Australian business conditions "deteriorated markedly and unexpectedly in the March quarter", according to the March quarter survey from the National Australia Bank, but there are still warning signs for a possible interest rate rise.
The NAB’s survey was released a day after its business confidence survey showed a sharp fall. Now the business conditions index fell six index points to a reading of plus-13 points: the largest quarterly fall in about seven years. The index is now at its lowest level since the middle of 2006.
The index is comprised of three components – trading conditions, profitability and employment.
The outlook for the next three and 12 months was also lower: the quarterly business expectations index for the June quarter fell five points to 20 index points and the index for the year ahead dropped seven points to 27 index points, its lowest level in five years.
Business conditions worsened in all states except Western Australia, although the deterioration in Queensland was partly related to the extreme weather conditions in that state during the early part of 2008
But the NAB said in commentary that despite this slowing, the Reserve Bank would be on "aggressive inflation watch for some time" with high oil and commodity prices and after the poor March quarter CPI.
"Clearly the Survey is signaling that the Australian economy may be slowing faster than we had expected. But against that there are still the impacts of income tax cuts, higher commodity prices and a rebound in farm output (of around 20 per cent) to come. Certainly it is clear that financial conditions have been (more than) tightened enough to cause a draw back in interest sensitive sectors – including the consumer."
"After the very disappointing inflation numbers for the March quarter, we now see the RBA’s core inflation measures staying around 4% for all of 2008.
"With oil prices and upstream pressures very high, the RBA will be on aggressive inflation watch for some time with a clear upside bias. Any signs of accelerating wages, a stronger economy or labour markets could well see the RBA in action again.
"That said, we still see downside risks to demand and expect core inflation to be back into the target range by mid 2009."
The bank said that while it was clearly highlighting potential downside risks to the forecasts, "on balance, we are happy to stay with our current activity forecasts. That is, we expect:
• GDP to increase by 2.75% in both 2008 and 2009;
• The 2009 forecasts mask a further slowing in non-farm GDP to around .5% offset by a rebound in farm GDP by around 20%;
• For the financial year 2007/08, these forecasts are consistent with GDP growth of 3.5% in 2007/08 and 2.5% in 2008/09.
"Reflecting tighter financial conditions and associated lower growth in asset prices (house price increases are expected to slow to around 4 per cent in 2008 and little growth is expected in equity markets in 2008), our forecasts see the pace of domestic demand slowing from the current annual rate of 5.5% to nearer 3.5% during 2008 and a touch lower in 2009
"Despite current uncertainties about the global outlook, with China still strong, we have seen very large commodity price increases in iron ore (65 per cent) and coal negotiations (up to 280 per cent). As a result, Australia’s terms of trade will move up significantly further during mid 2008, before starting to ease back from late 2008/early 2009.
"That, together with personal tax cuts and the farm sector rebound should provide powerful offsets to an overly hard landing in Australian activity – especially in 2008 but also probably in 2009 as well.
"The implied slowing in domestic demand will also slow employment growth from the current rate of around 2.75% to around 2.25% by early 2009 and nearer 1.5% by late 2009.
"That in turn will see unemployment remaining in the 4 – 4.5% range for most of 2008, before moving moderately higher during 2009, as the forecast slowing in demand eventuates.
Our commodity, activity and interest rate forecasts see the USD/AUD moving up to around 96 US cents in mid 2008 and staying above 90 US cents until 2009.
"Elsewhere in the Survey, there remains a very strong assumption of an upward shift in short term interest rates.
"In the March quarter, 84%respondents still expected another rate increase (85 per cent previously) with a mean expected increase of 57 basis points (53 points previously).
"However it may well be that these expectations (like those in financial markets) have subsequently been scaled back in the face of clearer signs of a slower domestic economy and a RBA more concerned about the potential for sharper than expected slowing in demand in both the local and global economies," the NAB said.
