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Business Outlook, 25 October 2011

by David Robertson, Head of Financial Markets, Bendigo and Adelaide Bank Limited

Once again the international focus has been on the stability of the European banking system and the health of EU banks - and how well capitalised the banks are to cope with likely default / haircuts on Greek assets.

Commitments to adequately capitalise the banks are still being agreed upon, as are the precise details of the role of the European Financial Stability Fund (EFSF). The general consensus is that while keeping the eurozone ‘operational’ will not only be politically challenging (an understatement) and will require enormous financial commitments, the alternative of allowing the euro currency to unwind would be far more damaging.  All of this is flowing through to stress in European money-markets, where credit spreads have been widening.

The fears for the rest of the world around contagion for banks and for the broader financial system have receded a little over the last fortnight, flowing through to a mild recovery in equity markets and riskier assets. Until the finer details of the EFSF role are fully agreed and implemented, it is difficult to predict a more meaningful recovery in confidence and risk appetite. Looking at the absolute value of ECB lending to the central banks in Ireland, Greece and Portugal (and more recently to Spain and Italy) we suspect volatility in the markets will only increase through November and December.

The news from the US has been mixed, with mildly encouraging news around retail sales and housing starts, although fairly insipid growth in Industrial Production and also new jobs. The fiscal stimulus proposed by President Obama (around 3% of GDP) in response to the lack of a sustainable recovery post GFC initially helped consumer and business sentiment a little, but like Europe the lingering concerns around public sector debt make it difficult to suggest this improvement in sentiment will last.

Asia remains the bright spot (still) other than Japan, and the latest data from China seems to indicate pleasingly a very minor deceleration in growth. Specifically, the figures from China this week were:

• Year-on-year GDP rose 9.1% from 9.5% prior
• Industrial Production rose 14.2% YoY (unchanged)
• Retail Sales rose 17.7% YoY from 17.0% prior, and
• Fixed Asset Investment rose 24.9% from 25% prior
   

- which combined with stubbornly high export figures earlier this month (including to Europe and North America) does not seem to suggest the EU/US issues are slowing China down just yet.

The volatility in overseas markets has flown through to the Aussie Dollar this month, falling to 0.9388 on October 4 at the lowest point of confidence around EU stability, but sharply rallying back to 1.0372 by October 17 as optimism returned.

Meanwhile the language from the RBA has been subtly evolving, from the implication that as recently as August a rate rise was seriously considered, to Tuesday’s minutes of the RBA Board meeting where it was noted ‘an improved inflation outlook, if confirmed by further data, would increase the scope for monetary policy to provide some support to demand’. 

The next inflation data is due on October 26, so the market will be highly sensitive to any surprises in this data. Core measures of inflation are surprisingly low at present, having stripped out volatile and one-off components, despite the headline CPI rate being 3.6%.

The latest quarterly growth figures were stronger than expected, with a rise of 1.2% in the June quarter as the flood-induced contraction of the previous quarter were reversed. The latest consensus around our GDP is for a recovery back to 3% growth next year, although the IMF were less confident forecasting only a 2% growth rate for 2011. The RBA minutes noted the significant variation in conditions across the sectors, with private sector demand particularly strong in resources investment, in contrast to challenging conditions for retail, tourism and manufacturing. Consumer and business confidence remained weak, and the housing market subdued. 

The latest jobs data was better than expected, with unemployment falling to 5.2%. Commodity prices and the Terms of Trade remain at record high levels. All a very challenging combination to assess.

The RBA have opened the door to a rate cut over the coming months, with the likelihood of a Melbourne Cup day rate-cut at the mercy of the inflation data to be released on October 26, as well as developments in Europe with respect to their sovereign debt crisis.

A rate cut prior to year end is possible, but we are sceptical of the large number of rate cuts currently priced into the futures market.

Archived:

• Business Outlook, June 2011 
• Business Outlook, February 2011
• Business Outlook, October 2010