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Newsletter Century 21 More Rate Cuts In February According to NAB & WESTPAC

Source: NAB�Group Chief Economist National Australia Bank

The Bigger Picture � A Global & Australian Economic Perspective

Global: The continuing European financial crisis has damaged European business confidence and is flowing through to weaker activity. We now expect a deeper recession in that region, with this weakness flowing through to other parts of the world, particularly the UK. The big emerging market economies are slowing too as earlier policy tightening takes effect in China, India and Brazil. The Asian Tigers are especially vulnerable to a slowing in global demand, and forecasts there have been lowered. The US economy is still faring surprisingly well against this unpromising background while Chinese growth continues at a solid pace. We have lowered our global growth forecast to 3.3% for 2012, a sub-trend performance heavily reliant on the US, China and India.

� As in 2008, the exceptional volatility seen in global financial markets is having an impact on economic activity. Share prices fell by around 15% in the big global markets between late July and early October but they have subsequently recovered around half of their losses. Market volatility rose to levels last seen during the GFC but the VIX index remained well below the levels seen during that period.

� Monthly measures of world trade and industrial production have levelled off recently after turning up around mid-year as global production chains recovered from the effects of the tsunami in Japan. The CPB index of world trade rose by 0.9% in September quarter after a decline of 0.4% in June quarter. The pace of growth in global industrial output accelerated from 0.2% to 1.4% between the two quarters. This growth performance faded toward the end of the third quarter, however, with both world trade and industrial output falling in September.

� Our survey-based indicator of industrial activity in the big industrial economies (based on purchasing manager surveys) shows business conditions stabilising in November. However, activity is not equal across the big developed economies. Activity is clearly slowing in the Euro-zone and UK as the financial crisis in the former takes a toll on confidence. The US surveys, on the other hand, have turned up toward the end of the year as firms become less worried by the prospect of a �double dip� recession.

� The US economy appears to be bucking the trend of the other big developed economies, with partial data and business surveys suggesting activity has been quite buoyant. The Fed�s November Beige Book reported that activity was expanding at a slow to moderate pace in almost all regions, with consumer spending, bank lending and industrial output all positive. The labour market has been fairly positive too. We expect US economic growth to accelerate from 1.8% this year to 2�% in 2012.

� While US data suggest that the economy has fared quite well, the Euro-zone appears have entered a recession. According to the national accounts, GDP grew by around 0.2% in the September quarter but the latest business surveys and monthly partial economic data show a much weaker picture. Industrial new orders fell heavily in September with the boom in German orders fading through recent months. Industrial output also fell by 2% in September across the Euro-zone and October data looks weak. Business surveys in many economies are generally showing declining levels of activity and confidence, with Germany a notable recent exception.

� The eventual outcome of the sovereign debt and banking issues in the Euro-zone will have a major impact on the economic outlook. While we believe the ECB will ensure that a disaster is averted, the mechanics already seem set in place for recession and we are expecting GDP to fall through the closing months of 2011, with a cumulative drop of around 1% points in GDP � much less than was recorded in the GFC, but not dissimilar to the 1�% fall in 1990/91.

� Activity in Japan has flattened out in recent months as the bounce-back in production from the tsunami is complete. Industrial output has stabilised but export volumes and the latest Shoko Chukin business survey have fallen recently. Machinery orders and shipments of capital goods have also softened, so too have some measures of consumer spending.

� The latest Chinese economic indicators show a slowing pace of growth but inflation has also receded, allowing the central bank to ease policy by loosening reserve requirements. The components of demand are mixed; while fixed investment fell in November, it rose by more than 20% over the year. While retail trade growth was still rapid, export growth has softened, with Euro-zone weakness hitting sales levels. Overall, while there are downside risks from the housing market and construction, we still expect solid Chinese growth.

Australia: The RBA�s decision to lower the cash rate for a second consecutive month in December reflected caution over-ruling prudence. National accounts data heralded the start of the long-awaited mining investment boom, while consumption growth remains firm. We see these components (in particular) supporting further growth in the Australian economy. Our core inflation (ex carbon tax) forecasts remain soft in the near term, but we still expect it to drift above 3% by end 2013, reflecting our stronger growth forecasts. We tentatively expect another 25bp cut in February 2012, on the assumption that core CPI will remain soft in the near term.

� The latest set of national accounts data confirmed that the recovery from the floods earlier this year continued into the September quarter, with GDP rising by 1.0%, to be 2.0% higher in year-average terms. The strength in September quarter GDP largely reflected a sharp increase in business investment and another solid rise in consumption, while net exports and stocks subtracted from growth in the quarter. The outlook for business investment remains very strong � largely due to investment in the resources sector � which should continue to support growth over the next year or so.

� The latest NAB business survey showed that business conditions edged higher in November, reflecting improvements in profitability and employment, while business confidence was unchanged, despite concerns about the European debt situation. The survey�s other activity measures, including forward orders, stocks and capacity utilisation, were all suggestive of better activity in the near term. The services sectors (outside finance) reported better business conditions in the month, while activity in mining, transport & utilities and retail was noticeably stronger. In contrast, manufacturing and construction conditions fell to worryingly low levels in November.

� Prices of mineral and energy commodities have fluctuated significantly over the past month but are generally lower than a month ago, with escalating concerns over European sovereign debt and a more uncertain global economic outlook overshadowing slightly more positive economic data out of the United States. Coordinated central bank action and prospects for a new European compact may have helped to restore a degree of �calm� in financial markets, by way of providing renewed hope for the resolution of sovereign debt problems. However, impressive real political hurdles remain along with continuing financial instability and fears of a European credit crunch.

� In financial year terms, our GDP growth forecasts are: 3.7% in 2011/12 (was 3.2%) and 3.8% in 2012/13 (was 3.3%).

� That said, the labour market remained soft in November, with employment growth falling in the month and the unemployment rate edging higher. While retail trade volumes rose in October, the pace of growth has softened over recent months and overall spending remains subdued. However, retailers may receive some reprieve from the RBA�s recent rate cuts in the lead up to Christmas. The property market appears to be struggling at present, with building approvals falling heavily in October, consolidating a heavy fall in the previous month.

� Fear of global contagion from a fast weakening Europe was probably the main reason behind the RBA�s decision to reduce the cash rate by 25 basis points for a second consecutive month in December, taking the official cash rate to 4.25%. While financial markets had priced in the cut with near certainty, the economics of a December cut was a good deal murkier.

� Our core inflation (ex carbon tax) forecasts remain at around 2.0% over 2011/12, drifting up to 2.7% by end 2012 and over 3% by end 2013. Consistent with this profile, we tentatively expect the RBA to cut the official cash rate by a further 25 basis points in February, on the basis that core inflation will remain subdued in the December quarter. Longer term, we expect the RBA to unwind the temporary stimulus, as the labour market strengthens and inflation pressures re-emerge.

Source: Westpac Chief Economist

The Westpac Melbourne Institute Index of Consumer�Sentiment fell by 8.3% in December from 103.4 in�November to 94.7 in December.

The Index has now fallen to its lowest level since August this year

when respondents were concerned that the Reserve Bank was

preparing to raise interest rates while global financial markets

had taken a tumble.

On face value it should be a surprise that the Index has not risen

following a second rate cut from the Reserve Bank (which was

eventually passed on in full by the major banks to mortgage

borrowers). However the history of previous easing cycles shows

that rate cuts do not guarantee an improvement in sentiment.

Since 1994 we have seen 20 rate cuts including last week�s.

On 12 occasions the Index has increased following the rate cut

and on 8 occasions it has fallen. The likely explanation is that

respondents� concerns over the reasons behind the rate cut may

overwhelm the perceived benefits of the cut itself.

For this survey we also ask respondents questions about those

news items which they most recall and whether these items are

perceived positively or negatively. When interest rates are moving

they typically capture considerable attention. For this survey

news on interest rates was recalled by 31.5% of respondents

whereas economic conditions attracted the attention of 60%;

international conditions 55.6% and Budget and taxation 36.9%.

The news on economic conditions; international conditions and

Budget and taxation was considered the most negative since

2008/09. News on interest rates was the most positive since

that period.

Despite the positive perception of interest rates the confidence of

respondents with a mortgage fell by 9.5%.

Specific news which is likely to have unnerved respondents is

the reported increase in the unemployment rate from 5.2% to

5.3% with a loss of 40,000 full time jobs. Of course, the constant

stream of news on developments in Europe is also likely to have

impacted respondents, while equity markets were volatile.

Four of the five components of the Index fell in December. The

sub-index tracking views on �economic conditions over the next

12 months� was down by 19.4%; while �economic conditions over

the next 5 years� fell by 14.4%; �family finances compared to a

year ago� fell by 8.6% although �expectations for family finances

over the next 12 months� improved by 3%. The sub-index tracking

views on �whether now is a good time to buy a major household

item� fell by 3%.�

Risk aversion increased markedly in this survey. When asked

about �the wisest place for savings� 26.6% of respondents

nominated �pay down debt�. That was an increase from 18.7% in

September. Since we started measuring that component in 1997

there has only been one higher measure, in March 2010. Only

6.6% of respondents nominated equities � the lowest percentage

since 1993; while the 14% nominating real estate was, apart from

2008, the lowest since the survey began in 1974.

Attitudes towards purchasing housing and motor vehicles also fell

modestly. The index tracking views on �time to buy a house� was

down by 1.9% while the index tracking views on �time to buy a

Car� was down by 1%.

The Reserve Bank Board next meets on February 7. After having

cut rates in both November and December the decision to move

will become progressively more difficult. However it is our view

that rates are still slightly above neutral giving plenty of scope

for more cuts. This read on Consumer Sentiment will be noticed

by the Bank although it will also observe the resilience of overall

consumer spending as measured by the national accounts

despite generally poor prints for Consumer Sentiment in the

second half of 2011.

For us a very important signal from this survey is the heightened

level of risk aversion. So far that high level of risk aversion and

associated rise in the savings rate has not unduly constrained

consumer spending due to strong labour income growth. Evidence

from a weakening labour market is pointing to a slowdown in

income growth which is likely to be associated with a softening of

spending if savings rates do indeed remain high. That dynamic will

have to feed into the Bank�s growth outlook although as indicated

by our �news heard� indexes respondents� and the Bank�s own

perceptions of overseas economic developments will continue to

be a key driver of interest rate policy.

We continue to expect that the Board will decide to further cut

rates at its upcoming meeting on February 7.

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Newsletter Century 21 More Rate Cuts In February According to NAB & WESTPAC

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