US Growth contracts As RBA Softens Us Up

Sydney, Oct 31, 2008 (ABN Newswire) - We are all going to be poorer and feel poorer over the next couple of years, according to the second most senior bloke at the Reserve Bank, Deputy Governor, Ric Battellino.

But at the same time, he believes there's a reasonable chance we could escape an actual recession, despite forecasts of such a slump by the likes of Goldman Sachs JBWere and JP Morgan in the past week or so.

And Westpac Bank yesterday said it saw no reason for Australia to enter a recession as it said it was looking for growth of around 2% next year.

That's unlike the US where growth contracted 0.3% in the first estimate of third quarter economic growth, the biggest fall since 2001 and the second within a year.

Consumer spending suffered its biggest fall in 27 years and the first in 17 years as tens of thousands of Americans lost their jobs and or their homes and simply stopped spending money on food, cars and the like, homes, you name it.

It was a depressing report and economists now expect growth in the current quarter to contract by more: estimates of a fall of 2% and more were being made this morning.

Even though we in Australia face an uncertain year and a possible slump, we will not face the bitter and deep recession that Americans are now enduring.

But it will get tougher here, which means lower sales for retailers, home builders and others serving the consumer. In our national accounts for the June quarter, consumption fell 0.1%, the first fall since 1991. In the US the fall was a huge 3.1%. 

That tells us something about the relative intensity of the two economic slowdowns.

Westpac rival, the National Australia Bank has said (this week in its monthly business survey) that it believes growth will slow, but not contract, but unemployment will rise to 6% over the next couple of years and the present budget surplus of around $22 billion, will become a deficit of around $10 billion in the same period of time.

That will mean a slowing in loan growth for banks and downward pressure on earnings in 2009 and heading into 2010.

In a speech to a Sydney conference yesterday Mr Battellino said Australia was going through "uncertain financial times at present which is leading some to question whether the period of prosperity that has been running for almost two decades has come to an end".

"The next couple of years will be noticeably more subdued than the past five. We should not be surprised by this as the income and wealth generated over the past five years were simply extraordinary.

"While nobody can predict accurately all that lies ahead, it is important not to become too pessimistic because, fundamentally, household finances and the economy more generally remain in good shape.



"The main problem that had built up – inflation – is manageable and is being dealt with.

"By definition, the economy must grow at a below average pace for some of the time. These periods provide the economy with the breathing space to sustain the expansion. There is no reason to assume that the next year or two will not do the same."

"Australia managed to sidestep the 2001 global recession. Can it do that again?" he asked.

"That is certainly what we are aiming for, and there is nothing in the data to date to suggest that we are off track.

"But the economy is being affected by powerful forces from different directions, and it is unclear what the net effect will be. The impact of global developments is particularly uncertain.

"We also have to recognise that the task of managing the economy this time will be more difficult than in 2001 because we are starting with a bigger inflation overhang."

And that comment got market economists wringing their hands and claiming that the bank would no longer be cutting rates as deeply as thought.

"The (Reserve) Bank has for some time thought that inflation would peak in the second half of 2008 and then fall; accordingly, we have acted pre-emptively in reducing interest rates.

"Nonetheless, there is still a big task ahead to bring inflation down and this could limit room for manoeuvre on monetary policy."

That had the market economists then wondering if there would be a cut at all next Tuesday.

But one of those economists, Rory Robertson of Macquarie Bank wrote before the speech that he was looking for more rate cuts from the RBA by the end of the year.

"I'm still expecting 100bp worth of further cuts (to 5%) before Christmas, in 50bp lots in November and December. The (likely) cut next Tuesday will come at 2.30pm, just half an hour before the 3pm running of this year's Melbourne Cup.

"Some have argued that Canberra's recently announced fiscal easing (worth nearly 1% of GDP) substantially limits the RBA's room - and inclination - to cut further before Christmas. I doubt it.

"In my opinion, the alarming deterioration of the global outlook and sharply increased risk of recession in Australia mean there is plenty of room for both further cuts in interest rates AND the announced fiscal stimulus."

Mr Battellino's speech was an update on "household finances''.

His appearance was rare, coming so close to a RBA rate setting board meeting on Tuesday.

Another senior RBA official, financial markets boss, Guy Debelle, is due to give a speech in Melbourne today updating us on how the bank's market operations have been going during the most volatile period seen for decades.

There's nothing to be read into the two public appearances by senior bank officials before a rate meeting, but it is unusual in the current context of intense speculation about a rate cut next Tuesday.

Mr Battellino's speech seems to have been one of those warming us up for the inevitable outcome of the slowing local and global economy.

He did point out that the past five years have been an extraordinarily favourable period for household incomes in Australia.

"Real disposable income of the household sector grew on average by 6.1 per cent per year, resulting in a cumulative increase over the five years of more than 30 per cent.

"One has to go back more than 30 years to find a bigger increase over a five-year period.

"This growth in household incomes in Australia greatly exceeded that in any other developed economy. In the US, for example, growth in real household disposable income was only about half that in Australia.

"It is also interesting to note that the growth in income in Australia was fairly evenly distributed through the household sector.

"The percentage increase in real income was very similar across all the income quintiles. In short, the boom in income in Australia was very strong by world standards and a high proportion of Australian households shared it.

"These facts help us to understand how we got to where we are, but the more relevant question for households is: where are we heading over the coming five years?

"I think it is now widely accepted that growth in real incomes over the next year or two will be more subdued than over the past five years. How subdued will depend importantly on the effects of the financial turmoil. 

"Nobody knows how significant they will turn out to be but it would be reasonable to assume that income growth for the household sector will be noticeably below average over the next year or two."

He mentioned the downturn in share markets and how that had cut the holdings of financial assets in householders:

"Australian households have much bigger holdings of financial assets than financial liabilities.

"Financial assets at 30 June averaged around $275 000 per household while liabilities averaged $150 000 per household. Since then, we estimate that average assets have fallen to around $245 000 per household, though this is still quite a strong position.

"The returns do not, however, accumulate evenly from year to year. Some years produce very strong returns while others produce negative returns.

"We are currently going through one of those periods of negative returns. As I mentioned, the Australian share market has fallen sharply this year.

"Largely because of this, the typical balanced superannuation fund experienced a negative return of about 8 per cent last financial year. Returns are again negative so far this financial year.

"Naturally, people find this very distressing. But it is not the first time this has happened. Over the past 100 years, the share market on average has had negative returns every 5 years."

Mr Battellino did point out that the "one-year forward earnings yield on Australian shares has risen to 11 per cent, well above the long-run average.

"This is a very attractive yield. When the yield has risen to these levels in the past, the return on shares over the subsequent 10 years has almost always been well above average."

On housing he was upbeat (relative, of course), pointing out the substantial differences between Australia and the US.

"The Australian housing boom ended because prices rose to levels that severely strained the financial capacity of buyers to pay higher prices, not because too many houses were built, as in the US.

"The overhang of unsold houses in the US has created downward pressure on house prices as builders and developers have been forced to sell. This is absent in Australia.

"Rather, the shortage of housing here means that there are buyers waiting for better circumstances – e.g. lower interest rates or rising incomes – to facilitate their entry to the market.

"This latent underlying demand for housing is a factor that will support the market."

And he said there was a third factor, the different customer groups targeted by lenders.

In the US it was lower socio income groups (subprime) who have had trouble paying off their loans; in Australia lenders aimed at mostly existing home owners who traded up to bigger and better homes and bought investment properties, but who could afford to service their loans.


 

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