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Australia’s macroeconomic prospects
National Convention Centre, Canberra
4th March 2008
Saul EslakeChief Economist, ANZ
Presentation to ABARE Outlook 2008
2Australia’s economy is at the intersection of two very powerful global forces
The crisis in global credit markets
– resulting from the bursting of the credit market ‘bubble’ which built up during the middle years of this decade
– triggered by, but no longer confined to, the US sub-prime mortgage market
– resulting in substantial declines in the value of a wide range of securities and derivatives
– threatening to lead to a global ‘credit crunch’
– and possibly to a recession in the US and other large industrialized economies
The on-going rapid growth and industrialization of China and other emerging economies
– putting continued upward pressure on a wide range of commodity prices
– as well as heightening concerns about climate change
Australia is exposed to both of these forces
– financing the world’s fourth largest current account deficit predominantly through borrowing means Australia is exposed to the risk of a global ‘credit crunch’
– but the commodities boom is also adding directly and indirectly to inflationary pressures within Australia, and putting upward pressure on the A$
Australia’s short- to medium-term macroeconomic prospects will largely depend on the relative strength of these two forces
3The current global financial crisis stems from the bursting of a‘credit market bubble’
From this …
Cheap andeasy money
Increased appetite for risk
Increased capacity for leverage
New forms of
‘financialengineering’
Rising asset prices
To this ….
Falling asset prices
Reduced appetite for risk
Distrust of new forms of finance
Slowing economy
Reduced capacity for leverage
4
Spreads between short-term (90-day) inter-bank borrowing rates and expected official cash rates
0
20
40
60
80
100
120
Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08
Basis points (5-daymoving average)
US
UK
Euro area
Australia
Note: ‘expected official cash rates’ proxied by overnight index swaps (OIS).Sources: Thomson Financial; Bloomberg.
Australian banks have been subject to the same short-term funding pressures as US and European banks …
5… and Australian longer-term debt markets have likewise seen similar increases in spreads as US debt markets
Swap spreads
United States
Australia
Note: spreads are to government bond yields of comparable maturities.Sources: Thomson Financial; Bloomberg; Reserve Bank of Australia.
0
25
50
75
100
125
01 02 03 04 05 06 07 08
Monthly average(basis points)
5 years
2 years
-50
-25
0
25
50
75
100
01 02 03 04 05 06 07 08
Monthly average(basis points)
5 years
2 years
United States
Australia
0255075
100125150175
01 02 03 04 05 06 07 08
Monthly average(basis points) A-rated
AAA-rated
050
100150200250300350
01 02 03 04 05 06 07 08
Monthly average(basis points)
A-rated
AAA-rated
Corporate bond yield spreads
6In Australia, as in the US, the debt securities markets have almost completely closed to non-bank borrowers
Note: excludes government debt securities. Source: Reserve Bank of Australia
0
50
100
150
200
250
00 01 02 03 04 05 06 07 08
$ bn
Mortgages
All loans
Securitizers’ loan assets
Australian non-government debt securities issued offshore
0
50
100
150
200
250
00 01 02 03 04 05 06 07 08
$ bn Banks & otherfinancial corporations
Other
Short-term debt securities issued in Australia
0100
200300
400500
600
00 01 02 03 04 05 06 07 08
$ bn
Banks & otherfinancial corporations
Other
Long-term debt securities issued in Australia
050
100150
200250
300
00 01 02 03 04 05 06 07 08
$ bn
Banks &other financialcorporations
Other
7With debt securities markets largely closed, credit demand is returning to the banking system – straining banks’ capital
Australian financial intermediaries’business lending
-5
0
5
10
15
20
25
30
83 88 93 98 03 08
% change from year earlier
Total (incl.securitizations)
'Narrow credit(excl. securitizations)
* Under APRA regulations, banks must maintain total base capital in excess of 8% of their risk-weighted assets,half of which must be in the form of ‘Tier 1’ capital (paid-up capital, disclosed reserves and retained earnings). Sources: Reserve Bank of Australia; Australian Prudential Regulation Authority.
Australian banks’ capitaladequacy ratios
0
2
4
6
8
10
12
14
88 93 98 03 08
% of 'risk weighted' assets
Total capital base ratio
'Tier 1' capital ratio
Minimum prudentialcapital ratio*
8Reliance on banks’ overseas borrowings to finance the deficit leaves Australia exposed to abrupt shifts in global markets
Financing Australia’s current account deficit
-40
-20
0
20
40
60
80
100
00 01 02 03 04 05 06 07
Net equity Banks' net borrowing
Other net borrowing Other (incl. reserves)
A$ bn - 4-qtr moving total
Current account deficit
Methods of financing
Maturity structure of net foreign debt
1015
2025
3035
40
00 01 02 03 04 05 06 07
% of total
< 28 days
-20
0
20
40
60
80
100
88 92 96 00 04 08
% of total% of total Private sectorfinancial corporations
Private sector non-financial corporations
Public sector
Net foreign debt, by borrower
Sources: Australian Bureau of Statistics; ANZ.
9Australian and US economic cycles have not been closely correlated this decade, and are diverging further now
-2
0
2
4
6
00 01 02 03 04 05 06 07 08
% change from year earlierAustralia
US
Real GDP growth
Australian and US economic indicators
Unemployment
3
4
5
6
7
8
00 01 02 03 04 05 06 07 08
%
US
Australia
Terms of trade
8090
100110120130140150160
00 01 02 03 04 05 06 07 08
Ratio of export to importprices (2000 = 100)
Australia
US
House prices
-15-10-505
10152025
00 01 02 03 04 05 06 07 08
% change fromyear earlier
US
Australia
Sources: Australian Bureau of Statistics; US Bureau of Economic Analysis; US Bureau of Labor Statistics; S&P.
10Australia is much less directly dependent on the US and other OECD export markets than it used to be
Australia’s major export markets
0
5
10
15
20
25
30
88 92 96 00 04 08
% of total (12-mth moving average)
US
Japan
NZ
EU
Sources: Australian Bureau of Statistics.
Advanced economies
0
2
4
6
8
10
12
14
16
18
20
88 92 96 00 04 08
% of total (12-mth moving average)
China
Other North-East Asia(Korea, Taiwan, HK)
India
ASEAN
GCC
Developing economies
11
75
100
125
150
175
200
225
250
275
300
90 92 94 96 98 00 02 04 06 08
2001-02 = 100(US$ terms)
All items
Expected rises in coal and iron ore export prices will deliver afurther leg upwards in the commodity price cycle in 2008-09
Australian export commodity prices
50
60
70
80
90
100
110
120
130
60 66 72 78 84 90 96 02 08
2005-06 = 100
All items
Note: “terms of trade” is the ratio of average export to average import prices.Sources: Reserve Bank of Australia; ABS; ANZ.
Australia’s “terms of trade”
12
0
1
2
3
4
5
6
7
8
01 02 03 04 05 06 07 08
Real % change fromyear earlier
Real GDP(output)
Real gross domesticincome (GDI = GDPadj. for changesin terms of trade)
This will boost Australia’s income by another 2% in 2008-09, on top of 11% from terms of trade gains already so far this decade
Australia’s real gross domestic income and output
Sources: Australian Bureau of Statistics; ANZ.
13Income will continue to be re-cycled from the business sector to households through the Budget, boosting total spending
Australian incometax collections
11.0
11.5
12.0
12.5
13.0
13.5
00 01 02 03 04 05 06 073.0
3.5
4.0
4.5
5.0
5.5
6.0% of GDP % of GDP
Companies(right scale)
Individuals(left scale)
Net saving by sectors ofthe Australian economy
-3
-2
-1
0
1
2
3
4
5
6
00 01 02 03 04 05 06 07
% of GDP (4-qtrmoving average)
Households
Government
Business
Sources: Australian Bureau of Statistics; ANZ.
14Business investment is expected to keep rising strongly, despiteglobal uncertainties and deteriorating financial conditions
Mining
Manufacturing
Other industries
Total excl. farm and finance
Actual and projected capital expenditure
Note: Data are for financial years ended 30 June. Projections for 2007-08 and 2008-09 are based on expected levels of capital expenditure reported to the ABS in its January-February 2008 survey, adjusted for the extent to which expectations in this survey have been realized over the five years to 2006-07. Sources: ABS; ANZ.
0102030405060708090
01 02 03 04 05 06 07 08 09
% change(current prices)
-20
-10
0
10
20
30
01 02 03 04 05 06 07 08 09
% change(current prices)
-505
1015202530
01 02 03 04 05 06 07 08 09
% change(current prices)
-10-505
1015202530
01 02 03 04 05 06 07 08 09
% change(current prices)
15
100
120
140
160
180
200
00 01 02 03 04 05 06 07 08
'000s (annual rate)
Completions
Underlying demand
0
1
2
3
4
00 01 02 03 04 05 06 07 08
%
Average forall capitals
The Australian housing market is likely to remain characterized by excess demand – a stark contrast to the US housing market
Housing supply and demand
Rental vacancy rates
Capital city house prices
0
5
10
15
20
25
00 01 02 03 04 05 06 07 08
% change from year earlier
Capital city dwelling rents
0
2
4
6
8
10
00 01 02 03 04 05 06 07 08
% change from year earlier
Australian housing market fundamentals
Sources: Australian Bureau of Statistics; Real Estate Institute of Australia; ANZ.
16After more than 16 years of continuous economic growth, Australia’s economy has run into serious capacity constraints
Unemployed persons per job vacancy
Indicators of ‘spare capacity’ in the Australian economy
05
1015
2025
30
88 92 96 00 04 08
No unemployed per job vacancy
Businesses reporting labour shortages
05
101520253035
88 92 96 00 04 08
% of businesses nominating 'suitable labour' as a constrainton output
Capacity utilization rate
7476
7880
8284
86
88 92 96 00 04 08
%
Office vacancy rates
0
5
10
15
20
25
88 92 96 00 04 08
%
Sources: Australian Bureau of Statistics; nabCapital; Property Council of Australia.
17
2
3
4
5
01 02 03 04 05 06 07 08
% pa
Actual
Trend
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
01 02 03 04 05 06 07 08 09
% change from year earlier'Headline
'Underlying'(weightedmedian)
Rising inflation (reflecting demand growth in excess of supply potential as well as global factors) is a serious policy concern
Consumer prices
Reserve Banktarget band
Measures of labour costs
01234567
01 02 03 04 05 06 07 08 09
% change fromyear earlier
Wage cost index
Compensationper employee
Household inflation expectations
Sources: Australian Bureau of Statistics; Reserve Bank of Australia; Westpac-Melbourne Institute; ANZ.
18In a fully employed economy if some sectors are to grow rapidly then others have to shrink
After more than 16 years of continuous growth Australia’s economy is running out of ‘spare capacity’
As a result, increases in aggregate demand in excess of the growth rate of the economy’s ‘supply potential’ will inevitably lead to higher inflation, a larger current account deficit, or both
If, in this situation, some sectors (eg mining) are to grow rapidly in order to meet global demand, other sectors have to grow more slowly (or shrink) if these consequences are to be avoided
Similarly if some regions (eg WA and Qld) are being pushed towards faster growth then other regions must of necessity grow at a slower rate
In practice, the ‘room’ required by faster growth in particular sectors or regions is being created by a combination of
– rising interest rates
– a stronger exchange rate
– and rising costs
Inevitably, these will disproportionately impact households with a mortgage, and sectors such as manufacturing and tourism
Over the medium-to-longer term the only way to avoid this situation is through policies which expand the economy’s ‘supply’ potential
19Resources boom benefits north and west more than the south-east, but the gap between the two is now narrowing a bit
Employment
-20-10
010
2030
40
01 02 03 04 05 06 07 08
Real % change from yearearlier (trend) Qld, WA
& NT
Rest of Australia
Business investment
02468
101214
01 02 03 04 05 06 07 08
% change from yearearlier (trend) Qld, WA & NT
Rest of Australia
Retail sales
-10
0
10
20
30
40
01 02 03 04 05 06 07 08
Real % change from yearearlier (trend)
Brisbane, Perth& Darwin
Other capitals
House prices
Resource-rich vs other States and Territories
Sources: Australian Bureau of Statistics; ANZ.
01
23
45
6
01 02 03 04 05 06 07 08
% change from yearearlier (trend) Qld, WA & NT
Rest of Australia
20
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
8.5
01 02 03 04 05 06 07 08 09
% pa
RBA officialcash rate
90-daybank bill yield
Reserve Bank will hike rates at least twice more to ‘slow demand’ and bring inflation back within the target range
Short-term interest rates 10 interest rate increases since mid-2002 have had little lasting impact in restraining growth in domestic demand –largely because they’ve been offset by commodity-related income gains, repeated rounds of tax cuts etc.The RBA now says that ‘a significant slowing in domestic demand … is likely to be necessary to reduce inflation over time’ …… and that unless something else happens to produce such a slowdown (for example, sharply weaker global growth, tighter credit conditions, changes in fiscal policy etc. ) ..… ‘monetary policy is likely to need to be tighter in the period ahead’ (ie, rates will rise some more) In other words – there will be a ‘signi-ficant slowing in demand’, what is not clear is how high rates will have to go in order to procure it
Sources: Thomson Financial; ANZ.
21
0.50
0.55
0.60
0.65
0.70
0.75
0.80
0.85
0.90
0.95
1.00
01 02 03 04 05 06 07 08 09-100
0
100
200
300
400
500
600US ¢
A$ vs US$(left scale)
Spread betweenAustralian & US
90-day interest rates(right scale)
2001-02 = 100
0.50
0.55
0.60
0.65
0.70
0.75
0.80
0.85
0.90
0.95
1.00
01 02 03 04 05 06 07 08 0975
100
125
150
175
200
225
250
275
300US ¢
A$ vs US$(left scale)
RBA index ofcommodity pricesin US$(right scale)
2001-02 = 100
Commodity prices and interest rate spreads likely to continue supporting the A$ into the second half of this year
A$ and commodity prices A$ and interest rate spreads
Sources: Thomson Financial; Reserve Bank of Australia; ANZ.
22
-2
-1
0
1
2
3
4
5
6
7
8
01 02 03 04 05 06 07 08 09
Real % change fromyear earlier
GDP(output)
Domesticfinal demand
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
01 02 03 04 05 06 07 08 092
3
4
5
6
7
8% change fromyear earlier
Unemployment(right scale)
Employment(left scale)
%
Higher interest rates will eventually squeeze domestic spending although it may take a while yet
Spending and output
Sources: Australian Bureau of Statistics; ANZ.
Employment and unemployment
23Summary
Australia’s economic prospects in 2008-09 will be shaped by the relative strength of two powerful forces
– the global ‘credit crunch’ triggered by (but no longer confined to) the US sub-prime mortgage market crisis, and its Australian echo
– the ongoing rapid growth and industrialization of China and other developing economies, and their impact on the prices of Australia’s export commodities
Notwithstanding that the full effects of the ‘credit crunch’ are yet to be felt, globally or in Australia, the effects of rising commodity prices seem more likely to be predominate – at least for the next six months
Unless the ‘credit crunch’ results in an abrupt slowing in the Australian economy, economic policy will of necessity continue to focus on the need to contain inflationary pressures
– the Reserve Bank will lift the cash rate to at least 7½% - and perhaps higher
– fiscal policy will desirably also make more of a contribution to restraining domestic demand growth than it has hitherto
Domestic demand growth will slow from its 2007 pace, reflecting both tighter policy settings and the (as yet unknown) effects of the ‘credit crunch’
– this combination will inevitably have a disproportionate impact on indebted households, trade-exposed non-commodity business and the south-east States
24
Australian forecast summary
Economic forecasts
51
145
3½
4
3½
2008f
55
153
3.0
4.6
2.8
2006
64
150
3.6
4.4
4
2007e
50
155
3
4¼
2¾
2009f
Current account deficit ($bn)
Housing starts (’000)
‘Underlying’ inflation (year-end, %)
Unemployment rate (year-end, %)
Real GDP growth (%)
780810830920807Gold price (US$ / oz)
5.505.005.756.406.3310-year bond yield (% pa)
7.707.707.757.857.2590-day bill yield (% pa)
88919510298A$-¥
0.790.850.910.940.88A$-US$
Financial market forecasts
0.63
7.50
Dec 08
0.63
7.50
Jun 09
0.63
7.50
Jun 08
0.60
6.75
Dec 07
0.62
7.50
Dec 09
A$-€
RBA cash rate (% pa)
780810880975807Gold price (US$ / oz)
5.505.005.756.406.3310-year bond yield (% pa)
7.707.707.757.857.2590-day bill yield (% pa)
88919810498A$-¥
0.790.850.910.960.88A$-US$
Financial market forecasts
87
0.65
7.50
Dec 08
79
0.63
7.50
Jun 09
93
0.65
7.50
Jun 08
92
0.60
6.75
Dec 07
80
0.62
7.50
Dec 09
Oil price (US$ / barrel, WTI)
A$-€
RBA cash rate (% pa)
