Trends. - Westpac

Trends.Westpac RegionalEconomic Report

(03/11) 223092

Westpac Institutional Bank is a division of Westpac Banking Corporation ABN 33 007 457 141. Information current as at date above. This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs. Westpac's financial services guide can be obtained by calling 132 032, visiting www.westpac.com.au or visiting any Westpac Branch. The information may contain material provided directly by third parties, and while such material is published with permission, Westpac accepts no responsibility for the accuracy or completeness of any such material. Except where contrary to law, Westpac intends by this notice to exclude liability for the information. The information is subject to change without notice and Westpac is under no obligation to update the information or correct any inaccuracy which may become apparent at a later date. Westpac Banking Corporation is registered in England as a branch (branch number BR000106) and is authorised and regulated by The Financial Services Authority. Westpac Europe Limited is a company registered in England (number 05660023) and is authorised and regulated by The Financial Services Authority. If you wish to be removed from our e-mail, fax or mailing list please send an e-mail to [email protected] or fax us on +61 2 8254 6934 or write to Westpac Economics at Level 2, 275 Kent Street, Sydney NSW 2000. Please state your full name, telephone/fax number and company details on all correspondence. © 2010 Westpac Banking Corporation. Past performance is not a reliable indicator of future performance. The forecasts given in this document are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from these forecasts.

Contents

This issue was finalised on 16 March 2011

The Westpac Regional Economic Report is a quarterly publication

Editors:Neil BurgessSenior Commodities Analyst, AgribusinessCommercial & AgribusinessLevel 2, 275 Kent Street, Sydney, NSW 2000Telephone: (61 2) 8253 7912email: [email protected]

Overview 3

Macro overviewDiesel hedging: managing the costs of farm inputs 4The Australian economy 6Australian interest rates 8Australian dollar 10

Commodity outlooksBeef and dairy 12Grains and oilseeds 14Sugar and cotton 16Sheep and wool 18

Summary forecast tablesFinancial forecasts – Australia 20Economic forecasts – Australia 21Forecasts – commodity prices 22Summary of world output 23

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

3

Chart 1. Chart 2.

Volume One 2011 Trends Report

Overview

In the previous report the economic and climatic conditions for the final quarter of the year were described as being a potential Pandora’s Box. It turned out to be a very good description. The commencement of 2011 has experienced fires, heat waves, devastating floods across Queensland, NSW and Victoria and finally a couple of cyclones thrown in for good measure. The loss of human life, livestock, crop production and infrastructure has proved to be a heavy burden, the full extent of which is still being determined.

The east coast grains harvest came to a very wet ending. The heavy rains during this period caused the harvest to be significantly extended and large volumes of wheat were down-graded into lower categories. The increase in feed wheat volumes was of particular concern for many as it was widely expected that prices would fall dramatically on increased availability. To date, wheat prices have maintained strength, even the lower grades of feed wheat have benefitted from international demand as supplies from the traditional feed wheat markets became tighter.

In the international grains markets, wheat, corn and soybeans are maintaining their bullish run as fundamental, technical, climatic and political issues all exert their individual influence. Adverse weather conditions over winter may result in a higher than expected winter kill rate, already a number of wheat growing regions are indicating that crop quality is poorer than expected. Heavy snow falls in some regions may well result in wetter than expected conditions during the spring thaw.

Over the last quarter, the continued rise in cotton price has been a stand out story. With strong mill buying from China and a tightening stock to use ratio, cotton has seen prices in excess of USc200/lb, this has translated into values of around AUD$1000 per bale. The upcoming planting intentions from US cotton growers will provide the market with some direction as to potential production volumes. In the meantime, Australian cotton growers are enjoying close to ideal conditions for a near record cotton crop. Heavy rains prior to planting have revitalised soil moisture profiles and provided a much needed re-charge to on-farm water storage.

Livestock production continues to benefit from the consistent rain which is keeping pasture in good condition which in turn is being translated into quality livestock. Sale yard prices remain very well supported as re-stockers and processors chase tight supplies of well conditioned cattle. Prices for cattle, sheep and lambs remain well above prices seen at the same time over the last two years.

In this quarter’s edition, the special feature article is on the farm inputs sector; in particular the issues associated with hedging diesel supplies. With the geo-political unrest in North Africa and parts of the Middle East, the price of crude oil has risen and high prices for fuel are being seen at the pumps. It is a timely reminder that there are mechanisms available to help mitigate price volatility in one of the major contributors to farm input costs.

40

90

140

190

240

Feb-85 Feb-90 Feb-95 Feb-00 Feb-05 Feb-10 40

90

140

190

240 index index

AUD index USD index

Sources: Bloomberg, MLA, Westpac Economics

An index of global agricultural commodity prices

Westpac commodity price index

3

4

5

6

7

8

3

4

5

6

7

8

Dec-85 Sep-89 Jun-93 Mar-97 Dec-00 Sep-04 Jun-08

$bn, qtr $bn, qtr

Farm GDP (lhs)

Sources: ABS, Westpac Economics

Farm output

4


Diesel hedging

Managing the costs of farm inputs.With the recent volatility in the international commodity markets, growers have been very focused on the price movements in their crops, be it grain, sugar, or cotton with a view to locking in forward prices at attractive levels either by selling physical forward or selling swaps.The revenue side of the business is only half the story as input costs have been rising and are equally volatile. Some input costs are easier to manage than others but one cost that is easily managed is the cost of diesel fuel. Many diesel users are unaware of the pricing mechanisms for diesel fuel in Australia and that the future price of diesel can be hedged in a similar fashion to the price of wheat for example.

The key is to understand how diesel pricing works. Since Australia does not refine enough diesel to be self sufficient, approximately 40% of diesel supplies are imported from the Asian refining market, often referred to as the Singapore oil market. This diesel is shipped to Australia incurring tanker freight charges, insurance and port costs which together form the landed diesel cost or “Import Parity Price”. It is this Import Parity Price which sets the base price for Australian diesel and is the main source of fluctuating prices. In addition to the Import Parity Price oil supply companies will recover their operational costs such as terminal overheads, distribution costs within Australia, corporate overheads including marketing and add a sufficient profit margin, plus excise, to arrive at the wholesale diesel price often referred to as the “Terminal Gate Price” or TGP. If the oil companies were to base their TGP pricing on a base price any higher than the import parity price, new entrants or independents could enter the market and undercut the incumbent oil companies, or any lower than the import parity price and the oil companies would not be recovering the cost of the imported diesel.

If we look at the schematic breakdown of these price components, we can see that most components are fairly static items of cost recovery or tax whilst the largest variation and volatility occurs in the Import Parity Price components: Singapore diesel product price (known as gasoil in the Singapore oil market) which is priced in US dollars, and the currency conversion the AU$/US$ rate, and a much smaller component being the international sea freight. Whilst the latter cannot be managed, the Singapore gasoil price (diesel) and the AU$/US$ rate can be hedged in much the same way as wheat or sugar.

So how does a hedge on diesel work? Essentially we are hedging Singapore gasoil and the AU$/US$ rate which accounts for approximately 95% of the movement in Australia diesel prices. Unlike wheat or sugar Singapore gasoil is not traded on an exchange but there is a professional wholesale market for physical cargoes and financial contracts which used by oil companies, refiners, commodity traders and financial institutions. Westpac is able to access this market and provide clients with over the counter swaps that combine both the commodity and the currency components.

The settlement of these contracts is based on the industry wide publication ‘Platts’ which publishes daily price assessments for a multitude of crude and refined petroleum products, and the daily AU$/US$ fixing as with other financial contracts. Settlement is monthly but there is the opportunity to close out or restructure contracts as with agricultural hedges.

If we want to know how effective this type of hedge would be we can look at past history for an indication. The following chart shows the price movement of the monthly average Australian terminal gate price (Source: Australian Institute of Petroleum) against the Singapore gasoil price. We can see that the prices move in a similar fashion, and if we add in the fixed excise element of 38.14 cents per litre and GST we can see the two prices track each other very closely. The difference being the additional costs of overheads and profit margin charged by the oil companies.

Volatility of input prices can be managed.

Australia requires significant imports of diesel.

The price breakdown.

Commodity and currency can be hedged.

Hedging can be an effective strategy.

Tax Fuel tax + GST

Oil Co gross Margin

Oil company margin

Transport Local terminaling & handling

Intl. Freight Import parity price:

Singapore gas oil price in AUD terms + Sea freight Singapore – Australia

Market price}


5

Chart 1. Chart 2.


Diesel hedging

If we look at the movement in Singapore gasoil since 2009 we can see that the clear trend in price has been upwards as the global economy has recovered. This is no surprise as the price of gasoil is closely linked to the price of crude oil from which it is refined. With the improving economic outlook and favourable conditions in the Australian economy, the AU$ has also strengthened which has mitigated some of the upward price movement in oil. As the AU$ becomes stronger goods and commodities priced in US$ become relatively cheaper in AU$.

However the AU$ gasoil component of the Australian diesel price has still risen from a low of AU 45 cents/litre to over AU 80 cents/litre recently (equating to a TGP diesel price rise of approximately 103 cpl to 142 cpl inc. GST). The trend in oil prices is clear, and as we emerge from the subdued economic activity in the US and Europe over the coming year the question is how long a strong AU$ can limit these price increases. In addition supply disruptions due to political tensions in the Middle East and North Africa have the capacity to dramatically impact oil prices. With such compelling evidence it’s a wonder larger diesel users in the agricultural sector are not hedging this input cost.

Keith Jones Director, Commodities Carbon & EngergyWestpac Institutional Bank

Crude and gasoil prices closely linked.

Geo–political issues will influence prices.

Aust. Terminal Gate Prices vs Singapore Gasoil

0 20 40 60 80

100 120 140 160 180 200

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11

Monthly TGP Monthly PLATTS Sing Gasoil Price Monthly PLATTS Sing Gasoil Price+Excise & Taxes

AUD Cents/Litre Source: Reuters, Westpac Institutional Bank

Singapore Gasoil 0.5% (Diesel) Spot Price

25

35

45

55

65

75

85

1/1/09 1/7/09 1/1/10 1/7/10 1/1/11

Gasoil 0.5% US Cents/Litre

Gasoil 0.5% Au Cents/Litre

Source: Reuters, Westpac Institutional Bank

6


The Australian economy

The Australian economy ended 2010 on a mixed note, with domestic demand growth (on official estimates) surprising to the low side. Even so, arguably, the medium-term outlook remains positive. At a time of strong demand from our major trading partners, Australia’s terms of trade has continued to surprise positively, reaching fresh 60 year highs. Not surprisingly, the latest official survey of business investment plans confirms further strengthening of the mining boom. As for the very near-term, we anticipate a bumpy start to 2011 with the January floods causing significant disruptions, while the reconstruction effort will boost growth subsequently. The economy may well contract in Q1, but a sharp rebound is expected in the June quarter. Another consideration is the patchy domestic demand evident late in 2010, raising uncertainty about underlying momentum heading into 2011.

GDP growth, which was 2.7% in 2010, is forecast to average 2.8% in 2011, before accelerating to 4.0% in 2012 as business investment gathers momentum. The 2011 forecast has been edged down from 3.2%. Patchy domestic demand late in 2010 and an upside surprise on inventories now suggests inventories will be a headwind to growth over the first half of 2011.

We continue to forecast domestic demand growth of 4½% over the year ahead, accelerating from 2.7% through 2010. The sub-trend outcome of 2010 was a full 1.0ppt below the historic average. Consumer spending, housing construction and business investment were all sub-par. By contrast, the contribution from public demand was 0.8ppts above the norm. However, that reflected strength in the March quarter, when the Federal Government’s stimulus building package provided a major boost. In the final three quarters of 2010, public demand increased by only 1.0%, following the 5.0% Q1 surge. Public demand is likely to remain a headwind over the coming four quarters, as the stimulus continues to unwind.

The household sector is going through a period of structural change. Consumers, accounting for 54% of domestic demand, ended 2010 as they began it, spending frugally. Consumption increased just 0.4%qtr, 2.8%yr in Q4, influenced in part by the Reserve Bank’s November rate rise. While consumers did have the ability to spend more freely - wage income growth was above par through 2010 at 7.6% - they decided instead to repair their balance sheets. The household saving rate reportedly increased from 8.0% at the end of 2009 to 9.7% at the end of 2010. Accordingly, our forecast of consumer spending for the year ahead is unchanged at a sub-par 3.1%. This assumes some moderation in wage incomes growth but a stable savings rate.

Housing construction is forecast to expand by 4½% through 2011, twice the 2010 pace. All the upside is on renovations, which were broadly flat during 2010, as the reconstruction effort following the January floods provides a significant boost. New residential construction, by contrast, is likely to remain patchy with demand constrained by higher interest rates during 2010 and prospects of one further rate rise in 2011.

Business investment is set to be the major growth engine in 2011 and again in 2012. Our forecast is for an increase of around 14% over the year ahead, following a 1.2% decline during 2010. Near-term, risks are in both directions. The latest official survey of business investment plans implies, on a conservative interpretation, total CAPEX spending will jump by 12% in both the March and June quarters in 2011. We have greatly discounted this given the mixed forces surrounding the non-mining sectors of the economy. Instead we’re forecasting growth of 2.5% and 4.2% for the two quarters, which is still a material improvement from the previous six months. More generally and central to the view is the prospect that infrastructure spending will surge over the next couple of years as the mining sector responds to historically high commodity prices. We’re forecasting activity in this sector at the end of 2012 to be 75% higher than at the end of 2010.

Turning lastly to the export sector, the 2010 performance showed promise but the overall result was held back by disruptions from unfavourable weather. The January floods and the February cyclone will extend the disruptions into 2011. We’re forecasting export volumes to dip in the quarter and for net exports to slice 0.5ppts off Q1 GDP growth, thereby contributing to the risk of a negative quarter. More fundamentally, expanding capacity in the resources sector and strong global demand will drive an uptrend in exports – with forecast growth of 7% through 2011, up from 5% over the last year.

Andrew Hanlan, Senior Economist

Demand has been patchy of late ...

... and a Q1 contraction is likely.

Beyond Q1, momentum will build ...

... as the economy rebounds.

The key theme will be ...

... the interplay of the capex upswing ...

... and present consumer caution.


7

Chart 1. Chart 2.

Chart 3. Chart 4.

Chart 5. Chart 6.


The Australian economy

Terms of trade: fresh 60 year high

40

60

80

100

120

40

60

80

100

120

Dec-49 Dec-59 Dec-69 Dec-79 Dec-89 Dec-99 Dec-09

index index

Australia's terms of trade

Sources: ABS; Westpac Economics

+25% yr

66% above avg

Wool boom 1950/51

Australia: positive economic outlook

-3

0

3

6

9

-3

0

3

6

9

Dec-85 Dec-90 Dec-95 Dec-00 Dec-05 Dec-10

% ann % ann Domestic demand GDP


f'csts to

end '12

Household spending vs income

-2

0

2

4

6

8

10

12

14

-2

0

2

4

6

8

10

12

14

Dec-02 Dec-04 Dec-06 Dec-08 Dec-10

% ann % ann

Total income, post tax & interest Consumption Wage income

Sources: ABS, Westpac Economics All in nominal terms

CAPEX plans by industry

-20

0

20

40

60

80

-20

0

20

40

60

80

2007 2008 2009 2010 2011f 2012f

% chg, yr avg % chg, yr avg

Mining Manufacturing Services Total

History in real terms, Expectations in nominal


Financial years 5th est 1st est

MTP growth supportive of exports

-10

-5

0

5

10

15

20

-6

-3

0

3

6

9

12


% ann % ann Major trading partner growth (lhs) Exports * (rhs)


f'csts to

end '12 * smoothed

Australia: the domestic growth mix

-2

0

2

4

6

-2

0

2

4

6

consumer housing business public demand

ppts cont'

2009 2010 2011f 2012f

ppts cont'


contributions to yr end domestic demand growth

8


Australian interest rates

As expected the Reserve Bank Board decided to keep the cash rate unchanged at 4.75% in March. The key themes that have dominated previous communications from the Bank this year remained the same.

They are 1) Terms of trade at their highest level since the early 1950s giving a strong boost to national incomes. 2) Unusually strong employment growth although likely to slow in 2011. 3) A cautious household sector with regard to both spending and borrowing. 4) Asset values little changed and credit growth subdued. 5) Policy is mildly restrictive. 6) An upbeat assessment of growth in the global economy.

Some new observations in this statement were a more hawkish assessment of wages; “growth in wages has returned to rates seen prior to the downturn” (for the record private wage growth peaked at 4.4%yr in June 2008 compared to the current 3.8%) compared to “wages picked up somewhat last year” from the February statement. However, presumably based on the Bank’s liaison work, skill shortages are reported to be confined at this point to the resource sectors. It was also interesting that the recent monthly falls in house prices did not attract any attention with asset values being described as “have generally been little changed.”

Westpac has never been in the group that has been anticipating aggressive rate hikes from the RBA. We remain comfortable with our forecast that, on balance, it is likely that only one rate hike will be delivered in 2011 with the timing most likely being in the September quarter. The most fundamental factor here will be how the household sector responds to the long period of steady rates which we anticipate.

Since the Governor’s statement the data flow has been generally supportive of our view that rate hikes are unlikely in the near term. The February Jobs Report printed a loss of 10,000 jobs for a net loss of 2,200 jobs over the last three months. That compares with a gain of 134,000 jobs over the previous three months. Apparently job creation is slowing. And that should be no surprise given the miniscule 1% growth in domestic demand in the second half of 2010 which contrasts with annual jobs growth peaking at 3.7% in the year to November last year.

The March print on the Westpac Melbourne Institute Index of Consumer Sentiment showed Sentiment fell by 2.4% to register its lowest level since June last year in the aftermath of three consecutive rate hikes and controversy over the mining tax. Of most concern was the 6.9% fall in how households assess prospects for their finances. This fall was despite steady interest rates and probably highlights the impact rising utility costs are having on households. Other aspects of the survey point strongly to the fall in Confidence being based on concerns about fixed price for carbon. For January, housing finance approvals fell by 4.5% and building approvals fell 16% further questioning the recovery in housing construction which contracted in both the September and December quarters.

Earlier in the year our “one rate hike in 2011” looked particularly timid in the face of market pricing for 2 and most economists looking for up to 4 by early 2012. Markets have now adjusted to pricing in one rate hike by year end, making our September quarter call look a little hawkish. That may well be the case but we cannot ignore the stream of hawkish rhetoric emanating from the key decision makers in the Reserve Bank. Recently both Governor Stevens and Assistant Governor Lowe outlined the framework for their thinking which is to manage an economy with very limited spare capacity through a mining boom which has already driven the terms of trade to “by far the highest level in more than a century”. Assistant Governor Lowe even attributed Australia’s extraordinary 3.7% annual employment growth to mining (those sectors which service mining) and the income effect of the terms of trade (boosting jobs in household services). That assessment gives little weight, as we do, to a likely slowdown in employment as those employers focussed on servicing the cautious household sector revise their expansion plans.

In short, our views have been ahead of the market and most commentators on a likely benign rate profile in 2011. However we are reluctant to follow the market fully to the logical conclusion of no rate hikes at all in 2011 due to the clear revealed preference, at this stage, of the policy makers.

Bill Evans, Chief Economist

Rates are on hold ...

... for now ...

... as the key themes ...

... driving RBA thinking ...

... remain unchanged.

RBA rhetoric retains a hawkish tilt ...

... but a near term move ...

... while consumers remain cautious.


9

Chart 1. Chart 2.

Chart 3. Chart 4.

Chart 5. Chart 6.


Australian interest rates

-2

0

2

4

6

8

10

12

-2

0

2

4

6

8

10

12


% %

US 10 yr bond yield AU 10yr bond yield

Sources: Factset, Westpac Economics.

spread

Australia – US 10 yr spread

2

3

4

5

6

7

8

9

2

3

4

5

6

7

8

9

Aug-01 Aug-03 Aug-05 Aug-07 Aug-09

% %

Cash rate 3yr swap

Sources: RBA, Factset, Westpac Economics

weekly average

updated 10 Mar

RBA cash & 3yr swaps

CPI core inflation moderated in 2010

1

2

3

4

5

1

2

3

4

5


%yr %yr

Core inflation

Sources: ABS, RBA, Westpac Economics

Credit subdued

-16

-8

0

8

16

24

32

-16

-8

0

8

16

24

32

Jan-91 Jan-95 Jan-99 Jan-03 Jan-07 Jan-11

Total Housing Business

Sources: RBA, Westpac Economics

3 mth % chg, annl’sd 3 mth % chg, annl’sd

Jobs growth slows, unemployment holds at 5.0%

-6

-4

-2

0

2

4

6

2 3 4 5 6 7 8 9

10 11 12

Feb-90 Feb-95 Feb-00 Feb-05 Feb-10

Unemployment rate (lhs)

Employment (rhs)

Sources: ABS, Westpac Economics % ann %

Jobs growth moderates

Unemployment holds at 5.0% in Feb

Terms of trade: fresh 60 year high

40

60

80

100

120

40

60

80

100

120


index index

terms of trade, goods & services

Sources: ABS; Westpac Economics

+22% yr Dec

66% above avg

Wool boom 1950/51

10


Australian dollar

Over the last month the AUD has been relatively stable, trading in a 99¢ to $1.02 range. This is in line with our expectations and we see no reason to alter our forecasts in any major way. They envisage broad based strength in the Australian dollar through to around the final quarter of 2011 when AUD will begin a period of correction mainly driven by a reversal in commodity prices. That reversal will be relatively modest since other factors which have generally supported AUD will remain positive. Nevertheless, our research indicates that commodity prices are the dominant driver of the Australian dollar unless there is a major US event such as the advent of quantitative easing.

The dogged resilience of the Australian dollar to the relentless surge in the oil price (up 21% since late January) has been remarkable. Over the last month volatility in the US equity market has increased by 18% whereas 1 month volatility in the AUD has fallen by 11.5%. Recall that the Australian dollar has in the past been the currency of choice to “attack” at times of global unrest. Higher oil prices which are caused by supply shocks should be seen as a precursor for slower global growth and risk currencies – headed by the Australian dollar – should be sold. If prices are rising because of stronger demand, as we saw in 2008, then because Australia is seen to be a major exporter of energy the Australian dollar would be supported.

The resilience of the Australian dollar to this supply shock could be related to a new found “respectability” of the Australian dollar. Westpac expects that Australia’s current account deficit, which recently touched 6% of GDP but is now around 2%, can be sustained in the 2–3% range for some years to come. With incomes growing at a faster pace Australia will be able to lower its foreign debt to income ratio going forward.

Despite our expectation of some reversal in commodity prices in 2012, volumes will have picked up sufficiently to partly compensate for the lower prices. For example, volumes of iron ore exports are likely to double over the next 4 to 5 years. Overall, we expect growth in export volumes of around 8% pa over 2011 and 2012.

The current account deficit has shrunk because Australia has moved into trade surplus of around 2% of GDP. The cost of servicing the stock of foreign liabilities is around 4% of GDP. That is more than enough to push the current account into deficit despite the trade surplus. In a recent research report one of my colleagues calculated that only half of this cost of servicing foreign liabilities is interest payments while the other is imputed dividend payments to foreign direct investors.

Foreign investors and some economists angst over current account deficits because a deficit country is vulnerable to the servicing costs of the foreign liabilities. This can be particularly painful during a domestic downturn when the interest payments are denominated in a foreign currency. However, if the cost of servicing the liabilities is dependent on the state of the domestic economy (as would be the case if the liabilities are equities or direct investments) there is a built in automatic stabiliser. This is an advantage to deficit countries whose liabilities are in the form of equities or direct investment rather than foreign currency debt.

Another source of Australia’s “respectability” in global markets which is driven by the same forces which have led to such an improvement in the current account deficit is the easing in the funding challenges of the Australian banks. Although maturities are higher in 2011 and 2012 than in 2010 the flow of new borrowings should be substantially reduced. Banks are the dominant vehicle used to finance Australia’s foreign debt. Rising levels of foreign debt put pressure on the Australian banks. But with the household and corporate savings rates rising and credit growth down to around 2%, pressure on the banks’ demands for new funds have eased.

The Australian banks were also under the cloud of how Basel III might impact them. While capital requirements were covered, the concern was with liquidity requirements. Australia’s regulator (APRA) has indicated that the banks will be able to avail themselves of a liquidity standby facility which will be provided by the RBA for a market price over acceptable collateral. That arrangement will take pressure off the banks’ requirements to hold excessive portfolios of liquid assets, further easing funding pressures. The spectre of Australian banks lowering the frequency with which they tap the overseas capital markets is also an added source of “respectability” for the Australian dollar.

Bill Evans, Chief Economist

The AUD has been resilient ...

... to bad news out of the Middle East ...

... which may signal ...

... a new found respectability ...

... reflecting an improved CAD ...

... and an associated decline ...

... in local bank financing needs.

... are two major swing factors.


11

Chart 1. Chart 2.

Chart 3. Chart 4.

Chart 5. Chart 6.


Australian dollar

AUD/EUR & AUD/NZD

1.00

1.10

1.20

1.30

1.40

Jan-07 Dec-07 Dec-08 Nov-09 Nov-10 0.40

0.50

0.60

0.70

0.80 NZD EUR

AUD/EUR (rhs)

AUD/NZD (lhs)


AUD/USD & AUD/JPY

0.45

0.55

0.65

0.75

0.85

0.95

1.05

Jan-07 Dec-07 Dec-08 Nov-09 Nov-10 50

60

70

80

90

100

110 USD JPY

AUD/JPY (rhs)

AUD/USD (lhs)


The Australian dollar & 2yr swap spreads

-2

-1

0

1

2

3

4

5

6

0.40

0.50

0.60

0.70

0.80

0.90

1.00

1.10

Jan 90 Jan 93 Jan 96 Jan 99 Jan 02 Jan 05 Jan 08 Jan 11

%pa USD

AUD/USD (lhs)

AU-US 2yr swap spread (rhs)

Sources: Bloomberg, Westpac

Australian dollar & US equities: volatility

5

10

15

20

25

30

35

40

45

50

0 10 20 30 40 50 60 70 80 90

100

Jan-07 Jul-07 Feb-08 Aug-08 Mar-09 Sep-09 Apr-10 Nov-10

vol vol

US equity volatility (lhs)

AUD/USD volatility (rhs)

Source: Bloomberg, RBA, Westpac

The Australian dollar & the terms of trade

-30

-20

-10

0

10

20

30

40

-30

-20

-10

0

10

20

30

40

Mar-72 Mar-81 Mar-90 Mar-99 Mar-08

%yr %yr

Terms of trade AUD real effective Sources: OECD, RBA

The Australian dollar: USD trend is crucial

0.45

0.55

0.65

0.75

0.85

0.95

1.05

60

70

80

90

100

110

120

130

Jan-94 Jan-98 Jan-02 Jan-06 Jan-10

index USD

USD majors index (lhs)

AUD/USD (rhs)

Source: RBA

12


Beef and dairy

Beef: supply and production tightens.Heavy rain and flooding in the first half of the quarter and subsequent rain later in the quarter has caused volatility of supply into the markets. As conditions improved, the markets experienced a supply surge as farmers took advantage of the better conditions to transport stock. During this time buying demand has remained spirited. The Eastern Young Cattle Indicator (EYCI) continues to reflect strong demand and closed at 410¢/kg on 8th March, significantly above the 346.75¢/kg of the same period the previous year. Strong buyer interest has seen the EYCI average just over 395 ¢/kg for the quarter.

The export markets continue to be a mixed bag. Shipments to the US for the quarter continue to be under pressure and remain below levels seen in the previous year. On the positive side, the Korean market continues to be a popular destination for Australian beef. February exports to Korea reached almost 15,300 tonnes, the highest monthly shipment since December 2007. The floods in Queensland severely disrupted shipment volumes to Korea in January, as conditions improved, shipments have increased significantly. Another driver to increased beef exports was the continued issues with Foot & Mouth disease (FMD) in Korea. Estimates are that 150,000 head of cattle have been culled since November 2010 and this has helped to lift the demand for imported beef. Exports to Japan have also seen an improvement after a sluggish start to the quarter. Exports of chilled and frozen beef Japan reached 30,063 swt for February, to make a calendar year total of 46,805 swt.

The live export of cattle from Australia commenced the quarter at much lower levels. Total volumes for January stood at 36,822 head, which is 46% lower than the corresponding month in 2010 and the lowest monthly volume since the start of 2007. A significant factor would have been the heavy rain and flooding experienced in December and January which significantly disrupted the movement of cattle. The major destination for live cattle exports was once again Indonesia, accounting for 80.6% of volume. Japan and Turkey were the other major destinations accounting for 6.2% and 5.1% respectively.

Dairy: good demand pushes prices higher.The heavy rains and flooding in the early part of the quarter resulted in some negative influences on the industry. Production losses were evident across a number of the dairy regions on the east coast from Queensland through to Victoria. As the quarter has progressed, production volumes have returned to near to pre-flooding levels as conditions improved. Despite the difficulties, there continues to be good confidence within the sector, particularly from those supplying milk to the major processors for secondary manufacturing. Milk prices have continued to rise on the back of increased prices available from the international markets with the strong possibility of further increases to come.

The developing issue within the fresh milk market is the current price war currently fought by the supermarkets. At this stage, the retail outlet is absorbing any losses from the reduction in price to $1/litre for house branded milk. There are currently a number of claims and counter claims over this pricing issue and it is now before a Senate Enquiry to investigate and make any appropriate recommendations. With farm-gate milk prices for the drinking milk market under some significant pressures, the potential for further downside will in turn make production at some farms unsustainable.

In the international markets, the European dairy season continues to develop, trade activity is increasing, but the real action is still in the Oceania market place. Tight supplies are driving the market, as limited volumes of uncommitted products are available. Good demand from the Asian markets, particularly China is continuing. For the three months (Dec 10 – Feb 11 incl) prices from globalDairyTrade reflected the increased activity as a larger number of bidders were active at the auction. Prices have increased against a backdrop of good demand and tighter supplies.

The following weighted average prices (USD/MT/FAS) were recorded for the months of December, January and February:

Anhydrous milk fat (AMF): US5,360, US5,965 and US6,405 respectively. Whole milk powder (WMP): US3,585, US3,765 and US4,158 respectively. Skim milk powder (SMP): US3,094, US3,536 and US3,906 respectively.

Looking forward into the short to medium term, global dairy prices appear to have continued good support through positive demand and tighter supplies.

Mixed weather but market remains strong.

Major export markets remain bouyant.

Heavy rains affect live cattle exports.

Heavy rains affect production but industry repsonds.

The supermarket price war continues.

International buyers remain active.


13

Chart 1. Chart 2.

Chart 3. Chart 4.

Chart 5. Chart 6.


Beef and dairy

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

50

75

100

125

150

175

200

225

Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09

Index, AUD AUD/kg

Export prices *

Eastern Young Cattle Indicator (rhs)

Sources: Bloomberg, MLA, Factset, Westpac Economics

* average

Beef prices

0

40

80

120

160

200

0

40

80

120

160

200


index index

AUD index USD index

Sources: MLA, Westpac Economics

Average beef export prices index

500

1500

2500

3500

4500

5500

6500

500

1500

2500

3500

4500

5500

6500

Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09

US$/t US$/t

skim milk powder butter

whole milk powder cheese

Sources: USDA, Westpac Economics

Global dairy prices

200

250

300

350

400

450

8/01/2007 8/01/2008 8/01/2009 8/01/2010 8/01/2011

4 year average

Source: MLA, Westpac Economics

AUD¢/kg/cwt

Eastern young cattle indicator

1000

2000

3000

4000

5000

6000

1000

2000

3000

4000

5000

6000

Mar-05 Mar-06 Mar-07 Feb-08 Feb-09 Mar-10

USD/t USD/t

Oceania

Western Europe

Sources: USDA-FAS, Westpac Economics

Global powdered skim milk prices

50

100

150

200

250

50

100

150

200

250

Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09

1997/98 = 100

dairy index USD (lhs)

dairy index AUD (rhs)

Sources: USDA-FAS, Westpac Economics

1997/98 = 100

Dairy prices remain volatile

14


Grains and oilseeds

Wheat: a mixing pot of issues drives volatility.The first quarter of the year has witnessed the continued volatility within the wheat markets. There are now a number of major factors that are influencing the price in addition to the fundamental issue of supply and demand.

The recent weeks have seen the emergence of geo-political influences. The unrest seen in the North Africa region and Middle East combined with continued increases in food prices has resulted in the hoarding of grains. Despite global wheat stocks-to-use ratios being adequate at the current time, there is still the push for increased acres to be planted. The battle for acres in the US is adding some uncertainty to the market. With the pricing for other commodities such as corn, soybeans and cotton all looking highly attractive and with a limited number of acres available for use, there will be some tough planting decisions ahead.

Weather conditions in some of the major wheat growing regions are also causing some concern. Winter conditions have been mixed, with some regions experiencing very cold and dry conditions. The lack of a protective winter snow cover has exposed the dormant plants to destructive conditions. Conversely, there are regions which have experienced excessive snow cover; this will result in wetter conditions during the spring thaw. Add to this mix the drought conditions in parts of Eastern Europe and the Black Sea and China, then it easy to see how such variation is driving market caution and volatility. The next 4 to 6 weeks will give a clearer indication on winter kill rates and spring thaw conditions and as such will either ease or intensify market concerns regarding production potential in the short term.

On the domestic scene, the wet weather that preceded harvest and continued throughout that period resulted in many farmers experiencing a long, difficult and frustrating end to their year. While the overall yields were well up on previous years, the quality for many grades was affected, resulting in a significant number of downgrades for harvested grains. Despite a significant increase in volumes of low grade and feed grade wheat, the expected large falls in value have not been generally seen. The export demand has remained buoyant and this has supported prices. Fed1 wheat in many instances is still above AUD$200/t delivered port and H2 and APW1 above AUD$300/t delivered port. Out of Western Australia, H1 is still commanding prices closer to AUD$400/t delivered port.

Coarse grains & Oilseeds: will high prices ration demand?Corn and Soybean prices remain very well supported as low ending stocks have the market a little nervous. Corn prices have risen dramatically on the back of strong demand. This increase in price is starting to bite into the profitability of many of those industries using corn as a major component of their animal feed rations. With prices increasing against the back drop of tighter supplies, substitution and rationing of demand is expected to be seen.

Increased demand is also being seen from the ethanol producers, as ethanol production and demand continues to rise. Additional demand is also being seen for the production of corn based starches and sweeteners adding to further tightening of supplies.

With global consumption of vegetable oil increasing and with tighter supplies of soybeans in the US, the major focus has switched to the upcoming South American harvest. The South American crop is expected to deliver an increase in production from the previous year, however, untimely rain has arrived and there are potential issues with crop damage and a delayed start to harvest. China remains a very active buyer and this demand is helping prices stay firm.

Canola crops across much of NSW, VIC and SA experienced ideal growing conditions but the arrival of extreme weather conditions badly affected the final harvest. One positive was that while yields were reduced oil content was above expectation.

Global canola prices remain very well supported. Global supplies remain tighter than previous years and this is being reflected in prices seen for local crop exports. Conditions in Canada, the major producer of canola have not been ideal and the prospect of a wet spring affecting plantings could translate into further price gains. Severe weather conditions hitting the production of palm oil in Malaysia and delivery to market has also given the oilseed complex a boost.

A number of forces gather in the markets.

Extreme winter weather may reduce crops.

Quality affected but yields are up.

Tight stocks drive prices.

Ethanol production still strong.

Oilseed demand remains strong.

Australian crops show the good oil.

Bad weather affects supplies of palm oil.


15

Chart 1. Chart 2.

Chart 3. Chart 4.

Chart 5. Chart 6.


Grains and oilseeds

$/tonne

100

150

200

250

300

350

4/01/10 4/04/10 4/07/10 4/10/10 4/01/11

CBOT wheat futures – USD/tonne CBOT wheat futures – AUD/tonne

Source: Westpac Economics, Reuters

Wheat prices – surge then consolidation

0 5

10 15 20 25 30 35 40 45 50

1997-98 1999-00 2001-02 2003-04 2005-06 2007-08 2009-10 2011-12(f)

Source: ABARES, Westpac Economics

Million Tonnes

Australia – winter crop production

10

15

20

25

30

35

40

200

400

600

800

1000

1983-84 1988-89 1993-94 1998-99 2003-04 2008-09

% US¢/bu

stocks to use (rhs)

price (lhs)

Sources: ABARE, Westpac Economics

Wheat supply & price to consolidate

50

100

150

200

250

300

350

400

450

50

100

150

200

250

300

350

400

450

Jan-89 Jan-94 Jan-99 Jan-04 Jan-09

US$/t AU$/t

CBOT wheat futures, US$ (lhs)

CBOT wheat futures, AU$ (rhs)

Sources: Factset, Bloomberg Westpac Economics,

Wheat prices

0

1

2

3

4

5

6

7

8

70

110

150

190

230

270

Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10

US$/t US$/bl

barley (lhs) corn (rhs)

Sources: Factset, Westpac Economics

World corn and barley prices

300

500

700

900

1100

1300

1500

1700

150

250

350

450

550

650

750

850

Feb-74 Feb-79 Feb-84 Feb-89 Feb-94 Feb-99 Feb-04 Feb-09

CAD$/t USc/bu

canola (lhs) soybean (rhs)


World canola & soybean prices

16


Sugar and cotton

Sugar: production down, price up.Australian sugar production has suffered badly over the last quarter. The arrival of Cyclone Yasi and its subsequent destructive effects across the cane producing regions will have a significant effect on sugar production in 2011. Damage to sugar cane crops has been extensive, with some fields destroyed and others suffering wind damage. While there is some time for cane fields to partially re-establish and re-grow, cane quality and sugar content will be affected. The full extent of volume and quality issues will not be known until harvest commences from around late June. Initial estimates place the losses in volume terms to be around 900,000 tonnes. If these losses are realised, it will result in the lowest Australian crop in the last 20 years.

Prices in the international market continue to remain volatile with both fundamental and technical issues driving the price. Over the last 3 months (Dec 1 – Mar 1) sugar prices have fluctuated 24.5%. A low on Dec 1, 2010 of USc28.37/lb was matched with a high of USc35.31/lb on Feb 2, 2011.

While initial estimates point towards a modest global surplus, there are concerns that even moderately unfavourable weather conditions in one of the major sugar producing nations will see this potential surplus greatly reduced. Eyes remain firmly fixed on the Brazil harvest due to commence shortly.

With the economic and political volatility in the Middle East, this has seen an increase in the price of crude oil. As the price increases, the competitiveness of ethanol production also increases. For major sugar producers such as Brazil, who have well developed ethanol production industries, crude oil price volatility will provide some interesting scenarios. The most attractive commodity price will determine which industry gets the greater share and consumption of cane production.

Cotton: prices continue to climb.Australian production for the 2011 cotton harvest is expected to be close to record volumes. The huge increases seen in planted area is due to the improved weather conditions and the availability of water for irrigation. The improved soil moisture profiles and improved on-farm water storage levels encouraged not only an increase in irrigated cotton but also a large increase in dry-land cotton plantings. Such has been the bullish nature for cotton in the 2010/11 growing season; new cotton plantings have even been recorded in southern NSW.

The recent flooding in southern Queensland and northern NSW has affected a number of cotton growing areas and this has lead to some loss of production volume. With the season progressing and harvest due to commence in the very near future, all eyes remain firmly fixed on the potential weather conditions. Dry conditions have affected some dry-land cotton plantings, again with the potential to reduce yield expectations; however, overall confidence is high for a near record breaking season.

Over the past quarter, the cotton price has generally displayed one direction and that is up. While some volatility has been seen, these corrections in price have only served to allow cotton to take a breather before pushing higher. Since Dec1, 2010 where cotton closed at USc131.95/lb it has subsequently charged through the USc200/lb with a high of USc215.15/lb seen on Mar 04, 2011.

While the continued strength in the AUD against a weak USD remains, the very bullish prices seen in the international market have assisted in offsetting a portion of the currency losses.

There are a number of factors driving the price up. The tight global supplies, increased demand and a reduced stock to use ratio have all contributed. Speculative buying has also added fuel to the fire. The potential size of the US cotton plantings will give the market some indication for future direction. Initial estimates (planting intentions) are that around 12.5 million acres will be planted to cotton; however, this is expected to change as the planting window opens. The cotton price at the time of planting will be an influencing factor on the final areas placed to cotton. The battle for acres in the US is heating up. With limited land available and with the major competing commodity crops such as corn and soybeans offering good returns, this will have give farmers other cropping options. The situation should start to become clearer in around 4 to 6 weeks as weather conditions improve and definitive planting decisions are made.

Bad weather affects cane production.

Prices remain volatile.

Tightness of supply looks to ease.

Turmoil in North Africa affects oil prices.

Cotton production close to record levels.

Flooding has some negative effects.

Record high prices.

Global supplies of cotton remain tight.


17

Chart 1. Chart 2.

Chart 3. Chart 4.

Chart 5. Chart 6.


0

30

60

90

120

150

180

0

30

60

90

120

150

180

1974 1979 1984 1989 1994 1999 2004 2009

Mt Mt

stocks production consumption


ABARE est. & f'cst

Global sugar market tightens

0

30

60

90

120

150

0

20

40

60

80

Aug-83 Aug-89 Aug-95 Aug-01 Aug-07

US$/bl US¢/lb

spot sugar (lhs) spot crude oil (rhs)


Sugar prices improve

Sugar and cotton

5

15

25

35

45

55

65

30

40

50

60

70

80

90

100

110

1980-81 1985-86 1990-91 1995-96 2000-01 2005-06 2010-11

% US¢/lb stocks to consumption ratio (rhs) Ave cotton price (lhs) Forecast (lhs)

Sources: ABARE, Westpac Economics.

Cotton prices: rebound strongly

0 20 40 60 80 100 120 140 160 180 200

0 20 40 60 80

100 120 140 160 180 200


AU¢/lb US¢/lb

US¢ (lhs) AU¢ (rhs)

Sources: Bloomberg, Westpac Economics

AU¢ period avg

Cotton prices spike Australian cotton production to surge

200

400

600

800

1 000

1 200

2005-06 2006-07 2007-08 2008-09 2009-10 2010-11(f)

2011-12(f)

Source: Westpac Economics, ABARE

‘000’ Tonnes

10

20

30

40

50

60

70

80

90

0

5

10

15

20

25

30

35

1972-73 1980-81 1988-89 1996-97 2004-05

Mt Us¢/lb

closing stocks (rhs) world price (lhs) Est, f'csts

Sources: ABARE, Westpac Economics, ISO

World sugar prices & stocks

18


Sheep and wool

Sheep & wool: tight supplies drive prices higher.The market for both sheep and wool continues to be very well supported. The continued tightness of supply and the inability to introduce additional supplies due to production timeframes is ensuring that current demand is underpinning prices. The re-stocking of the flock will take time; however, the current price levels for ewes and lambs are ensuring that a wholesale increase in flock numbers is prohibitive at this time. The balancing act for farmers continues. With record wool prices across many of the grades and robust demand and price for lamb, cash-flow still remains a major necessity for the farm. Neither commodity can continue to rise in price at the levels seen over the past two quarters, at some point price will begin to ration demand as alternatives are sought. However, if sustainable levels are realised, this will provide the longer term incentive that the industry is looking for sustained rebuilding of the flock.

The export of live sheep commenced in 2011 at a much reduced level than seen at the corresponding time the previous year. January shipments were around 76% lower when compared with January 2010. The tough conditions and tight supplies of sheep out of WA resulted in Victoria supplying close to 70% of the shipments to date. Continued tight supplies and higher prices in the physical markets within Australia, together with strong demand from overseas markets will leave exporters scratching their heads as to how export orders will be filled.

On the wool front, robust demand has seen wool prices continue to rise to record levels. The Eastern Market Indicator (EMI) does not appear to be affected by the strength in the Australian dollar as demand pushed the price through 1300 ¢/kg; significantly well above any corresponding period over the last 8 years.

As supplies remain tight, demand from China continues to keep prices well supported. In addition, export supplies of wool from South Africa have been suspended on the back of an outbreak of foot and mouth disease. While only small volumes, South Africa competes against Australia, particularly in the fine wool market.

Lamb & mutton: confidence drives prices higher.The first quarter of 2011 has witnessed a continuation of the confidence in the lamb and mutton markets. Prices have continued to rise as farmers have increased options available to them. With the continued rain, pastures have been able to maintain condition and as a result have been able to support stock. Farmers have therefore not had to choose between watching stock lose weight or take lower prices which has been the case in previous years. With the continued better conditions, the market has not seen the early sell off of lambs, farmers have been able to hold stock and turn off heavier and better conditioned lambs. The protracted grain harvest has also had some minor effects, with producers of mixed operations focusing on grains as opposed to exiting their lambs.

This quarter has seen the prices gather some considerable momentum, breaking through the 650¢/kg (cwt) level. The condition and weight of lambs remains solid and is reflected in the prices being offered. Lamb sales have fluctuated in volume across the quarter, with February seeing historically low turn off numbers across the eastern states. For the processing sector, January and February have been difficult months as slaughter numbers are well below the 5 year monthly averages.

The tight supplies have seen processors starting to struggle to source sufficient stock to fill their kill spaces. As the prices in the physical markets have continued to increase, processors have had to look elsewhere. This has resulted in an increase in the ‘over the hooks’ price paid by processors to compete with the increases in other markets. Eastern States Trade Lamb Indicator (ESTLI) remains outstanding at 650¢/kg (cwt) as at 08 Mar 2011.

In the international markets exports of lamb continue to improve. With international demand still strong and with the emergence of a decreased lamb supply out of New Zealand, Australian lamb has taken its chances. Despite the high cost of lambs and a very strong Australian dollar, exports of lamb have lifted in volume to all the major export destinations. The important US, Middle East and China markets all showed good export growth for February of 7%, 19% and 8% yoy respectively. A major highlight was a 12% yoy increase in exports to the European market. The EU is the largest export market for NZ lamb; however, with the tighter supplies from NZ, this should present some great opportunities for Australian exports to fill the void.

Flock still low but looks to the future.

Tight supplies slow export volumes.

Wool prices remain strong.

Disease pressures affect competition.

Good conditions improve stock quality.

Prices remain robust with strong demand.

Tight supplies remain.

Australian lamb fills export demand.


19

Chart 1. Chart 2.

Chart 3. Chart 4.

Chart 5. Chart 6.


Sheep and wool

0

25

50

75

100

125

150

175

200

0

25

50

75

100

125

150

175

200

1986 1991 1996 2001 2006 2011

mn Sources: ABARE, Westpac Economics

mn

forecast

Australia’s flock gradually rebuilds

0

1

2

3

4

5

6

7

8

0

50

100

150

200

250

300

350

400

450

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

AUD value (LHS) Number of head (RHS)

AUD Millions Million head

Live sheep exports – value remain robust

0 0.5

1 1.5

2 2.5

3 3.5

4 4.5

5

2000 2001 2002 2003 2004 2005 206 2007 2008 2009 2010

W.A Victoria S.A

Million head

Sources: Livecorp, Westpac Economics

Live sheep exports – WA leads the way

0

100

200

300

400

500

600

700


Lamb market price

Sources: ABS, MLA, Westpac Economics

Lamb prices elevated

0

200

400

600

800

1000

400

600

800

1000

1200

1400

1600

1980 1985 1990 1995 2000 2005 2010

kt A¢/kg

stocks (rhs)

eastern market indicator (lhs)


ABARE forecasts

Wool stocks remain supportive of prices

0

200

400

600

800

1000

1200

1400

1600

1800

0

200

400

600

800

1000

1200

1400

1600

1800


A¢/kg A¢/kg

A¢/kg avg price

Sources: Bloomberg, Westpac Economics

Wool prices above trend

20



Financial forecasts – Australia

Interest rate forecasts

Latest (11 Mar) Jun 11 Sep 11 Dec 11 Mar 12 Jun 12

Cash 4.75 4.75 5.00 5.00 5.00 5.25

Market implied* na 4.78 4.86 4.94 5.00 5.02

90 Day Bill 5.00 5.00 5.25 5.25 5.25 5.30

3 Year Swap 5.44 5.45 5.60 5.70 5.70 5.80

3 Year Bond 5.06 5.10 5.20 5.30 5.30 5.45

10 Year Bond 5.48 5.50 5.20 5.40 5.50 5.60

10 Year Spread to US (bps) 209 175 210 220 210 180* Market implied rate is the anticipated target rate in the OIS market. Sources: Bloomberg, Westpac Strategy.

Currency forecasts

Latest (11 Mar) Jun 11 Sep 11 Dec 11 Mar 12 Jun 12

AUD vs

AUD index* 100 97.5 98.6 96.8 93.6 91.2

USD 1.0019 1.02 1.04 1.01 0.97 0.94

USD forward^ na 1.00 1.01 0.98 0.97 0.95

JPY 83.09 85 86 90 88 87

EUR 0.7259 0.74 0.74 0.74 0.72 0.71

NZD 1.3628 1.34 1.33 1.31 1.29 1.27

CAD 0.9763 0.99 0.97 0.96 0.96 0.95

GBP 0.6233 0.62 0.62 0.61 0.58 0.55

CHF 0.9337 0.97 0.97 0.96 0.97 0.99

DKK 5.4134 5.53 5.53 5.51 5.38 5.28

SEK 6.4110 6.68 6.61 6.54 6.35 6.23

NOK 5.6623 5.79 5.76 5.91 5.66 5.52

ZAR 7.3083 6.96 6.95 6.97 7.00 7.02

SGD 1.2752 1.26 1.28 1.23 1.17 1.13

HKD 7.8046 7.93 8.07 7.83 7.52 7.29

PHP 43.60 44.06 44.62 43.03 41.16 39.74

THB 30.45 29.41 29.74 28.40 27.08 26.05

MYR 3.0433 3.06 3.10 3.00 2.85 2.75

CNY 6.5860 6.62 6.72 6.46 6.17 5.95

IDR 8800 8894 8986 8676 8296 8004

TWD 29.54 29.50 29.91 28.31 27.47 26.50

KRW 1127 1108 1119 1067 1017 978

INR 46.33 45.02 45.52 43.46 41.44 39.87

*Nominal trade weighted index, with latest data compiling the base. Weights from Reserve Bank of Australia. A reading above (below) 100 indicates a rise (fall) in the AUD. ^Approximate mar-ket forward price for AUD/USD, not a forecast. Sources: Bloomberg, Westpac Economics.


21


Economic forecasts – Australia

Activity*

2010 2011 Calendar years

% change Q2 Q3 Q4 Q1f Q2f Q3f Q4f 2009 2010 2011f 2012f

Private consumption 1.3 0.8 0.4 0.7 0.9 0.7 0.8 1.0 2.7 3.0 3.0

Dwelling investment 4.3 –0.4 –0.4 0.0 0.8 2.1 1.6 –4.2 4.8 2.7 1.5

Business investment* –0.6 1.8 0.5 2.5 4.2 3.4 3.6 –5.2 –1.0 10.0 14.0

Private demand * 1.1 0.8 0.2 1.0 1.6 1.4 1.4 –0.7 2.0 4.1 5.2

Public demand * 0.2 0.1 0.7 0.5 0.6 0.2 0.3 1.9 9.3 1.7 2.4

Final demand 0.9 0.6 0.3 0.9 1.4 1.1 1.1 –0.1 3.6 3.5 4.5

Stock contribution –0.5 –0.3 0.8 –0.6 0.3 0.1 0.0 –0.5 0.4 0.0 0.0

GNE 0.4 0.2 1.1 0.3 1.7 1.2 1.1 –0.7 4.1 3.5 4.5

Exports 5.7 –2.3 3.0 –0.5 3.0 2.4 2.0 2.8 5.3 6.0 8.5

Imports 3.8 0.0 3.0 1.5 2.8 2.6 2.8 –9.0 13.2 9.0 10.5

Net exports contribution 0.4 –0.5 0.0 –0.5 0.0 –0.1 –0.2 2.8 –1.6 –0.7 –0.5

GDP (1) 1.2 0.1 0.7 –0.2 1.7 1.1 0.9 1.3 2.7 2.8 4.0

annual chg 3.2 2.7 2.7 1.9 2.4 3.4 3.5 – – – –

Other macroeconomic variables

2010 2011 Calendar years

% change Q2 Q3 Q4 Q1f Q2f Q3f Q4f 2009 2010 2011f 2012f

Employment (1) 0.7 0.9 1.0 0.2 0.2 0.5 0.8 0.7 2.7 2.2 2.6

annual chg 2.4 3.1 3.5 2.8 2.3 2.0 1.8 – – – –

Unemployment rate % (1) 5.2 5.2 5.2 5.1 5.1 5.0 4.8 5.6 5.2 5.0 4.5

Wages (WPI) (sa) (2) 0.8 1.1 1.0 1.0 0.9 0.9 1.1 – – – –

annual chg 3.0 3.5 3.9 3.9 4.0 3.9 4.0 3.6 3.3 4.0 4.2

CPI Headline (2) 0.6 0.7 0.4 1.3 0.6 0.2 0.6 – – – –

annual chg 3.1 2.8 2.7 3.1 3.0 2.5 2.7 2.1 2.7 2.7 2.6

CPI average RBA core 0.5 0.5 0.4 0.4 0.6 0.6 0.7 – – – –

annual chg 2.7 2.4 2.2 1.8 1.9 2.0 2.3 3.3 2.2 2.3 3.0

Current account AUDbn –4.4 –6.5 –7.3 –7.0 –4.5 –6.5 –10.0 –52.9 –34.5 –28.0 –45.0

% of GDP –1.3 –1.9 –2.1 –2.1 –1.3 –1.8 –2.7 –4.2 –2.6 –2.0 –3.0

Terms of trade annual chg (1) 19.9 25.2 22.2 18.5 11.2 6.0 0.7 –10.0 16.2 8.8 –3.5Calendar year changes are (1) period average for GDP, employment and unemployment, terms of trade (2) through the year for inflation and wages. * GDP & component forecasts are reviewed following the release of quarterly national accounts.** Business investment and government spending adjusted to exclude the effect of private sector purchases of public sector assets.

Macroeconomic variables – recent history

2010 2011

Monthly data May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar

Employment ’000 16.7 40.4 29.1 30.3 47.4 32.4 54.2 0.1 7.7 –10.1 –

Unemployment rate % 5.2 5.1 5.3 5.1 5.2 5.4 5.2 4.9 5.0 5.0 –

Westpac-MI Consumer Sentiment 108.0 101.9 113.1 119.2 113.2 117.0 110.7 111.0 104.6 106.6 104.1

Retail Trade %mth 0.3 0.3 0.7 0.3 0.1 –0.8 0.3 0.2 0.4 – –

Dwelling approvals %mth –6.1 –1.4 –0.5 3.0 –9.1 7.6 –4.5 10.0 –15.9 – –

Private sector Credit %ann 3.0 3.1 3.2 3.1 3.2 3.3 3.6 3.4 3.3 – –

Trade balance AUDbn 1.80 3.47 1.37 2.57 2.05 2.62 2.01 2.02 1.88 – –

22



Forecasts – commodity prices

latest***latest*** Jun-11Jun-11 Sep-11Sep-11 Dec-11Dec-11 Mar-12Mar-12 Jun-12Jun-12 Sep-12Sep-12 Dec-12Dec-12all commodities index# 348 398 360 336 331 346 355 362

bulk commodities index# 494 642 582 547 525 551 556 541

iron ore (USD/t)* 133 164 152 143 137 142 142 135

coal (USD/t)* 132 180 161 151 145 153 156 155

WCFI**# 329 398 360 336 331 346 355 362

crude oil (USD/bbl) NYMEX 105 100 95 87 90 95 100 115

gold (USD/oz) 1,425 1,430 1,250 1,145 1,184 1,224 1,262 1,376

base metals index# 251 278 244 229 240 257 273 273

copper (USD/t) 9,326 10,500 9,100 8,400 8,800 9,474 10,163 9,700

aluminium (USD/t) 2,562 2,700 2,552 2,304 2,396 2,549 2,703 2,967

nickel (USD/t) 26,497 30,000 26,000 25,000 26,130 28,033 29,866 30,400

zinc (USD/t) 2,309 2,550 2,200 2,100 2,195 2,300 2,433 2,300

lead (USD/t) 2,516 2,700 2,220 2,200 2,315 2,510 2,656 2,523

rural commodities index# 177 156 140 127 122 121 126 140

wool AU¢/kg 1,218 1,125 1,140 980 980 980 1,053 1,171

wheat US¢/bu 765 700 650 620 620 620 644 717

sugar US¢/lb 28 20 13 15 16 16 17 19

cotton US¢/lb 196 160 120 100 75 75 78 87

levels % change

annual 2009 2010e 2011f 2012f 2009 2010e 2011f 2012f

all commodities index# 225 299 363 348 -21 33 21 -4

bulk commodities index# 334 452 575 543 -20 35 27 -6

iron ore (USD/t)* 65 112 149 139 -19 72 33 -7

coal (USD/t)* 114 130 160 152 -20 14 23 -5

ave coking price (USD/t) 149 171 206 176 -22 15 21 -15

ave thermal price (USD/t) 83 86 103 105 -9 3 20 2

iron ore lump contracts (US¢ dltu) 112 231 265 252 -44 106 15 -5

iron ore fines contracts (US¢ dltu) 97 202 220 207 -33 108 9 -6

coal coking contracts (US$/t) 129 209 223 218 -58 62 7 -2

coal thermal contracts (US$/t) 70 98 100 100 -44 40 2 0

WCFI**# 201 260 303 297 -24 29 17 -2

crude oil (USD/bbl) NYMEX 63 80 95 100 -37 27 18 6

gold (USD/oz) 974 1,227 1,306 1,262 11 26 6 -3

base metals index# 154 213 252 261 -27 38 19 3

copper (USD/t) 5,171 7,564 9,425 9,534 -25 46 25 1

aluminium (USD/t) 1,687 2,190 2,514 2,654 -35 30 15 6

nickel (USD/t) 14,690 21,871 27,125 28,607 -31 49 24 5

zinc (USD/t) 1,673 2,178 2,313 2,307 -12 30 6 0

lead (USD/t) 1,726 2,164 2,405 2,501 -18 25 11 4

rural commodities index# 103 125 149 127 -20 21 19 -15

# Chain weighted index: weights are Australian export shares. * Average Australian export prices fob – Source ABS 5432.0 Merchandise Trade Exports. ** WCFI – Westpac commodities futures index. *** Weekly averages except for bulks. Sources for all tables: Westpac Economics, Bloomberg, ABS.

Commodity futures contracts

Future contracts latest*** 3rd 6th 9th 12th 18th 24th

crude oil (USD/bbl) NYMEX 105 106 106 106 106 104 103

gold (USD/oz) COMEX 1,425 1,432 1,436 1,444 1,468 na na

aluminium (USD/t) LME 2,562 2,589 2,614 2,635 2,652 2,683 2,711

copper (USD/t) LME 9,326 9,745 9,758 9,759 9,743 9,661 9,524

nickel (USD/t) LME 26,497 28,115 28,059 27,837 27,528 26,902 26,316

zinc (USD/t) LME 2,309 2,440 2,460 2,474 2,482 2,495 2,497

lead (USD/t) LME 2,516 2,601 2,588 2,569 2,555 2,536 2,512


23


Summary of world output

Economic growth forecasts#

Real GDP %ann 2006 2007 2008 2009 2010e 2011f 2012f

World 5.2 5.3 2.8 –0.6 4.9 4.3 4.2

United States 2.7 1.9 0.0 –2.6 2.8 2.5 2.1

Japan 2.2 2.2 –1.5 –6.6 4.3 1.8 2.3

Euro zone 3.2 2.8 0.3 –4.0 1.7 1.4 1.4

Group of 3 2.8 2.3 –0.1 –3.7 2.6 2.0 1.9

United Kingdom 2.8 2.7 –0.1 –4.9 1.3 1.0 1.5

Canada 2.8 2.2 0.5 –2.5 2.9 3.0 3.0

Australia 2.5 4.6 2.6 1.3 2.7 2.8 4.0

New Zealand 1.0 2.8 –0.2 –1.7 1.4 1.5 5.1

OECD total 2.7 2.5 0.1 –3.4 2.4 2.0 2.1

China 12.7 14.2 9.6 9.1 10.3 9.2 8.2

Korea 5.2 5.1 2.3 0.2 6.1 4.0 4.9

Taiwan 5.4 6.0 0.7 –1.9 10.8 4.1 4.0

Hong Kong 7.0 6.4 2.2 –2.8 6.8 4.9 4.5

Singapore 8.6 8.5 1.8 –1.3 14.5 3.1 4.7

Indonesia 5.5 6.3 6.0 4.5 6.1 6.4 5.3

Thailand 5.1 4.9 2.5 –2.2 7.8 5.2 3.5

Malaysia 5.8 6.5 4.7 –1.7 7.2 4.9 3.5

Philippines 5.3 7.1 3.7 1.1 7.3 5.6 3.9

Vietnam 8.2 8.5 6.3 5.3 6.5 7.4 8.2

East Asia 9.8 10.9 7.1 5.9 9.3 7.7 7.0

East Asia ex China 5.7 6.1 3.2 0.4 7.6 4.9 4.7

NIEs* 5.8 5.8 1.8 –0.9 8.3 4.0 4.6

India 9.7 9.9 6.4 5.7 8.6 8.7 9.4

Russia 8.2 8.5 5.2 –7.9 3.7 5.5 4.4

Brazil 4.0 6.1 5.1 –0.2 7.5 4.5 4.1

South Africa 5.6 5.5 3.7 –1.8 2.8 3.4 3.8

Mexico 4.9 3.3 1.5 –6.5 5.2 4.2 4.8

Argentina 8.5 8.7 6.8 0.9 7.5 4.0 3.0

Chile 4.6 4.6 3.7 –1.5 5.0 6.0 4.6

CIS^ 8.8 9.0 5.3 –6.5 4.2 4.7 4.6

Middle East 5.8 6.0 5.0 2.0 3.9 4.6 4.7

C & E Europe 6.5 5.5 3.0 –3.6 4.2 3.6 4.0

Africa 6.4 7.0 5.5 2.6 5.0 5.5 5.8

Emerging ex–East Asia 6.8 7.0 4.8 –0.7 5.6 5.4 5.5

Other countries 7.0 7.6 5.4 3.6 4.7 4.5 4.4

World 5.2 5.3 2.8 –0.6 4.9 4.3 4.2

#Regional and global groupings are weighted using PPP exchange rates updated to reflect ICP 2005 benchmark revisions. Adding ½ppt to the global headline approximates growth under the prior weighting system * “NIEs” signifies “Newly Industrialised Economies” as defined by the IMF, viz; Republic of Korea, Hong Kong SAR, Taiwan Province of China, and Singapore. ^ CIS is the Commonwealth of Independent States, including Mongolia. Sources: IMF, Westpac Economics.

24

Notes

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Notes

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Notes

Corporate directory

Publication enquiries, Neil Burgess, Senior Commodity Analyst, Agribusiness Telephone: (61 2) 8253 7912

SydneyLevel 2, 275 Kent StreetSydney NSW 2000Telephone (61-2) 8254 8372Facsimile (61-2) 8254 6934

Bill EvansChief Economist

Andrew HanlanSenior Economist

Matthew HassanSenior Economist

Huw McKaySenior International Economist

Justin SmirkSenior Economist

Anthony ThompsonSenior Economist

Elliot ClarkeEconomist

SydneyLevel 29, Westpac Place275 Kent Street Sydney NSW 2000 Telephone (61-2) 9220 1083Facsimile (61-2) 8253 0955

Graham JenningsChief Executive, Commercial and Agribusiness, Regional BankingTelephone (61-2) 8254 1083

Rick AylettState General Manager, Commercial and Agribusiness, Regional Banking VICTelephone (61) 427 249 059

Rodney KellyState General Manager, Commercial and Agribusiness, Regional Banking QLDTelephone (61-7) 4688 6063

Ben MariniState General Manager, Commercial and Agribusiness, Regional Banking WATelephone (61-8) 9426 2831

Steve HannanState General Manger, Commercial and Agribusiness, Regional Banking NSW Telephone (61-2) 6580 3926

Richard HockneyState General Manager, SA/NT/TAS Regional, Westpac Retail & Business Banking Telephone (61-8) 8230 2225

Westpac Commercial and Agribusiness BankingWestpac Economics

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