There is a silver lining from the terrible conditions we seem to be seeing in the financial markets and in the economy: there’s a forecast the Reserve Bank will probably cut interest rates next year by more than we expect.
But we will face a sharper slowdown in economic activity next year than previously thought. For that we can blame high interest rates, boosted by the Reserve Bank’s anti inflation campaign, the credit crunch, and of course, high oil prices.
According to forecasts from the National Australia Bank, the economy will slow by more than forecast next year because businesses and consumers will chop back on their spending, which will in turn see the central bank cut rates by a bit more than we have been expecting.
We will get an update on building approvals figures for June later today from the Bureau of Statistics, and June retail sales tomorrow.
The NAB now says the RBA could cut rates by 1.25% in total from next year into 2010 from the present rate of 7.25%.
That’s more than the cuts of around 0.75% to 1% that most forecasters have been predicting.
The National’s forecasts are contained in a fuller version of its quarterly business confidence and conditions survey which we highlighted yesterday.
The NAB forecasts that the Australian economy will grow 2.25% next year, lower than the 2.75% it forecast three months ago.
NAB’s head of Economics, Alan Oster said in the survey statement that "The combination of much tighter financial conditions, falling global equity markets and the global credit crunch has continued to undermine confidence and activity levels”.
He says the RBA will "continue to look through the high core inflation in the near term and remain on hold for the rest of 2008 as demand moderates significantly further this year”.
The NAB said its new Australian GDP forecast was unchanged at 2.75% for this year and 2009’s 0.50% cut means, that excluding the farm and mining sectors, domestic growth will only be 1% next year.
"These forecasts reflect global factors and the sharper than expected slowing that has already occurred,” the bank said.
The NAB said its core inflation forecasts were unchanged – at around 4% through most of 2008 and will not be back in the target range till mid 2009.
"The treatment of the financial sector during the credit crisis overstates the real rate of increase in core inflation (by around 1%). Nab still expects RBA cuts to begin from early 2009 with a cash rate of around 6% by late 2009 or early 2010.
"The clear message from the Quarterly (and recent Monthly) business survey is that the economy is weakening much faster than expected in the face of tighter financial conditions, further falls in equity markets, high oil prices and very weak confidence levels.
"Credit markets are not improving and consumers are increasingly concerned about its impact – both on equity markets and in their cost of borrowing.
"Business expectations have been significantly cut and their future hiring and investment intentions are being pared back – as is their demand for credit. Further, we now face the prospect of a significantly weaker global outlook in 2009 (or at least among the developed economies).
"In that environment it is very easy to become overly negative. Against that background it is, however, important to remember that Australia still has a number of powerful positives, including:
* Substantial personal tax cuts (which may be starting to help stabilise retail spending in recent weeks);
* A substantial increase, from already high levels, in our terms of trade – especially via high coal and iron prices. The chart below – left hand panel – summaries the likely outcome and clearly represents a once in a generation event. Our estimates point to the benefit to the Australian economy of the recent jump to be around $40b per annum – with the likely economic impact mainly in 2009;
* It is worth noting that among our revisions to the global outlook we did not lower our Chinese GDP forecasts – meaning that those forecasts do not see a sudden crash in the commodity markets or our terms of trade;
* A significant jump in farm GDP which could add as much as ½ per cent to GDP in 2008/09 (see chart below – right hand panel);
* And, of course, significant room for fiscal and monetary policy adjustment if the global outlook deteriorates more than currently expected.
"Globally the bank expects economic growth to be unchanged at 3.4% in 2008, but drop to 2.75% next year.
"This reflects further negative wealth effects from lower equity and house price markets, higher oil prices and a view that financial conditions will be tighter for longer given ongoing credit market difficulties.
"The impact is most evident in the USA – where growth has been lowered by 0.75% 1% in 2009. Those forces also impact on other major economies. China forecasts continue to point to moderate slowing (8.25% in 2009)."
China is currently growing at 10.1% so that will be a sharpish fall in growth (but still stronger than the Western economies.) It will be almost one third the 11.9% annual growth rate for the country for 2007.
The Bank’s survey confirmed Monday’s preliminary report that business conditions have slumped to the lowest levels since the aftermath of the September 2001 terrorist attacks in the United States. And business confidence has tumbled even further, to levels not seen since the last recession in 1991.
The National Australia Bank survey found business conditions for the June quarter fell by seven index points to six points.
It is the lowest index reading since the December quarter of 2001, when the business conditions index was minus-two points.
"Business
