february 2008 saul eslake chief economist

Economic outlook for 2008

February 2008

Saul EslakeChief Economist

2

What’s going on in the global financial system?

‘Bubble’ conditions in the first half of the decade …

– prompted by a combination of exceptionally easy monetary policy in advanced economies and rapid reserve accumulation (which creates liquidity) in developing economies

… dramatically lowered the ‘price of risk’ …

… in turn leading to a significant increase in ‘risk tolerance’ …

– manifested in general lowering of credit standards (Exhibit A: the surge in sub-prime mortgage lending in the US)

… and widespread ‘disintermediation’

– explosive growth in off-balance sheet asset creation, derivatives etc (fuelled by efforts to engineer higher rates of return on capital)

Last year, the price of risk rose dramatically, and risk tolerance slumped …

– prompted by tighter monetary conditions and a belated recognition that risk had been ‘under-priced’

Market forces (including customer demand) are now pushing strongly in the direction of ‘re-intermediation’

– in circumstances where liquidity and capital are much more scarce

The relationships between the price of risk and risk tolerance are non-linear on the way up, and on the way down

3The US housing bubble has burst, like the equities bubble earlier this decade

US housing starts

-10-505

10152025

90 93 96 99 02 05 08

% change from year earlier

(Case-Shiller index)

US house prices US unsold homes

US housing market

0.751.00

1.251.50

1.752.00

2.25

90 93 96 99 02 05 08

Mns (annual rate)

Actual

Trend

US mortgage delinquencies

1.0

1.5

2.0

2.5

3.0

3.5

90 93 96 99 02 05 08

% 'seriously delinquent'

456789

1011

90 93 96 99 02 05 08

Months' supply

Actual

Trend

Sources: S&P; US Commerce Department; US National Association of Realtors; US Mortgage Bankers’ Association.

4

ABX index of prices of US mortgage-backed securities

30405060708090

100

Jun-07 Sep-07 Dec-07 Mar-08

AAA

AA

Dramatic declines in the value of mortgage-backed securities have led to substantial losses incurred by big global banks

10

20

30

40

50

60

Jun-07 Sep-07 Dec-07 Mar-08

BBB-(sub-prime)

2.5Royal Bank of Scotland

2.3Deutsche Bank

1.7Wells Fargo

3.2JPMorgan Chase

3.2Canadian Imperial (CIBC)

2.7Barclays

2.6Bear Sterns

133.0TOTAL*

7.9Bank of America

9.4Morgan Stanley

10.7HSBC

14.4UBS

22.1Citigroup

24.5Merrill Lynch

4.7

4.9

6.5

Total (US$ bn)

Wachovia

Credit Agricole

Washington Mutual

Bank

Losses announced by major banks since mid-2007

* incl. smaller banks not shownseparately.

Source: Bloomberg.

5These losses (and fears of more to come) have made banks reluctant to lend to one another

Inter-bank borrowing rates and overnight index swap (OIS) rates

2.0

3.0

4.0

5.0

6.0

7.0

Dec-06 Jun-07 Dec-07 Jun-08

% pa

3-mth Libor

OIS

United States

3.0

3.5

4.0

4.5

5.0

5.5


% pa

3-mth Libor

OIS

Euro area

4.5

5.0

5.5

6.0

6.5

7.0


% pa

3-mth Libor

OIS

United Kingdom

5.5

6.0

6.5

7.0

7.5

8.0


% pa3-mth Libor

OIS

Australia

* The OIS is an indicator of market expectations of future movements in cash rates.Sources: Thomson Financial; Bloomberg.

6Banks’ short-term funding margins have eased since year-end but remain much wider than ‘normal’

Spreads between inter-bank borrowing rates and expected official cash rates

0

20

40

60

80

100

120

Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08

Basis points (5-daymoving average)

US

UK

Euro area

Australia

Sources: Thomson Financial; Bloomberg.

7The narrowing in money-market spreads largely reflects central bank efforts to inject additional liquidity

Net cash injections to the US banking system by the Federal Reserve

0

50

100

150

200

250

300

350

400

Jan-07

Feb-07

Mar-07

Apr-07

May-07

Jun-07

Jul-07

Aug-07

Sep-07

Oct-07

Nov-07

Dec-07

Jan-08

Feb-08

Mar-08

Regular open market operations Term Auction Facility

US$bn

Source: US Federal Reserve.

8However longer-term borrowing spreads for both banks and corporates remain wide by historical standards

Swap spreads

United States

Australia

Note: spreads are to government bond yields of comparable maturities.Sources: Thomson Financial; Bloomberg; Reserve Bank of Australia.

0

25

50

75

100

125

01 02 03 04 05 06 07 08

Basis points

5 years

2 years

-50

-25

0

25

50

75

100

01 02 03 04 05 06 07 08

Basis points

5 years

2 years

United States

Australia

0

25

50

75

100

125

150

01 02 03 04 05 06 07 08

Basis points

A-rated

AAA-rated

050

100150200250300350

01 02 03 04 05 06 07 08

Basis points

A-rated

AAA-rated

Corporate bond yield spreads

9The commercial paper market was severely disrupted, although some stability seems now to be returning

2.0

3.0

4.0

5.0

6.0

7.0


% paAsset-backed(30 days)

Financial(30 days)

US commercial paper yields

Asset-backed CP issuance

0.0

0.5

1.0

1.5

2.0

2.5


US$bn

0.6

0.7

0.8

0.9

1.0

1.1

1.2


US$trn

Asset-backed CP outstanding

0.100.120.140.160.180.200.22


US$trn

Non-financial CP outstanding

Sources: US Federal Reserve; Bloomberg.

10Sharply diminished investor appetite for securities has forced banks to take large volumes of assets onto their balance sheets

US banks’ business lending

1.0

1.1

1.2

1.3

1.4


US$trn

Governmentsecurities

Othersecurities

US banks’ securities holdings

1.1

1.2

1.3

1.4

1.5


US$trn

US banks’ commercial& industrial loans

-10-505

10152025

88 92 96 00 04 08


Australian financial intermediaries’business lending

-10

0

10

20

30

88 92 96 00 04 08


Sources: US Federal Reserve; Reserve Bank of Australia.

11Banks in the US and the euro area are tightening credit standards

US banks

-40-20

020

4060

80

00 01 02 03 04 05 06 07 08

Net balance tightening standards (%)

LargeSmall

Commercial & industrial loans

Mortgage and consumer loans

-20

0

20

40

60

00 01 02 03 04 05 06 07 08


Mortgage*

Consumer

Euro area banks

-20-10

01020304050

00 01 02 03 04 05 06 07 08


Loans to enterprises

Mortgage and consumer loans

-10-505

10152025

00 01 02 03 04 05 06 07 08


Housepurchase

Consumer

* Weighted average of prime & sub-prime after June 2007Sources: US Federal Reserve and European Central Bank surveys of loan officers.

12It’s too soon to be confident that the financial system is ‘out of the woods’

Further write-downs in the value of mortgage-backed securities as a result of on-going defaults and falling house prices

– estimates of eventual total losses are in the range US$200-500bn (cf. $133bn written off to date)

Write-downs in the value of other securities triggered (eg) by ratingsdowngrade of ‘monoline’ bond insurers

– these institutions have ‘guaranteed’ US$2.4trn of municipal and consumer debt (of which $900bn is structured finance debt (CDOs etc)

Rising defaults by corporate borrowers, prompting losses on credit default swaps (CDSs)

– total CDS outstanding estimated at US$45trn, potential losses in the event of ‘normal’ corporate insolvency rate estimated of the order of US$250bn

On-going pressure on banks’ capital from having to expand balance sheets to meet needs of customers unable to debt issue securities, and from further write-downs

– which could eventually lead to banks being unable to extend further credit

Regulatory backlash and civil lawsuits

Risks still facing the financial system

13Cutting short-term rates sufficiently to restore a positive yield curve would help financial system stability

United States

Euro area

-100

0

100

200

300

400

01 02 03 04 05 06 07 08

Basis points

United Kingdom

Australia

10-year / 3 mth yield curves

-100-50

050

100150200250

01 02 03 04 05 06 07 08

Basis points

-200-150-100-50

050

100150

01 02 03 04 05 06 07 08

Basis points

-150-100-50

050

100150200250

01 02 03 04 05 06 07 08

Basis points

Source: Thomson Financial.

14But that poses a dilemma for central banks in countries where inflation remains uncomfortably high

United States*

Euro area

0

1

2

3

4

5

01 02 03 04 05 06 07 08


'Headline'

Excl. food & energy

United Kingdom

Australia†

Consumer price inflation

0

1

2

3

4

01 02 03 04 05 06 07 08


'Headline'

Excl. food & energy

0

1

2

3

4

5

6

01 02 03 04 05 06 07 08


'Headline'

Excl. food & energy

0

1

2

3

4

5

01 02 03 04 05 06 07 08


'Headline'

'Underlying'#

* Personal consumption expenditure deflator. † excludes GST impact in 2001. # Average of RBA’s two preferred measures. Sources: US Bureau of Economic Analysis; Eurostat; UK Office of National Statistics; ABS; RBA.

15Equity markets have fallen sharply since mid-2007 – it’s as yet unclear whether mid-January marked the bottom

Equity markets

12501300135014001450150015501600


US – S&P 500

Japan - Nikkei

UK – FTSE 100

Australia – ASX All Ords

1200013000140001500016000170001800019000


5500

5750

6000

6250

6500

6750

7000


500052505500575060006250650067507000


Source: Thomson Financial.

16Share market investors are more concerned about the risk of earnings downgrades than about stretched valuations

United States

05

101520253035

80 84 88 92 96 00 04 08

x

Japan

0

20

40

60

80

80 84 88 92 96 00 04 08

x

United Kingdom

05

1015

2025

30

80 84 88 92 96 00 04 08

x

Australia

05

1015

2025

30

80 84 88 92 96 00 04 08

x

Price-earnings ratios compared with long-term averages

Source: Thomson Financial; ANZ.

17US real GDP growth slowed sharply in the final quarter of last year – but that doesn’t mean the US is already in recession

US real gross domestic product

-2

-1

0

1

2

3

4

5

6

7

8

00 01 02 03 04 05 06 07

% change from previousquarter (annual rate)

Note: there weren't any consecutivequarters of negative growth in the 2001 recession

-2

-1

0

1

2

3

4

5

6

Mar-07 Jun-07 Sep-07 Dec-07

Change in stocks Net exports Final domestic demand

% pt contribution tochange in real GDPfrom previous qtr

Composition of GDPgrowth

Source: US Bureau of Economic Analysis.

18So far, the US economy has held up better since the peak of the housing bubble than it did after the equities peak in 2000

3.54.0

4.55.0

5.56.0

6.5

0 6 12 18 24 30 36

Mar 00 / Jun 06= 100

From Mar 2000From Jun 2006

Months from market peak

Unemployment rate

98

99

100

101

102

0 6 12 18 24 30 36

Mar 00 / Jun 06= 100

From Mar 2000

From Jun 2006


Non-farm payroll employment

98100

102104

106108

110

0 6 12 18 24 30 36

Mar 00 / Jun 06= 100 (trend)

From Mar 2000

From Jun 2006


Real retail sales

70

80

90

100

110

0 6 12 18 24 30 36

Mar 00 / Jun 06= 100 (trend)

From Mar 2000

From Jun 2006

Months from market peak* excl. aircraft

Non-defence capital goods orders*

US economic indicators after the peaks of two most recent ‘bubbles’

Sources: US Bureau of Labor Statistics; US Commerce Department; ANZ.

19Both the household and corporate sectors are in a stronger financial position than they were ahead of the 2001 recession

Personal net worth

98

100

102

104

106

108

0 6 12 18 24 30 36

Mar 00 / Jun 06= 100 (trend)

From Mar 2000From Jun 2006


Real personal disposable income After-tax corporate profits

US household sector

450

500

550

600

650

0 6 12 18 24 30 36

% of annual personaldisposable income

From Mar 2000

From Jun 2006


3

4

5

6

7

0 6 12 18 24 30 36

% of GDP

From Mar 2000

From Jun 2006


Debt-equity ratio

40

60

80

100

120

140

0 6 12 18 24 30 36

%

FromMar 2000

FromJun 2006


US non-financial corporate sector

Sources: US Bureau of Economic Analysis; Federal Reserve; ANZ.

20Rising exports, aided by a weaker US$, have more than offset the impact on GDP growth of falling housing construction

Real exports of goods and services

8590

95100

105110

115

0 6 12 18 24 30 36

Mar 00 / Jun 06= 100 From Mar 2000

From Jun 2006


Trade-weighted value of US$ Exports and housing

-200

-150

-100

-50

0

50

100

150

200

Jun-06 Dec-06 Jun-07 Dec-07 Jun-08

Cumulative change since Q2 2006(US$bn at annual rate)

Exports ofgoods & services

Residentialconstruction

US dollar, exports and housing

85

95

105

115

125

0 6 12 18 24 30 36

Mar 00 / Jun 06= 100

From Mar 2000

From Jun 2006


Sources: Thomson Financial; US Bureau of Economic Analysis; ANZ.

21

0

1

2

3

4

5

01 02 03 04 05 06 07 08 09

% change fromyear earlier

All of the world’s major advanced economies will experience slower growth in 2008

Major advanced economies – real GDP growth

United States

-2-1

01

23

4

01 02 03 04 05 06 07 08 09


Japan

0

1

2

3

4

01 02 03 04 05 06 07 08 09


Euro zone

0

1

2

3

4

5

01 02 03 04 05 06 07 08 09


United Kingdom

Sources: national statistical agencies; ANZ.

22

0

2

4

6

8

10

12

01 02 03 04 05 06 07 08 09


There’ll be some slowing in major developing economies too, though more due to domestic policies than to weaker exports

Major developing economies – real GDP growth

China

0

2

4

6

8

10

12

01 02 03 04 05 06 07 08 09


India

0

2

4

6

8

01 02 03 04 05 06 07 08 09


Other East Asia

-2

0

2

4

6

8

01 02 03 04 05 06 07 08 09


Brazil

0

2

4

6

8

01 02 03 04 05 06 07 08 09


South Africa

-12

-8

-4

0

4

8

12

01 02 03 04 05 06 07 08 09


Turkey

Sources: national statistical agencies; ANZ.

23Asian economies will feel the effects of a US slowdown, though not by as much as suggested by simple exports/GDP ratios

67.3

73.6

65.9

243.0

47.3

123.4

42.5

14.3

33.5

22.9

197.9

34.1

Exports as a % of GDP

19.2

16.4

20.8

10.8

21.4

21.2

15.0

24.2

11.8

16.3

15.2

21.4

Exports to US as

a % of total*

26.2

28.8

25.7

44.3

14.4

36.1

19.8

6.8

13.9

10.5

42.6

12.6

Total export value-added

as a % of GDP

5.0

4.7

5.3

4.8

3.1

7.7

3.0

1.6

1.6

1.7

6.5

2.7

US export value-

added as a % of GDP

-0.5Taiwan

-0.5Thailand

-0.5Vietnam

-0.3Korea

-0.2Japan

-0.2Indonesia

-0.2India

-0.6Hong Kong

-0.3China

-0.5

-0.3

-0.8

GDP impact of a 10%pt

US import slowdown

Singapore

Philippines

Malaysia

Country

Asian economies’ exposure to a downturn in the US economy

* Includes indirect exposure through China.

Source: Jonathan Anderson (UBS, September 2006)

24China’s and India’s growth has been predominantly driven by domestic demand, not by net exports

Contributions to China’s real GDP growth

-2

0

2

4

6

8

10

12

00 01 02 03 04 05 06

Domestic demand Net exports

% pts

Source: China National Bureau of Statistics, CEIC.

-4

-2

0

2

4

6

8

10

12

01 02 03 04 05 06

Domestic demand Net exports

% pts

Contributions to India’s real GDP growth

25Chinese authorities have been tightening monetary policy and using other instruments to dampen inflation pressures

Inflation

Interest rates Rmb vs US dollar

China - inflation and monetary conditions

-4

-2

0

2

4

6

8

01 02 03 04 05 06 07 08


Producer prices

Consumerprices

4.04.55.05.56.06.57.07.58.0

01 02 03 04 05 06 07 08

% pa1-year loan rate

7.07.27.47.67.88.08.28.4

01 02 03 04 05 06 07 08

Rmb per US$

4

6

8

10

12

14

16

01 02 03 04 05 06 07 08

%

Banks’ required reserves ratio

Sources: China National Bureau of Statistics; People’s Bank of China; Thomson Financial.

26India has also been seeking (with some success) to reduce inflationary pressures

Inflation Interest rates

Rupee vs US dollar

India - inflation, trade balance and monetary conditions

0

2

4

6

8

10

01 02 03 04 05 06 07 08


Wholesale prices

Consumerprices*

4

6

8

10

12

14

01 02 03 04 05 06 07 08

% pa

RBI repo rate

Prime lending rate

3638404244464850

01 02 03 04 05 06 07 08

Rp per US$

* CPI for urban non-manual workers. Sources: India Department of Statistics; CEIC; Thomson Financial.

Merchandise trade balance

-80

-60

-40

-20

0

20

01 02 03 04 05 06 07 08

US$bn (12-mth moving total)

27

75

100

125

150

175

200

225

250

275

300

90 93 96 99 02 05 08

2001-02 = 100(US$ terms)

All items

Apart from coal and iron ore, Australian export commodity prices will ease in 2008 and 2009

Australian export commodity prices

75

100

125

150

175

200

225

250

275

300

325

350

90 93 96 99 02 05 08

2001-02 = 100(US$ terms)

Non-rural(incl. coal

& iron ore)

Rural

Sources: Reserve Bank of Australia; ANZ.

28Australian and US economic cycles have not been closely correlated this decade, and are diverging further now

Unemployment

-2

0

2

4

6

8

90 93 96 99 02 05 08


Australia

US

Real GDP growth Terms of trade

Australian and US economic indicators

House prices

2

4

6

8

10

12

90 93 96 99 02 05 08

%

US

Australia

80

100

120

140

160

90 93 96 99 02 05 08

Ratio of export to importprices (2000 = 100) Australia

US

-10-505

10152025

90 93 96 99 02 05 08


US

Australia

Sources: Australian Bureau of Statistics; US Bureau of Economic Analysis; US Bureau of Labor Statistics; S&P.

29Australian corporate sector profits and balance sheets are (in aggregate) very strong

Debt-equity ratio

02468

101214

90 93 96 99 02 05 08

% of GDP

Non-financial sector profits Interest cover ratio

Australian corporate sector income, balance sheet and sentiment

‘Business conditions’

50

75

100

125

150

175

90 93 96 99 02 05 08

%

0

2

4

6

8

90 93 96 99 02 05 08

x

-40-30

-20-10

010

20

90 93 96 99 02 05 08

Net balance positive (%)

Quarterly

Monthly

Sources: Australian Bureau of Statistics; ANZ; nab.

30The US now accounts for less than 6% of Australia’s exports –less than China, Korea or even India

Australia’s major export markets

0

5

10

15

20

25

30

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

% of total (12-mth moving average)

US

Japan

India

China

Korea

EU

Sources: Australian Bureau of Statistics.

31Higher commodity prices and other ‘terms of trade’ gains have boosted Australia’s income by over 1% per annum

70

80

90

100

110

120

01 02 03 04 05 06 07 08 09

Ratio of export to importprices (2004-05 = 100)

Australia’s “terms of trade”

0

2

4

6

8

01 02 03 04 05 06 07 08 09

Real % change fromyear earlier

Real GDP

Real GDI (= GDPadj. for changesin terms of trade)

Australia’s gross domestic product and income

Australia’s ‘terms of trade’ have improved by over 50% so far this decade, boosting income relative to output by over 1% pa (or by 11% in total)

‘Terms of trade’ gains have been spread broadly across the Australian community through repeated rounds of personal income tax cuts (financed in part by higher tax revenues from mining companies) – which have in turn boosted household spending (and largely offset the impact of rising interest rates)

This boost to Australian incomes is likely to peak in mid-2008 but seems unlikely to unwind substantially before the end of the decade

Sources: Australian Bureau of Statistics; ANZ.

32Personal tax cuts financed by windfall business tax revenues have boosted overall spending

Australian incometax collections

11.0

11.5

12.0

12.5

13.0

13.5

00 01 02 03 04 05 06 073.0

3.5

4.0

4.5

5.0

5.5

6.0% of GDP % of GDP

Companies(right scale)

Individuals(left scale)

Net saving by sectors ofthe Australian economy

-3

-2

-1

0

1

2

3

4

5

6

00 01 02 03 04 05 06 07

% of GDP (4-qtrmoving average)

Households

Government

Business


33The mining boom and efforts to alleviate infrastructure bottle-necks have prompted a surge in non-residential construction

Engineering construction

2025303540455055

00 01 02 03 04 05 06 07

A$ bn (2004-05 prices,annual rate)

Real value of work done

0

10

20

30

40

50

00 01 02 03 04 05 06 07

A$ bn (2004-05 prices)

Commencements

Work yetto be done

Commencements and backlog of work yet to be done

Non-residential building

Real value of work done

Commencements and backlog of work yet to be done

15

20

25

30

00 01 02 03 04 05 06 07

A$ bn (2004-05 prices,annual rate)

0

3

6

9

12

15

00 01 02 03 04 05 06 07

A$ bn (2004-05 prices)

Commencements

Work yetto be done


34The mining boom continues to benefit Queensland, WA and the Northern Territory more than the south-eastern States

01234567

01 02 03 04 05 06 07 08

% change from yearearlier (trend) Qld, WA & NT

Rest of Australia

Employment

-30-20-10

01020304050

01 02 03 04 05 06 07 08

Real % change from yearearlier (trend)

Qld, WA& NT

Rest of Australia

Engineering construction work

02468

101214

01 02 03 04 05 06 07 08

% change from yearearlier (trend) Qld, WA & NT

Rest of Australia

Retail sales

-10

0

10

20

30

40

01 02 03 04 05 06 07 08

Real % change from yearearlier (trend)

Brisbane, Perth& Darwin

Other capitals

House prices

Resource-rich vs other States and Territories


35

100

120

140

160

180

200

00 01 02 03 04 05 06 07 08

'000s (annual rate)

Completions

Underlying demand

0

1

2

3

4

00 01 02 03 04 05 06 07 08

%

Average forall capitals

Housing is also in short supply, putting upward pressure on prices and rents

Housing supply and demand

Rental vacancy rates

Capital city house prices

0

5

10

15

20

25

00 01 02 03 04 05 06 07 08


Capital city dwelling rents

0

2

4

6

8

10

00 01 02 03 04 05 06 07 08


Australian housing market fundamentals

Sources: Australian Bureau of Statistics; Real Estate Institute of Australia; ANZ.

36Although mortgage delinquencies have been rising, they remain very low by international standards

Prime securitized mortgages 30 days + past due, by lender

Mortgage delinquency rates

0.00.5

1.01.5

2.02.5

3.0

01 02 03 04 05 06 07

% of prime securitized mortgages outstanding

Banks

Originators

(0.23%)

(2.03%)

Prime securitized mortgages 30 days + past due, by type of loan

0.00.5

1.01.5

2.02.5

3.0

01 02 03 04 05 06 07

% of prime securitized mortgages outstanding

Total

'Full-doc'

'Lo-doc'(~ 'Alt-A')

Sub-prime securitized mortgages 30 days + past due

0

5

10

15

20

01 02 03 04 05 06 07

% of sub-prime securitizedmortgages outstanding

30+dayspast due

90+days past due(7.2%)

(12.8%)

Sub-prime mortgages as a pc of total mortgages

0

1

2

3

4

5

01 02 03 04 05 06 07

% of total % of all securitizedmortgages

% of allmortgages

(0.7%)

(3.7%)

Sources: S&P.

37After more than 16 years of continuous economic growth, Australia’s economy has run into serious capacity constraints

Unemployed persons per job vacancy

Indicators of ‘spare capacity’ in the Australian economy

05

1015

2025

30

88 92 96 00 04 08

No unemployed per job vacancy

Businesses reporting labour shortages

05

1015

2025

30

88 92 96 00 04 08

% of businesses nominating 'suitable labour' as a constrainton output

Capacity utilization rate

7476

7880

8284

86

88 92 96 00 04 08

%

Office vacancy rates

0

5

10

15

20

25

88 92 96 00 04 08

%

Sources: Australian Bureau of Statistics; nab; Property Council of Australia.

38

2

3

4

5

01 02 03 04 05 06 07 08

% pa

Actual

Trend

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

01 02 03 04 05 06 07 08 09


'Headline'

'Underlying'(weightedmedian)

Rising inflation (reflecting demand growth in excess of supply potential as well as global factors) is the major macro concern

Consumer prices

Reserve Banktarget band

Measures of labour costs

01234567

01 02 03 04 05 06 07 08 09


Wage cost index

Compensationper employee

Household inflation expectations

Sources: Australian Bureau of Statistics; Reserve Bank of Australia; Westpac-Melbourne Institute; ANZ.

39By contrast with the 1990s, Australian productivity growth during the current decade has been very poor

Labour productivity growth

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

80 84 88 92 96 00 04 08

Change over rolling 5-yearperiods (% pa)

Australian labour productivityas a p.c. of US level

78

80

82

84

86

88

90

80 84 88 92 96 00 04 08

%

Sources: Australian Bureau of Statistics; The Conference Board and Groningen Growth & Development CentreTotal Economy Database January 2008.

40Reliance on banks’ overseas borrowings to finance the deficit leaves Australia exposed to abrupt shifts in global markets

Financing Australia’s current account deficit

-40

-20

0

20

40

60

80

100

00 01 02 03 04 05 06 07

Net equity Banks' net borrowing

Other net borrowing Other (incl. reserves)

A$ bn - 4-qtr moving total

Current account deficit

Methods of financing

Maturity structure of net foreign debt

1015

2025

3035

40

00 01 02 03 04 05 06 07

% of total

< 28 days

-20

0

20

40

60

80

100

88 92 96 00 04 08

% of total% of total Private sectorfinancial corporations

Private sector non-financial corporations

Public sector

Net foreign debt, by borrower


41

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

01 02 03 04 05 06 07 08 09

% pa

RBA's cash rate

90-daybank bill yield

Reserve Bank will likely need to tighten monetary policy furtherin order to ensure inflation returns to the 2-3% band

Short-term interest rates10 interest rate increases since mid-2002 have had little lasting impact in restraining growth in domestic demand – largely because they’ve been offset by commodity-related income gains, repeated rounds of tax cuts etc.

The RBA does not appear to be greatly concerned about near-term downside risks to Australian growth from higher borrowing costs as a result of global financial turmoil, global effects of weaker US growth or intangible confidence effects

Although the new Government has committed to running a tighter fiscal policy than its predecessor, that will make little difference in the short term to deliberations over monetary policy

Sources: Thomson Financial; ANZ.

42

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

01 02 03 04 05 06 07 08 09-100

0

100

200

300

400

500US ¢

A$ vs US$(left scale)

Spread betweenAustralian & US

90-day interest rates(right scale)

2001-02 = 100

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

01 02 03 04 05 06 07 08 0975

100

125

150

175

200

225

250

275

300US ¢

A$ vs US$(left scale)

RBA index ofcommodity pricesin US$(right scale)

2001-02 = 100

Commodity prices and interest rate spreads likely to continue supporting the A$ until mid-2008

A$ and commodity prices A$ and interest rate spreads

Sources: Thomson Financial; Reserve Bank of Australia; ANZ.

43The new Government has made a promising start although there are lot of policy details to be filled in

Further strengthened the independence of the Reserve Bank (by reducing the scope for political interference in appointment of Board members and termination of senior executives)

Foreshadowed a Budget surplus target of 1½% of GDP, up from the previous Government’s 1% (though that was usually exceeded)

Foreshadowed longer-term strategies to address skilled labour shortages and infrastructure bottlenecks

Ratified the Kyoto Protocol

What the new Government has already done

What is still to come

Detail of proposed industrial relations changes (abolishing statutory individual contracts, re-introducing ‘unfair dismissals’ laws but retaining much of the remainder of the previous Government’s reforms)

Specific measures to attain the Budget surplus objective

Detail of policies to ‘foster a culture of savings’

Specific targets for greenhouse gas emission reductions and strategies for achieving them

Reviews of specific industry policies (eg innovation, coastal shipping) -Productivity Commission excluded

44

Australian forecast summary

Economic forecasts

63

145

3

4

4

2008f

54.2

153

3.0

4.6

2.8

2006

55

150

3.6

4.4

4

2007e

67

155

2¾

4

3½

2009f

Current account deficit ($bn)

Housing starts (‘000)

‘Underlying’ inflation (year-end, %)

Unemployment rate (year-end, %)

Real GDP growth (%)

670710780920807Gold price (US$ / oz)

5.505.005.256.006.3310-year bond yield (% pa)

7.407.407.507.507.2590-day bill yield (% pa)

8889919898A$-¥

0.790.820.870.900.88A$-US$

Financial market forecasts

75

0.61

7.25

2.00

Dec 08

79

0.61

7.25

3.25

Jun 09

82

0.60

7.25

2.25

Jun 08

92

0.60

6.75

4.25

Dec 07

80

0.62

7.25

4.25

Dec 09

Oil price (US$ / barrel, WTI)

A$-€

RBA cash rate (% pa)

US Fed funds rate (% pa)

february 2008 saul eslake chief economist

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