The Bigger Picture – A Global & Australian Economic PerspectiveGlobal: Although financial markets are still very volatile and there are numerous downside risks, the latest global economic indicators have not been as bad as many had feared. Instead of a full-scale global recession, the evidence is pointing to a softening in the pace of growth to just below trend.
The US economy is faring surprisingly well in this difficult environment but the Euro-zone seems to have entered recession. Elsewhere, there are clear signs of a slowing in the big emerging economies, with China faring the best in terms of maintaining growth momentum. We have made small changes to our forecasts for China and Japan with little impact on the bottom line for global growth (3.2% for 2012), which remains heavily reliant on the emerging economies as the OECD faces a long period of modest growth.
Financial markets are still volatile but sentiment has clearly improved recently. Spreads on sovereign bonds across several Euro-zone economies have narrowed and international bank funding, while still tight, has become a little easier. Equity markets across the biggest OECD economies in the latter half of January were at their highest level since August 2011 and up by around 10% from their troughs in early October. The VIX index of market volatility is back around levels last seen in July. The indicators of global economic activity show a clear slowing in the pace of growth but not an outright fall in activity. Industrial activity in the big developed economies has certainly softened but expansion has continued in the emerging market economies, leaving global industrial output and world trade fairly flat. While this is a poor outcome by the standards of early 2011 expectations, it is not as bad as the global recessions experienced in 2008/9 or the early 1980s. Although our monthly measure of global industrial output also shows a clear softening in the pace of growth, business surveys at the end of 2011 were less pessimistic than might have been expected. The rate of growth in global industrial output was down to only 2% yoy by December, well below the 7¼% yoy seen at the start of the year and the 3½% yoy recorded mid-year. However, our index of business sentiment in the biggest OECD economies, which had been falling quite rapidly since the start of the year, actually turned up in November and December, which is not indicative of a global economy sliding into a deep recession. US economic conditions in the second half of 2011 turned out considerably better than many had feared. US real GDP grew by around 2% annualized in the third quarter and by 2.8% in the final quarter. The Fed’s Beige Book showed “modest to moderate” growth continuing through December across the various districts, while the Philadelphia Fed’s January survey showed regional manufacturing doing well in early 2012. Finally, the job market is looking stronger with the recent increase in monthly payroll numbers and the drop in new jobless claims. Overall, we expect US economic growth of around 2.3% in 2012 and 3.1% in 2013. The weakest global region is now the Euro-zone where we are expecting a severe downturn in activity. The data for late 2011 was already weak with industrial output down by 2½% in the three months to November, new orders down by around 5%, retail trade falling by 1½% and construction down by 2%. With employment already falling in the September quarter, we expect a general softening across household consumption – easily the biggest part of GDP. There are, however, big differences between countries within the Euro-zone. Germany and those parts of neighbouring economies linked to German demand are holding up much better than elsewhere. The situation in the Euro-zone periphery is, however, much worse with rounds of austerity programmes cutting activity levels and resulting in deep recessions. We expect GDP to fall by 0.6% in 2012, before rising by a below-trend 1.3% in 2013. The upturn in the Japanese economy from the effect of the tsunami has been marred by a combination of yen appreciation and slower growth in world trade, which have hit exports – the main engine of growth over recent years. Supply chain disruptions resulting from the floods in Thailand have also slowed the pace of growth. Although Chinese economic growth is slowing, at just over 8% annualised in the December quarter it is easily the fastest growing major world economy. Manufacturing sector growth was almost 14% yoy in December but some of the main business survey indicators are well below their peak levels.
Australia: The outlook for the domestic economy remains firm but global uncertainty is not helping hiring and investment intentions. While business conditions were unchanged in December, they remain mixed across industries. Forward indicators suggest a slightly weaker start to 2012. Labour market conditions have also weakened in recent months and we now expect little improvement in unemployment in 2012/13. The expected coal export rebound now appears to be less robust. All of this sees our GDP forecasts lowered to 3¾% (from 4½%) in 2012 but broadly unchanged at 3½% in 2013. As a result, we have lowered our core inflation forecasts (ex carbon tax) to 2.2% over 2011/12, before rising to 2.6% over 2012/13. We now expect two RBA cash rate cuts in 2012; the first 25 bp cut in February, followed by another cut in mid 2012 – possibly around August (timing data dependent). The outlook for the Australian economy appears to have softened over the past month or so, reflecting continuing uncertainty on the global / European outlook, a related softening in private forward orders and further delays in the recovery in mining activity. In addition, there is the ongoing process of further withdrawal of domestic public final demand. Consistent with recent softness in domestic activity and a high AUD, ABS CPI data confirmed that price pressures remained fairly benign in the December quarter. Underlying inflation was just 0.6% in the quarter and 2.6% over the year. In December, the NAB business survey showed that overall confidence strengthened a little, despite European sovereign debt concerns, perhaps reflecting the effects of the RBA’s recent interest rate cuts. Conditions were unchanged in the month, with improvements in trading conditions and profitability offset by a softening in employment conditions. Business conditions in construction and manufacturing improved in the month, while mining conditions softened on the back of falling commodity prices. Other indicators of activity were mixed, with trading conditions, profitability and stocks all improving in the month, while forward orders, investment spending, capacity utilisation and employment weakened. Prices of mineral and energy commodities have generally drifted higher over the past month, with markets commencing the New Year slightly more optimistic about the global outlook, despite signs of a slowdown in emerging economies, and continued uncertainty in Europe. Prices of growth commodities have also been supported by hopes of further policy easing in China, as well as some restocking ahead of the week-long Lunar New Year holiday. The softness in the labour market at present points to relatively weak near-term domestic activity. In December, 29,300 jobs were shed and the participation rate fell sharply, from 65.5% to 65.2%, suggesting that job seekers have become discouraged and are exiting the labour force. ABS job vacancies data also weakened over the three months to November, pointing to a still soft near-term outlook for the labour market. Overall, while the Australian economy is expected to remain strong (albeit mixed), we have lowered our growth forecasts for 2012 to 3.7% (from 4.5%) and 3.4% (unchanged) in 2013. Consistent with this, our labour market forecasts are also softer (with unemployment remaining around current levels in 2012/13) and so too are our inflation forecasts. The December quarter CPI was fairly soft and the risk that inflation will rise above the RBA’s 2-3% target band over the medium term appears small. There is no doubt that the RBA has become increasingly cautious over recent months, having been wrong footed by a serious resurgence in international financial market instability emanating from European sovereign debt concerns. The weak underlying CPI result in the December quarter, coming on the heels of declining asset prices, soft credit demand and an apparent rise in discouraged workers, is likely to complete the case for a rate cut of 25 bps in February. In addition, the softer growth outlook and uncertainties on the extent to which banks will fully pass on RBA cuts, mean that we now expect another reduction in the current cycle – most likely in mid year (say August).
Alan Oster
Group Chief Economist National Australia Bank |
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