particular level when corporate


scope there is for DSR to rise, we have adopted an alternative framework. ANZ has estimated a plausible range for the aggregate DSR of between 11% and 13.6%. This compares to the current level of around 9% and 10.4% projected by ANZ by June 2006. This does not suggest there cannot be financial stress for householders and lenders until that level is reached (for instance, in a situation where the economy experiences severe employment loss), but that in a stable economic and interest rate environment, further growth in household debt levels is plausible and sustainable. While we do not believe interest rates are likely to increase much above current levels, the present indebtedness of households leaves the household sector more vulnerable than ever to financial disruption. Having said that, we believe the probability of a severe financial disruption remains low.

Debt service ratios can move higher

3

4

5

6

7

8

9

10

11

12

13

14

15

87 89 91 93 95 97 99 01 03 05 07 09 11


Sources: RBA, Economics@ANZ

Personal debt service ratio

Plausible DSR range in a ‘stable’

environment

•A major economic or interest rate shock would interrupt this structural adjustment. Clearly, the fall-out from such a scenario would be significant, even though DSR is not breaching the ‘plausible range’

The economy is not more debt-exposed It has been widely argued that the heightened indebtedness of the household sector has left the economy far more at risk in any potential future economic downturn. This ignores the substantial reduction in business debt after the early 1990s recession, structural improvement in government sector finances and improvement in risk management practices adopted by lenders. Aggregate private sector debt-servicing burdens remain near historic lows. In particular, business sector balance sheets are in great shape and suggest financial disturbances to business have less

sector adjustment began. The DSR level in the late 1980s therefore offers little guidance for what is sustainable or plausible in the future.

chance of flowing through to labour markets and consumer confidence.

Aggregate debt servicing costs remain low

0

5

10

15

20

25

30

35

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Household*

Source: ABS, Economics@ANZ

% of gross income

Corporate

Total

* Includes unincorporated enterprises

Debt service ratios

…and the RBA is not stupid With the household debt-to-income ratio at record levels and high ‘month on month’ increases still being recorded, it is easy to see why there may be heightened levels of anxiety in the financial community about potential fall-out. These fears are exacerbated by talk of substantial increases in interest rates (eg 300 basis points) and by simulations of the effects of such rises on economic growth, unemployment etc. Without a reasonable context or rationale, the probability of such scenarios actually occurring remains low. Policy makers are well aware of the heightened sensitivity of the household sector to interest rate movements and would not exert undue influence on it unnecessarily. Rate rises of just 50 basis points in late 2003 resulted in a 20% fall in housing finance approvals. For this reason, we believe only modest interest rate increases (another 50 basis points) over 2005 can be justified. The economy is well positioned to grow at a healthy rate in the years ahead. Risks (eg wages, oil prices, house prices, fiscal stimulus) are present but none, at this stage, is likely to have a fundamental impact on the economic environment. In any event, monetary policy is now more potent and the RBA has more influence than ever to fine-tune or alternatively, deal more aggressively with any emerging imbalances it perceives to be around the corner. Paul Braddick, Senior Economist (03) 9273 5987 Ange Montalti, Economist (03) 9273 6288

Financial markets forecast table

26

End period End periodJun-2004 Sep-2004 Dec-2004 Mar-2005 Jun-2005 2002/03 2003/04 2004/05 2005/06

actual forecast actual forecast

Interest rates Australia

90 day bank bills (%p.a.) 5.5 5.4 5.6 5.6 5.9 4.7 5.5 5.9 5.9

10 year bond rate (%p.a.) 5.8 5.5 6.4 6.7 6.9 5.0 5.8 6.9 5.9

United States

3 month LIBOR (%p.a.) 1.6 2.0 2.3 2.8 3.3 1.1 1.6 3.3 4.5

10 year bond rate (%p.a.) 4.6 4.1 4.8 5.1 5.5 3.6 4.6 5.5 5.4

Euro area

3 month LIBOR (%p.a.) 2.1 2.1 2.1 2.3 2.6 2.1 2.1 2.6 3.5

New Zealand

90 day bank bills (%p.a.) 6.3 6.8 6.6 6.6 6.6 5.3 6.3 6.6 6.1

Exchange rates

AUD/USD 0.70 0.71 0.74 0.78 0.81 0.67 0.70 0.81 0.72

NZD/USD 0.64 0.67 0.68 0.67 0.70 0.59 0.64 0.70 0.58

AUD/JPY 75.3 79.2 79.4 83.3 86.7 80.6 75.3 86.7 73.4

AUD/EUR 0.57 0.58 0.59 0.62 0.63 0.58 0.57 0.63 0.57

AUD/GBP 0.38 0.40 0.41 0.43 0.43 0.41 0.38 0.43 0.40

AUD/NZD 1.09 1.07 1.08 1.15 1.15 1.15 1.09 1.15 1.23

USD/JPY 107.9 110.7 108.0 107.5 107.0 119.7 107.9 107.0 102.7

EUR/USD 1.21 1.23 1.25 1.26 1.30 1.15 1.21 1.30 1.26

A$ Trade weighted index 59.6 61.0 60.3 63.5 65.7 59.3 59.6 65.7 58.4

Economic forecast table

27

Quarterly % change Annual % changeJun-2004 Sep-2004 Dec-2004 Mar-2005 Jun-2005 2002/03 2003/04 2004/05 2005-06

actual forecast actual forecast

Australia GDP 0.6 1.2 0.9 1.2 0.7 3.1 3.6 3.7 3.4

- Final demand 1.6 0.9 1.1 0.9 1.1 6.2 5.4 4.6 3.6

- Stocks -1.0 0.2 0.0 0.0 0.0 0.0 0.6 -0.2 -0.1

- Net exports -0.1 0.4 -0.2 0.1 -0.4 -2.8 -2.7 -0.7 -0.3

CPI 0.5 0.8 0.4 0.4 0.6 3.1 2.4 2.4 2.6

Wages 0.5 1.4 1.0 1.1 0.8 3.5 3.6 4.0 4.3

Employment 0.7 0.2 0.4 0.6 0.7 2.5 1.8 1.9 1.7

Unemployment rate (%) 5.6 5.6 5.6 5.5 5.3 6.2 5.8 5.5 5.5

Current account deficit ($b) -12.0 -11.1 -10.5 -10.8 -11.0 -40.3 -47.9 -43.5 -44.6

- % GDP -5.7 -5.2 -4.9 -4.9 -4.9 -5.3 -5.9 -5.0 -4.8

New Zealand GDP 0.8 0.3 1.0 0.8 0.5 4.1 4.4 3.3 2.2

CPI 0.8 0.6 0.9 0.7 0.6 1.5 2.4 3.1 2.4

Wages 2.6 0.8 0.7 0.9 0.8 3.2 3.5 3.2 3.9

Employment 0.9 0.2 0.3 0.3 0.1 1.9 3.1 0.9 0.5

Unemployment rate (%) 4.0 4.1 4.1 4.1 4.2 4.7 4.0 4.2 4.5

Current account deficit ($b) -1.8 -2.9 -2.1 -0.3 -1.7 -3.0 -5.2 -7.0 -8.3

- % GDP -4.6 -4.8 -4.9 -5.0 -4.8 -2.4 -5.0 -4.8 -5.4

DISCLAIMER: Australia and New Zealand Banking Group Limited is represented in: AUSTRALIA by: Australia and New Zealand Banking Group Limited ABN 11 005 357 522 10th Floor 100 Queen Street, Melbourne 3000, Australia Telephone +61 3 9273 6224 Fax +61 3 9273 5711 UNITED KINGDOM by: Australia and New Zealand Banking Group Limited ABN 11 005 357 522 Minerva House, PO Box 7, Montague Close, London, SE1 9DH, United Kingdom Telephone +44 20 7378 2121 Fax +44 20 7378 2378 UNITED STATES OF AMERICA by: ANZ Securities, Inc. (Member of NASD and SIPC) 6th Floor 1177 Avenue of the Americas New York, NY 10036, United States of America Tel: +1 212 801 9160 Fax: +1 212 801 9163 NEW ZEALAND by: ANZ National Bank Limited Level 7, 1-9 Victoria Street, Wellington, New Zealand Telephone +64 4 802 2000 In Australia and the UK, ANZ Investment Bank is a business name of Australia and New Zealand Banking Group Limited, ABN 11 005 357 522 (“ANZ Bank”), which holds an Australian Financial Services licence no. 234527 and is authorised in the UK by the Financial Services Authority (“FSA”). In New Zealand, ANZ Investment Bank is a business name of ANZ National Bank Limited WN / 035976 (“ANZ NZ”). This document is being distributed in the United States by ANZ Securities, Inc. (“ANZ S”) (an affiliated company of ANZ Bank), which accepts responsibility for its content. Further information on any securities referred to herein may be obtained from ANZ S upon request. Any US person(s) receiving this document and wishing to effect transactions in any securities referred to herein should contact ANZ S, not its affiliates. This document is being distributed in the United Kingdom by ANZ Bank for the information of its market counterparties and intermediate customers only. It is not intended for and must not be distributed to private customers. In the UK, ANZ Bank is regulated by the FSA. Nothing here excludes or restricts any duty or liability to a customer which ANZ Bank may have under the UK Financial Services and Markets Act 2000 or under the regulatory system as defined in the Rules of the FSA. This document is issued on the basis that it is only for the information of the particular person to whom it is provided. This document may not be reproduced, distributed or published by any recipient for any purpose. This document does not take into account your personal needs and financial circumstances. Under no circumstances is this

document to be used or considered as an offer to sell, or a solicitation of an offer to buy. In addition, from time to time ANZ Bank, ANZ NZ, ANZ S, their affiliated companies, or their respective associates and employees may have an interest in any financial products (as defined by the Australian Corporations Act 2001), securities or other investments, directly or indirectly the subject of this document (and may receive commissions or other remuneration in relation to the sale of such financial products, securities or other investments), or may perform services for, or solicit business from, any company the subject of this document. If you have been referred to ANZ Bank, ANZ NZ, ANZ S or their affiliated companies by any person, that person may receive a benefit in respect of any transactions effected on your behalf, details of which will be available upon request. The information herein has been obtained from, and any opinions herein are based upon, sources believed reliable. The views expressed in this document accurately reflect the author’s personal views, including those about any and all of the securities and issuers referred to herein. The author however makes no representation as to its accuracy or completeness and the information should not be relied upon as such. All opinions and estimates herein reflect the author’s judgement on the date of this document and are subject to change without notice. No part of the author's compensation was, is or will directly or indirectly relate to specific recommendations or views expressed about any securities or issuers in this document. ANZ Bank, ANZ NZ, ANZ S, their affiliated companies, their respective directors, officers, and employees disclaim any responsibility, and shall not be liable, for any loss, damage, claim, liability, proceedings, cost or expense (“Liability”) arising directly or indirectly (and whether in tort (including negligence), contract, equity or otherwise) out of or in connection with the contents of and/or any omissions from this communication except where a Liability is made non-excludable by legislation. Where the recipient of this publication conducts a business, the provisions of the Consumer Guarantees Act 1993 (NZ) shall not apply. For further information, please email [email protected]

Date post:	03-Jul-2020
Category:	Documents
Upload:	others
View:	1 times
Download:	0 times

March quarter 2002 December Quarter 2004 ANZ …Australia and New Zealand Banking Group A.B.N. 11...

Documents