Australia and New Zealand - Weekly Prospects

Australia and New Zealand - Weekly Prospects

In a forecast change, we now expect the RBA to tighten 25bp on 4 July. Last week’s upbeat data showed the economy growing way above potential and the jobless rate unexpectedly plunging to 4.2%. The economy’s lack of spare capacity will trigger inflation pressure at the same time that food and electricity prices spike owing to the drought, and as petrol prices reach fresh highs. Tightening in July gets the move out of the way well ahead of the Federal election, which probably will be held in November, and before the plunge in annual inflation in 2Q and 3Q, expected on the back of favourable year-ago base effects. We expect another tightening in February 2008.

In New Zealand, RBNZ surprised the market by tightening last Thursday, and delivered a hawkish commentary signaling more to come. The surprise tightening was designed to shock the market and clear the slate, so that the RBNZ can shift into 'data dependency' mode. Although there never is just one reason for a rate hike, the last straw was (NZ's largest dairy company) Fonterra's announcement that next fiscal year's dairy payout will increase by 27%. This comes on top of rapid growth in domestic demand and government spending. The likely impact was too much for a central bank with little-to-no headroom for inflation over the medium term. Yesterday, the RBNZ announced that it had intervened in the FX market, selling NZD.

Over the past year, we have consistently argued that the US housing downturn was not a major threat to global growth and financial market buoyancy. The sectoral nature of the housing adjustment—reflecting a squeeze on affordability not caused by a generalized tightening in US or global financial conditions— made it unlikely it would produce broad-based macroeconomic weakness. Our confidence in this view was bolstered by the supportive role of global central banks. Real policy rates have been moving higher but have remained below long-term norms, despite sustained above-trend growth.

The growth-supportive stance sustained by global central banks during this expansion is not unconditional. It has been based on a view of lingering downside risks—Asian deflation, Eurosclerosis, and the recent US housing slide—and a willingness to experiment with the limits to growth in an environment where resource utilization rates are high. But central banks have not relaxed their commitment to low inflation, and growth risks are now fading alongside a surprisingly rapid rise in resource utilization rates.

ENDS

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