Published on April 13, 2008
Economic OutlookPrepared for AFIAA ConferenceGold Coast, 31 May 2007Corinne Le Gallic: Economic Outlook Prepared for AFIAA Conference Gold Coast, 31 May 2007 Corinne Le Gallic Overview: Overview International Context US Economy Euro-area and Japan Global Outlook Implications for Australia Domestic economy Housing Inflation Consumer spending Consumer and business confidence Conclusion / Outlook The US strong growth since mid-2003 had created an inflation problem: The US strong growth since mid-2003 had created an inflation problem The massive monetary policy easing post tech-bubble burst revived the US economy but also inflation; The Fed succeeded in slowing the US economy…: The Fed succeeded in slowing the US economy… The Fed raised its target rate 4.25% since the middle of 2004; GDP growth has responded to the Fed’s interest rate increases and has slowed markedly; … But has also ended the housing boom: … But has also ended the housing boom Existing and New Home Sales have fallen sharply since the beginning of 2006; This was the sharpest decline since the beginning of the 1980’s; Housing Permits and Starts have also declined massively and may have further to go; Housing building activity will be slow and will detract markedly from growth in 2007; Presently, US employment growth and consumer spending are holding up: Presently, US employment growth and consumer spending are holding up Employment growth remained firm (around 150,000 jobs created per months); This kept the unemployment rate at a low 4.5%. Consumer spending growth has decelerated since the beginning of 2006; However, it remains firm: close to 5% per annum …but a sharp housing downturn means downside risks to growth: …but a sharp housing downturn means downside risks to growth Housing sector’s activity has collapsed in the US since the beginning of 2006; We are experiencing the sharpest downturn by far since the beginning of the 1990’s; Back then, the housing downturn and Saving and Loans crises had led to a recession; The problems on the sub-prime lending market could mean tighter credit conditions and a second leg of housing weakness: The problems on the sub-prime lending market could mean tighter credit conditions and a second leg of housing weakness The housing downturn and recessions of the beginning of the 1970’s, 1980’s and 1990’s were all associated with a tightening of credit conditions / credit crunch; There is a risk at present that the problems of the sub-prime ARM’s lending market could spread to the overall housing market; This would mean a sharper downturn on housing, spreading to the rest of the economy (a recession). We should know whether this scenario finally unfolds within 3 months. Japan and the Europe will continue to support world growth: Japan and the Europe will continue to support world growth The Japanese Tankan index of business activity has been above zero (showing expansion) for almost three years; This is the first time it has stayed well above zero since the beginning of the 1990’s; European business and consumer confidence has also improved markedly; The German IFO index of business conditions (which has existed for a long time, as opposed to the Euro-Zone index left), shows that this pace of growth is historically very high. Global Growth Implications for Australia: Global Growth Implications for Australia The commodity boom and our terms of trade are dependant on the continuation of strong world growth; China and its trading partners should continue to grow at a fast pace, supporting commodity prices; However, commodity prices should at best plateau and more likely decline (-5% on the index over 2007), as supply increases; National income growth should go back in line with GDP growth, which will close the gap between domestic demand and production; Slide11: Domestic Economy The 2006 interest rate increases delayed the housing recovery, but housing finance has re-accelerated recently: The 2006 interest rate increases delayed the housing recovery, but housing finance has re-accelerated recently The three cash rate increases in 2006 have delayed the recovery in housing finance (vertical line matches the May rate hike), but housing finance has re-accelerated recently; Building approvals, which had recovered beginning of 2006, have fallen back to a level well below underlying demand (of around 175,000 dwellings per annum); Housing: should continue to detract from growth until at least mid-2007, but strong fundamentals will lead to a slow recovery in FY08: Housing: should continue to detract from growth until at least mid-2007, but strong fundamentals will lead to a slow recovery in FY08 Affordability is still poor; Prices are plateauing, not falling. It will take several years for income to catch up with house prices and restore affordability; Rental yields are rising, but from a very low base; Changes in superannuation legislation means selling pressure from property investors; It will be some time before property investors re-enter the market in numbers; Housing growth should recover slowly from Financial year 2007-08, on the back of strong underlying demand; Source: HIA Source: ABS Inflation is still elevated, but has slowed markedly already over the last two quarters: Inflation is still elevated, but has slowed markedly already over the last two quarters Source: RBA Annualised RBA measure of inflation was only 2% annualised in the past 6 months; Capacity utilisation of both equipment and labour are high… but wages growth has moderated : Capacity utilisation of both equipment and labour are high… but wages growth has moderated The strong growth in domestic demand over the last 10 years has led to an increase in utilisation of resources: capital and labour; This had to lead to inflationary pressures, which we had in 2006. However, wages growth is already moderating. Retail sales growth has re-accelerated since the beginning of the year: Retail sales growth has re-accelerated since the beginning of the year Retail sales growth has slowed markedly since the 2003-2004 boom, but is reaccelerating since the beginning of the year; Consumer and business confidence are very high: Consumer and business confidence are very high Consumer confidence is strong, buoyed by a strong labour market, prospects of stable interest rates and in coming tax cuts & bonus payments. Business conditions are close to survey’s high and confidence has picked up since the beginning of the year; Conclusion: Conclusion The pick-up in activity in Australia is very recent; The uncertainty on the US economic outlook points to caution; December and March quarter CPI were tame (0.5% underlying inflation); The RBA can afford to leave rates unchanged in the foreseeable future Outlook: 2 scenarios: 2/3 probability: US slowdown is a soft landing: World growth remains very strong; Domestic rebound + positive contribution from net exports => capacity constraints Inflation pressures will tighten and the cash rate will rise in 2008 1/3 probability: the US housing downturn is sharp and triggers a US recession: World growth slows markedly; Net exports detract from growth; The unemployment rate start to rise in the second part of the year, followed by a slowdown in domestic demand; The Fed cut interest rates at the end of the year. RBA cut follow in 2008.