Tonight we get an update on the strength of the US economy and a much awaited speech from Fed chairman, Ben Bernanke which some in the market reckon will reveal a new move to stimulate the slowing economy.
Any move from the Fed though is likely to be at the margin, or there will be nothing from the Fed for now. The European economy is definitely slowing and parts of the US economy are showing a distinct downward trend and have been doing so since July.
China remains solid, which as many analysts say (and as BHP Billiton proved this week), will sustain us here.
AMP Capital Investors’ chief economist, Dr Shane Oliver examines how well we are placed to ride out any global economic storms.
Introduction
The combination of European and US debt problems, softer economic data and share market falls are all feeding on themselves, resulting in a significantly increased risk of recession in the US and Europe, particularly in the latter.
Signs of rising stress in European interbank lending markets are also adding to fears of a re-run of the GFC.
Our assessment is growth in advanced countries over the year ahead will be a paltry 1% and global growth will be around 3.25%, well below trend and consensus.
There is significant downside risk to this, particularly in Europe and the US.
During the GFC, as a result of the impact on confidence, loss of share market wealth, disruptions to lending markets and reduced demand for our exports, Australia wasn’t left unscathed.
However, thanks to a combination of rapid monetary and fiscal stimulus, a strong financial system, resilient Chinese export demand and a bit of good luck, Australia got by with only a slowdown in growth.
It was the only advanced country to avoid recession.
But would we be so lucky this time around?
How vulnerable is the Australian economy?
Australia is not immune to any renewed global economic slump.
Business and consumer confidence have already been hit hard (see the next chart), the fall in share markets has resulted in a renewed loss of wealth, another global credit crunch will adversely affect lending and exports will be impacted if economic weakness in the US and Europe drags down our key trading partners in Asia.
What’s more, the renewed threat to global growth is occurring at a time when household demand in Australia is weak on the back of consumer caution and the global turmoil may only reinforce this.
Announced job layoffs are rising – totalling around 9000 so far – and are likely to – increase further as companies revise down the demand expectations that underpinned last year’s employment surge.
By year end unemployment is likely to rise to 5.5%.
Australia’s high house prices relative to income levels and associated high level of household debt is an added source of vulnerability should an economic downturn threaten the ability of Australians to service their mortgages.
However, notwithstanding these risk points, Australia is reasonably well placed to withstand a possible return to recession in the US and Europe.
As in 2008, interest rates have a long way to fall if need be.
While it may take a month or so for the RBA to change its thinking from rate hikes to rate cuts, we expect the combination of increased global risks and rising unemployment to convince the Bank to start cutting interest rates by year end, possibly as early as October.
With 85% of Australian mortgagees on floating rate loans, as we saw in 2009 slashing them has a powerful impact on demand.
While the scope for fiscal stimulus is less than it was in 2008 as the budget is now in deficit, Australia’s trivial level of net public debt (i.e. 8% of GDP compared to 72% in the US) suggests there is room for targeted, timely and temporary fiscal stimulus if needed.
Gearing and financial leverage is low compared to the situation prior to the GFC.
Corporate gearing is well below long term average levels in contrast to 2007, margin lending is low, and private credit growth is running around its lowest level since the early 1990’s recession.
In fact, the Australian corporate sector as a whole is cashed up having gone from a borrowing sector of the economy in 2007 to a net lender now.
In the event of a sharp fall in commodity prices, the $A would likely fall sharply, just as it fell nearly 40% in second half 2008 – providing a huge boost to competitiveness and thus acting as a buffer.
Banks are less dependent on global markets for funding than in 2007, with 50% of funding coming from deposits compared to less than 40% at the time of the GFC, and are far less dependent on short term funding.
In fact, banks are now starting to cut deposit rates as they are awash with cash at a time when credit growth is weak.
While households are cautious, they have built up a large savings buffer which they are likely to eat into if unemployment rises and interest rates fall.
While the mining sector is not immune to lower commodity prices, the huge pipeline of work in mining in 2008.
Finally, our key export markets in Asia are more secure than those in Europe and the US and may prove more resilient this time around.
A big factor behind the transmission of the GFC to emerging countries in 2008 was a drying up in trade finance.
That is less likely to occur this time.
In the meantime, credit growth in emerging countries has been much more constrained this time around, Chi
