Australian & New Zealand Weekly

Week beginning 2 February

• Australia: we've downgraded our growth forecasts.
• RBA to cut rates in Feb by 100bps to 3.25%.
• Australian data: retail, building approvals, trade, house prices, monthly inflation gauge, monthly PMI.
• New Zealand data: wages, employment, migration.
• BoE to cut by 0.5% but ECB to pause in Feb & then cut in March.
• US data: ISMs, payrolls, factory orders, construction, personal income & spend, consumer credit, Fedspeak.
• Key economic & financial forecasts.

Australia: We've Downgraded Our Growth Forecast RBA to Cut by 100bps

• Australian economy to contract by 0.7% through 2009.
• Australian economy to outperform G7 in 2009 due to greater policy flexibility.
• Unemployment rate to rise to 7.0% by end 2010.
• RBA's cash rate to reach 2% by June Quarter; 100 bp rate cut on February 3.
• Global recovery will be slow keeping global rates very low through 2009 and 2010.

The events of the last 18 months, particularly the last few months, have convinced us that the corporate sectors of the US; UK; Europe and Japan have or are very likely to enter into balance sheet recessions. Balance sheet recessions are rare but the evidence we have from the 1930's and Japan in the 1990's suggest they are drawn out and very painful. A balance sheet recession can result when economic entities encounter violent falls in asset prices. In the case of the corporate sectors the collapse in equity and commercial property prices and the implications which these prices have for other unlisted assets on their balance sheets have and will continue to spur the corporates to hoard cash and/or pay down debt.

Debt reduction and cash hoarding has replaced profit maximisation as the key corporate objective. Due to excessive gearing and poor risk management policies, the worst affected balance sheets have been those of the financial sector entities. The combination of limited supply of credit (as financials seek to restore their balance sheets) and weak demand for funds (as corporates pay down debt and hoard cash) will constrain economic growth prospects for a considerable period - well beyond 2009.

The depth and timing of these recessions will be heavily affected by the responses of the authorities.

Monetary policy has little impact in these circumstances because the demand for funds is not driven by price rather the need to restore balance sheets. However monetary policy should certainly not exacerbate the problems by adopting policy settings associated with targeting inflation which are appropriate for a "profit maximisation world". Interest rates should be reduced to extremely low levels very quickly and held there for a considerable time. Hence monetary policy's role has to be to "get out of the way" while corporates are operating in this way. In time, when it becomes clear that the balance sheet effect is no longer driving economic decisions then monetary policy needs to be activated quickly to mop up excess liquidity and manage the spending recovery.

Even quantitative easing has a limited impact since both lenders and borrowers are more concerned with restoring balance sheet health than making or receiving more loans. Such an environment will mean continuing contraction in corporate spending and employment plans. In those countries like US; UK; and parts of Europe the collapse in house prices has had a comparable impact on the household sector's demand for funds while the collapse of asset quality in the financial sector's balance sheets has constrained supply of funds to the household sector. Household spending will be affected by the households' balance sheet concerns; the financial sectors' risk aversion and the reduced employment opportunities as the corporate sector reacts to its own balance sheet problems.

The most important policy response must come from the fiscal authorities. Total spending in the economy can only be sustained if the public sector spending largely fills the gap created by the reduced spending from the private sector. When we saw a similar response from both corporate and household sectors in the aftermath of the share market collapse in 1929 the 4 year delay in an appropriate fiscal response exacerbated the Great Depression and allowed deflation to take hold. The fiscal authorities must also act to restore the functioning of the financial system through guarantees; capital injections; and assistance in restoring the balance sheet quality of the banks. While the central bank may be used as the agent of these initiatives these are really aspects of fiscal policy.

The general fiscal stimulus needs to be focussed on spending rather than tax cuts since corporates and possibly, households which are still in the "balance sheet recession" mode are likely to save much of any tax cut.

Fiscal policy should be used aggressively to ensure that total spending and the money supply do not contract as we saw in the period in the US between 1929 and 1933 particularly to manage the risk associated with entrenching deflation and deflationary expectations.

This environment points to an extended period of weak global growth with the contractions/anaemic growth in the G7 through 2009 and 2010. At this stage the fiscal responses of these major economies remain underwhelming given the enormity of the problems although the lessons of the 1929 - 1933 period have been partly heeded.

What Does This Mean for Australia?

It is likely that the Australian corporate sector is also entering a period where balance sheet health overrides profit maximisation. While trends prior to the RBA's recent aggressive rate cuts pointed to the household sector adopting a more conservative approach to debt, there is early encouraging evidence that the demand for funds has picked up in response to the recent aggressive rate cuts by the RBA and the efficient pass through of those cuts to borrowers.

While the collapse in equity and commercial property prices will focus the attention of the corporate sector on balance sheet issues, house prices, which are the key asset price for households, have been relatively stable. Policy needs to be aimed at avoiding a balance sheet recession for the household sector. With Australia's household sector holding record debt levels the risk of a balance sheet recession for the household sector cannot be ignored.

Monetary policy is still effective in Australia with banks being in a position to pass rate cuts through to borrowers and households likely to continue to respond positively to those cuts. There is considerable scope for monetary policy to be used in this way and that policy option must be taken. Nevertheless, households will inevitably be adversely affected by the employment decisions of the corporate sector so aggressive rate cuts are important to assist the cash flow positions of the household sector; encourage more borrowing and investment in housing and avoid a balance sheet recession in the household sector.

However, the most important policy option needs to be fiscal policy. The Australian government is already showing positive signs of accepting its responsibility to ensure the stability of the financial system. There is more work to be done in sustaining demand in the face of the inevitable weakness in private sector spending. As with the US and others, direct spending needs to be favoured over tax cuts to ensure maximum support to demand.

These Observations have Significant Implications for our Financial and Macro Forecasts.

1. In previous global recessions Australia has underperformed the average G7 (see Figure 1). Because this global recession is different there is a respectable case for Australia's growth profile to exceed average G7. Australia has more policy flexibility to deal with current problems and, in particular, these policy options should allow the household sector to avoid a balance sheet recession. However, we emphasise that an aggressive mix of monetary and fiscal policy will be required to achieve this desirable outcome.

2. Despite this relatively favourable outcome we still expect that the Australian economy will contract in 2009 by 0.7%. With appropriate policy that low point should be followed by positive but anaemic growth of around 1.8% through 2010.

3. The RBA will cut rates even more aggressively than we previously expected reaching a low point in the cash rate of 2% (from the current 4.25%) by June quarter 2009 (our previous forecast low was 2.75%). Risks on this low point are to the downside because the essential role for the RBA in 2009 will be to manage interest rates to a level where rates are providing the maximum possible boost to the household sector. Hopefully, the Bank is quickly accepting that inflation targeting is not appropriate in the current environment and minimisation of the impact of the global balance sheet recessions on the real economy is the central policy objective.

4. With the corporate balance sheet issues remaining a constraint for some years both globally and locally there will be insufficient evidence for the RBA to see the need to return policy to a more "normal" policy stance before 2011 - expect these low rates to be sustained throughout 2010.

5. The Australian corporate sector will not only be adversely affected by deteriorating balance sheets but those in the resource sector and those companies that service the resource sector will also have to deal with a massive reversal in Australia's terms of trade - the resulting impact on cash flows will complement the balance sheet issues in constraining capital and labour expenditure. Our view of the world economy is not consistent with any major revival in commodity prices over the next two years.

6. Business investment, employment and exports will be much softer than previously expected, reflecting the likely weakness in corporate spending plans. We expect business investment to contract 13% in 2009 and a further 8% in 2010. The unemployment rate is likely to reach 6% by end 2009 and 7.0% by the end of 2010. Export growth will fall from 6% in 2008 to -1.0% in 2009.

7. While our policy expectations envisage that the household sector will avoid a balance sheet recession household spending will be constrained for longer due to the conservative approach taken by the business sector both in Australia and globally. Consumer spending will grow by only 1% in 2009 and 1.7% in 2010. That anaemic growth while well below par is still contingent on aggressive fiscal and monetary policy responses.

8. The authorities will embrace a much more aggressive fiscal policy than previously expected and the stimulus will need to last longer than one year. Expect continuing additional stimulus policies to be enacted in both 2009 and 2010. With the starting position being "no net debt" the Australian authorities have considerable scope to use fiscal policy effectively. We note that the latest fiscal package being considered by the new US president is around 8% of GDP - so far Australian's fiscal stimuluses have been only around 1.5% of GDP. We expect more stimulus packages mainly centred on public works and other spending policies. Our current growth forecasts for 2009 and 2010 assume further fiscal initiatives while recognising that our preferred policy emphasis of public works and direct expenditure will have the major impact in 2010.

9. With the global economies realising the urgent need for stimulatory fiscal policies those economies with below par growth and running trade surpluses should rely exclusively on domestic policies to stimulate growth- we are encouraged by announced intentions of both China and Japan in this regard. Those economies with below par growth and trade deficits should be able to expect some growth "assistance" from external factors. That implies appreciation of surplus currencies and depreciation of deficit currencies. USD and AUD fit into that deficit framework while RMB; JPY; and EURO fit the surplus model.

10. With global risk concerns likely to be sustained for some time; its fiscal stimulus policies lagging the US and the interest rate differential closing by 225 ppts the AUD is likely to depreciate against USD in the near term. However we expect that in the medium term Australia will be more successful than US in stimulating its economy particularly due to a much healthier financial and household sectors. That points to eventual strength of AUD against USD although the surplus countries are likely to continue to outperform (on the assumption of an absence of official intervention).

Australia: Data Wrap

Q4 PPI

• Q4 Final Stage PPI inflation was well above consensus at 1.3%qtr (consensus 0.4%, Westpac 1.7%), lifting the annual rate to 6.4% from 5.6%, a new record high. However, with weakness in demand we see little prospect of PPI pressures flowing through to consumer prices, leaving margins under continued pressure.
• Non-core elements subtracted less from the PPI than expected, with weaker than expected petroleum refining prices (fell 29.1%, subtracting 1.02ppts) but stronger than expected food prices (rose 3.1%, adding 0.51ppts), giving a net 0.52ppt subtraction from the quarterly PPI.
• The strong 3.1% rise in food prices followed a 2.5% rise previously. While CPI food prices are more margin dependent and not well correlated with PPI equivalents, the stronger pace of PPI food price pressures supports our expectation of stronger CPI food group inflation in Q4 than Q3 (our f/c is 1.5%qtr vs 1.4% prev).
• Ex-food and petroleum, the core PPI rose at a record pace in Q4 of 2.3%qtr and 6.8%yr (vs 2.0%qtr, 4.8%yr prev). Core import prices were entirely responsible for the record core PPI pace, a reflection of the AUD plunge, rising 16.9%qtr and 17.2%yr.
• Abstracting from import pressures, domestic core pressures eased encouragingly, even after allowing for an unexpected fall in building construction prices and the dropping out of last quarter's seasonal jump in utilities. The domestic core PPI ex-construction and utilities rose 0.9%qtr and 4.5%yr (vs 1.2%qtr, 4.0%yr prev).
• Building construction prices saw an unexpected 0.4%qtr fall led by non-residential building construction and 'other' residential building construction. House construction output prices rose only 0.3%.

Nov Westpac-MI Leading Index

• The annualised growth rate of the Westpac-Melbourne Institute Leading Index, which indicates the likely pace of economic activity three to nine months into the future, was -2.2% in November, well below its long term trend of 3.5%. The annualised growth rate of the Coincident Index was 1.3%, also below its long term trend of 3.5%.

Q4 CPI

• Australian CPI 2008Q4 - headline CPI was above consensus but cuts annual rate markedly; quarterly underlying CPI decelerates significantly and below consensus.
• The headline CPI was -0.3%qtr in Q4, the weakest result since 1997Q3, after a 1.2% rise previously. With a markedly higher +0.9%qtr result from the prior year dropping out, the annual rate fell sharply to 3.7%yr from 5.0%yr previously, the lowest since 2007Q4. The consensus forecast was -0.4%qtr, our Westpac forecast was -0.5%qtr and the forecast range was wide, from -0.9% to +0.2%.
• The main source of the upside surprise relative to our forecast was a stronger than expected rise in the food group, explaining 0.08ppts of the 0.2ppt difference between the headline result (-0.3%) and our forecast (-0.5%). Alcohol and tobacco contributed 0.04ppts more than expected due to the cessation of specials. Slightly higher than expected contributions were also seen in clothing and footwear.
• The main negative headline contributions were from petrol, motor vehicles, deposit and loan facilities and pharmaceuticals. These were partially offset by increases in rent, fruit, tobacco, and takeaway and fast foods.
• The ABS published RBA measures of underlying inflation (published only to one decimal place) showed a trimmed mean CPI of 0.6%qtr (vs 1.2% prev) lowering the annual rate to 4.2%yr from 4.6%, the lowest since 2008Q1. The weighted median CPI was 0.9%qtr (vs 1.3% prev) lowering the annual rate to 4.5%yr from 4.8%, the lowest since 2008Q2. This gives an approximate average RBA underlying result of 0.75%qtr (vs 1.25%qtr prev) and 4.35%yr (vs 4.7%yr prev), the lowest annual rate since 2008Q1. The consensus forecast for the average RBA underlying rate was 0.8%qtr, our Westpac forecast was 0.6%qtr, and the forecast range was wide from 0.4% to 1.2%.
• We calculate the average RBA underlying rate to two decimal places was 0.74%qtr (vs 1.24%qtr prev), the lowest since 2007Q1. Also using our two decimal place figures, this has lowered the average annual RBA underlying rate to 4.36%yr from 4.72%yr, the lowest since 2008Q1.

Dec private credit

• Private credit in December contracted by 0.3%, following a 0.4% rise in November. The December result, the first decline since December 1992, was much weaker than expected (mkt 0.5%, Westpac f/c 0.4%). The major surprise was business credit, which contacted by 1.1% in the month - the first decline since early 2004.

Round-up of local data released last week

New Zealand: The Week ahead & Economic Wrap

Cut to the quick

The Reserve Bank cut the OCR by a further 150 basis points to 3.50% this week, in line with our expectations. The majority of analysts were picking a 100bp move, with market pricing splitting the difference.

The RBNZ has received at least as much unwelcome news on the economy since the December Monetary Policy Statement as it did between the October and December reviews. Consensus Forecasts for global growth have been slashed at an unprecedented pace. New Zealand's main trading partners are expected to contract by 0.1% this year, compared to forecasts of 1.3% growth at the time of the December MPS, and we expect this will be downgraded even further as forecasters come to grips with the idea that Australia won't avoid recession this year. RBNZ Governor Bollard was accurate in describing this as “worse than anything we have seen since World War II”.

Closer to home, the near-term outlook for activity is substantially worse. In December, the RBNZ shared our view at the time that negative GDP growth would be limited to the first three quarters of 2008 (though growth would remain sub-par for a while longer than that). But recent business surveys have been extremely weak - firms are shoring up their own prospects by delaying investments and shedding staff. Meanwhile, it's becoming clear that much of the extra cash hitting consumers' pockets from cheaper fuel, lower interest rates and tax cuts is staying there. We now expect Q4 GDP to mark the deepest point of the recession with a 0.9% decline, followed by further declines in the first half of 2009.

And if the RBNZ needed any more reason to deliver a large cut, this week also saw another significant drop in Fonterra's dairy payout forecast to $5.10/kg for this season. Global recession has hit demand for dairy products, at the same time that previously high dairy prices have spurred new supply. Even allowing for a recovery in production from last year's drought, this still means around $3bn less in dairy farmers' pockets compared to last season. The threat to prices from market interventions in Europe, with the US possibly to follow, adds further downside risk to the dairy price outlook.

The RBNZ's press release noted that further rate cuts would likely be smaller and dependent on events. We see this more as a reflection of the fact that the RBNZ has delivered most of the expected easing up-front - we think that they have an end-point in mind of around 3% for 90-day rates (compared to 5% in the December MPS), and today's cut gets them much of the way there. We don't think they're at all concerned about running out of room to ease - zero rates are still a long way away. Bear in mind that many developed economies started their easing cycles from rates closer to 4-5%.

Nor do we put any credence on the idea that the RBNZ can't afford to lower interest rates further for fear of scaring off foreign funding. With many major countries likely to face zero or near-zero interest rates this year, New Zealand's interest rates would still be attractive even at lower levels from here.

We remain of the view that the OCR is heading to a low of 2.50% by the middle of the year - and the RBNZ clearly intends to get there sooner rather than later. With that in mind, we think that 50bp is in the bag for the March MPS, and any further nasty surprises on the global economy will increase the odds of a larger move.

Next week brings key updates on the labour market. Wage growth (Monday) has been very strong in recent years, with the Labour Cost Index recording a record annual gain of 3.7% in the September quarter. We expect another solid gain of 0.9% in Q4, taking the annual rate down slightly to 3.5%. Wage inflation tends to follow inflation expectations far more than economic growth or unemployment, and inflation expectations were still very high in the RBNZ's most recent survey in November. Seasonal strength is also likely to be a factor, reflecting the fact that a greater share of pay reviews occur in the second half of the year.

Thursday's employment figures are expected to show that the downturn in New Zealand has entered a new phase. For the first three quarters of 2008, employment was basically flat. Sure, there were layoffs, but for the most part disaffected workers were able to find alternative jobs fairly quickly. Consequently, unemployment rose only modestly.

The picture is now uglier. The latest Quarterly Survey of Business Opinion revealed that more firms have been firing than hiring. We expect overall employment to fall 0.5% for the December quarter, with full-time employment disproportionately weak. We are bracing for something much worse next quarter. In this environment, workers laid off from one firm are much less likely to find work at another. Instead, many will become unemployed. We expect the unemployment rate to rise to 4.6% in Q4, on its way to 6.4% by the end of 2009. The labour force participation rate tends to fall when unemployment rises, so we are forecasting a small fall in participation this quarter.

Round-up of local data released last week

Data Previews

Aus Q4 house price index

Feb 2, Last: -1.8%, WBC f/c: -1.4%

Mkt f/c: -1.0%, Range: -2.5% to flat

• House prices fell 1.8% in Q3 after slipping 0.2% in Q2. All major capital cities recorded declines as markets came under intense pressure from high mortgage rates (peaking at 9.6% in August) and global financial turmoil.
• Prices stayed under pressure in Q4 with private measures recording falls ranging from -1.1% to -1.6%. Rate cuts and the Govt's boost to the first home buyers' grant would have had little impact in the quarter. Meanwhile, negatives from financial turmoil are likely to have intensified with more 'motivated' sellers in Q4. Overall we expect a 1.4% fall in the official price index in Q4, dragging annual growth to -2.8%yr, the biggest fall since official data began in 1987 (although similar real price declines were recorded in 1987, 1990 and 1996). Falls remain milder than in the US, UK, NZ and Europe due to the acute shortage of housing in Australia.

Aus Dec international trade balance, AUDbn

Feb 3, Last: +$1.448bn, WBC f/c: +$0.1bn

Mkt f/c: $0.95bn, Range: -$0.6bn to $2.4bn

• The trade surplus fell markedly in Nov by $1.512bn to $1.448bn. X fell 3.6% led by a 4.7% drop in non-rural goods, driven by a sharp pullback in metal ores and minerals as China's imports slumped. Total X trend growth slowed to 2.5%mth from 3.0% with non-rural growth slowing to 3.2%mth from 3.9%. M rose 2.0%, but ex-volatile nonmonetary gold, they fell 0.2%, indicative of weak volumes as the AUD fell 4.4% pressuring prices.
• Further X weakness is likely for Dec. Lower prices, cereal and meat vols and a Sadj drag gives a 7.3% rural X fall. Anecdotes imply a rebound in ore X vols, but we look for vol weakness elsewhere amidst deteriorating global trade. Lower prices and a big Sadj drag gives an 8% non-rural X fall, with total X -7%, and downside risks. Merchandise M data implies -2% for total M. This gives a near balanced trade position, with downside risk.

Aus Feb RBA policy announcement

Feb 3, Last: 4.25%, WBC f/c: 3.25%

Mkt f/c: 3.25%, Range: 3.25% to 3.50%

• The RBA will announce a reduction in the cash rate, with a move of 0.75% or 1.0% the likely options. We come down in favour of a 1.0% reduction to a 'record' low of 3.25%. The risk at the moment is doing too little.
• The global and domestic economic environment have deteriorated further since the RBA last lowered rates on 3 December, with various indicators surprising on the low side.
• The world economy may well not expand at all in 2009, an outcome that would be the weakest since WWII. Against that backdrop it now appears likely that the Australian economy will contract during 2009. The latest dwelling approval and job ads data were extremely weak, suggesting a rapid deterioration in Q4. Moreover, and not surprisingly, inflation pressures are moderating quickly.

Aus Dec retail trade trends

Feb 4, Last: 0.1% (0.4% sa), WBC f/c: 1.0% (5.0% sa)

Mkt f/c: 0.2% (1.4% sa), Range: flat (flat sa) to 1.0% (5.0% sa)

• Trend sales rose 0.1%mth in Nov following gains of 0.2%mth in the previous three months. Sales rose 0.4% in seas. adjusted terms after several volatile months partly due to a survey redesign introduced in July. The ABS has reinstated the original design but data will still need to be treated with extra caution.
• Adding to this volatility, Dec will see a massive policyinduced spike in sales. One-off fiscal payments and 300bps in interest rate cuts are giving the biggest direct cash infusion to households in Australia's history. The boost is estimated to be $9.4bn in the Dec month alone. While much of this will be saved by a consumer deeply concerned about job prospects in the year ahead, some will inevitably be spent. We expect about $1bn to find its way into retail, resulting in a 5%mth jump (though unevenly across segments). This gives a 2%qtr rise for Q4 and an estimated increase of 1.4%qtr in real terms.

Aus Dec dwelling approvals

Feb 4, Last: -12.8%, WBC f/c: 5%

Mkt f/c: 2.5%, Range: -5.0% to 7.0%

• Dwelling approvals recorded a disconcertingly large 12.8% drop in Nov. The fall followed steady declines in the previous four months but was much larger - the biggest since 2002.
• While activity was clearly under pressure through 2008H2 the Nov slump is out of kilter with other indicators - new home sales and finance approvals for construction and purchase of new dwellings were both up slightly through Oct-Nov. Indeed industry figs show finance approvals surged strongly in Dec.
• We suspect the Nov figure will be revised up in time - a similar drop in Dec 2007 was revised up substantially. Either way, the RBA's aggressive rate cuts and the increased first home buyer grant should have a more pronounced positive impact on approvals from December. Funding constraints and heightened concerns about the global economy will still be a dampener but we expect a solid 5% rebound with risks to the upside.

NZ Q4 wage growth

Feb 2, LCI Last: 1.1%, WBC f/c: 0.9%

QES Last: 1.1%, WBC f/c: 0.9%

• Wage growth has been very strong in recent years and hit a record high last quarter. We expect the most useful guide on wage inflation, the LCI, to post another strong quarter mainly due to emerging seasonality in the series.
• In terms of market reaction, strong wage data was ignored last quarter and we expect a repeat this quarter. Conversely, a very weak wage number might generate a big market reaction, because wages are usually a lagging indicator typically following inflation expectations far more than economic growth or unemployment. Inflation expectations were still high in November when the survey was taken.
• We anticipate weakness in wages to begin in earnest only in 2009, given the usual lag.

NZ Q4 employment and unemployment

Feb 5, Employment Last: 0.1%, WBC f/c: -0.5%

Unemployment Last: 4.2%, WBC f/c: 4.6%

• Significant job losses probably began in Q4 2008.
• Unemployment to begin rising more rapidly, with an ultimate peak of 6.4%.
• Beware that employment has been volatile recently, and could give another false signal. The aberrant employment numbers were accompanied by sudden lurches in the labour force participation rate, while unemployment was more steady. Markets should therefore focus more closely on unemployment than employment.

US Jan ISM factory & non-manufacturing surveys

Feb 2, Factory Last: 32.9, WBC f/c: 33.2

Feb 4, Non-man Last: 40.1, WBC f/c: 41.0

• The factory ISM plunged from just under 50 in Aug to 32.9 in Dec, its lowest since 1980, reflecting the dramatic slump in Q4 growth (that should be confirmed in Q4 GDP on 30/1). However the regional Fed factory surveys for Jan out of New York, Philadelphia, Dallas and Richmond all showed modest improvement. That suggests that the Jan factory ISM should also be a little less weak, though our forecast of 33.2 would still be consistent with deep recession in Q1 2009.
• The non-manufacturing ISM fell to its lowest since the survey's 1997 inception in Nov at 37.4, but then corrected higher in Dec to 41.0. Lower gasoline prices, banking sector support, the Fed's zero interest rate policy and the prospect of fiscal stimulus are supportive factors which we expect will see the Jan non-man ISM hold onto that gain.

Bank of England and European Central Bank

Feb 5, BoE Last: 1.5%, WBC f/c: 1.0%

Feb 5, ECB Last: 2.0%, WBC f/c: 2.0%

• The BoE policy committee voted 8:1 for Jan's 50bp rate cut with the dissenter preferring a larger move. The minutes suggested that the new quarterly forecasts being prepared for the Feb policy meeting might make the case for further easing; we have no doubt that is the case given the steep fall in Q4 GDP growth and inflation. Lower rates won't solve the economy's problems but there is no place for unnecessarily high rates. The BoE will ultimately cut to zero.
• The ECB also cut 50bp in Jan but ECB chief Trichet hinted strongly that the next "important rendez-vous" would be the March meeting (when Q4 GDP and new staff forecasts will be available), not February. The ECB will cut to 1.0% or lower in coming months but the lack of killer weak data since the Jan 15 meeting means Trichet can stick with his Feb pause plan.

US Jan non-farm payrolls

Feb 6, Payrolls ch' Last: -524k, WBC f/c: -550k

Feb 6, Unemployment rate % Last: 7.2%, WBC f/c: 7.5%

• The US shed more than 1.5mn payroll jobs in Q4; the separate household survey found 1.7mn fewer people in employment.
• Employment tends to lag economic growth, so the plunge in activity last quarter should be reflected in further jobs market weakness. That said, initial unemployment insurance claims have not continued to accelerate, although the jobs indices in Jan regional business surveys were mostly weaker than in Dec.
• Given these factors, we expect a further jobs decline of over 500k in Jan. The recent tendency for subsequent reports to include unfavourable revisions could see either/both of Nov/ Dec's results revised to losses of over 600k.
• This should see the jobless rate jump to 7.5%, even allowing for some unemployed leaving the labour force altogether.

Westpac Institutional Bank
http://www.westpac.com.au

Disclaimer

All customers please note that this information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs. Australian customers can obtain Westpac's financial services guide by calling +612 9284 8372, visiting www.westpac.com.au or visiting any Westpac Branch. The information may contain material provided directly by third parties, and while such material is published with permission, Westpac accepts no responsibility for the accuracy or completeness of any such material. Except where contrary to law, Westpac intends by this notice to exclude liability for the information. The information is subject to change without notice and Westpac is under no obligation to update the information or correct any inaccuracy which may become apparent at a later date. Westpac Banking Corporation is regulated for the conduct of investment business in the United Kingdom by the Financial Services Authority. © 2004 Westpac Banking Corporation. Past performance is not a reliable indicator of future performance. The forecasts given in this document are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from these forecasts.