Australia and New Zealand Weekly Prospects

Australia and New Zealand Weekly Prospects

* The RBA again takes centre stage this week, with a premiere performance on Monday and an encore Friday. The tone of Monday's quarterly policy statement will echo last week's announcement of the higher cash rate. Importantly, the statement probably will leave unchanged the core inflation forecast at 2.75%—raising the forecast to 3.0% would send an unnecessarily hawkish signal. On Friday, Governor Stevens appears before a Parliamentary committee to present a prepared statement and take questions from MPs. Amid the inevitable questions from MPs trying to score political points by having the Governor attribute blame for the economy's capacity constraints and higher interest rates, Mr Stevens will provide invaluable colour on the economic and policy outlook.

* This week's retail trade release will take centre stage in New Zealand - we expect 2Q volumes to contract 0.1%q/q. The likely disappointing quarterly outcome will add more downside risk to the RBNZ 2Q GDP forecast of 0.8%q/q. House prices fell for the second consecutive month in June, as the cracks in the housing market fortress widened. The RBNZ will take some comfort in the housing report, but will remain on edge as pressures continue to build in the labour market—which is currently tight as a drum. Last week's labour cost index is testament to an economy which is operating at full capacity, with wages growth remaining above 3%oya, and points to further pipeline pressure on non-tradables inflation.

* In many ways, the repricing of risk was expected and welcomed by most monetary authorities. The consistent message sent by central bankers last week reflects their view that a repricing of credit risk is warranted and promotes sustained healthy macroeconomic performance. It also reflects their view that the temporary removal of liquidity in long-term credit markets does not pose a threat to growth. The drying up of short-term liquidity to financial institutions in recent days, though, is a far more serious concern to central banks. If left unchecked, it could produce a withdrawal of funding that might quickly transform a liquidity squeeze into a disruption of the normal activities of businesses and households.

* Faced with a decline in short-term liquidity, the Fed, the ECB, and other central banks are increasing daily operations to maintain overnight rates at targeted levels. A further deterioration in risk appetite, however, would be reflected in additional losses in the equity market and most likely a contagion into other markets. In this scenario, the stability of the financial system would be threatened, along with the macroeconomic outlook. In response, the Fed, along with other central banks, would be quick to respond by lowering the path of policy they currently are following. As a result, we now view a Fed ease in August as a genuine possibility. For now, we are flagging increased downside risk to our upbeat global growth forecast, without making changes to the baseline view.

ENDS

AusNZ_weekly_120807.pdf

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