• Global share markets mainly rose over the past week on the back of further monetary stimulus from the European Central Bank. The ECB’s move also provided a boost to the Australian share market but not enough to fully reverse earlier weakness driven by worries about the fall in the iron ore price and the impact of the Budget on retail stocks. Bonds generally continued to sell-off, except in peripheral Eurozone countries where the ECB’s measures pushed yields down. Worries about China continue to weigh on commodity prices, but at least the iron ore price rose a bit after the previous week’s fall and the $A got a boost as the ECB announcement boosted risk appetites. The Euro also benefitted possibly as the ECB moves are seen as boosting growth prospects in Europe, which is likely to have caused some consternation at the ECB which would rather see the Euro lower.
• Super Mario to the rescue as the ECB delivers on stimulus expectations. The past week was largely all about the ECB with expectations riding high that it would deliver more stimulus and in the event it did not disappoint, deploying virtually everything it could think of, cutting its key interest rate to just 0.15%, cutting the rate of interest banks receive on excess deposits at the ECB to -0.10%, an extension of guidance as to how long rates will remain low, an extension of the commitment to supply unlimited short term funds to banks at the 0.15% interest rate, a new long term lending program to banks (called Targeted Long Term Refinancing Operations or TLTRO), an end to the sterilisation of its existing bond buying program (which it calls SMP) and preparation for program to purchase asset backed securities (which would amount to a US style quantitative easing program). The highlight was probably the TLTRO program which is effectively a “funding for lending” program that will allow banks to borrow to fund their non-mortgage lending at just 0.25% interest for four years.
• A big move in the right direction. To be sure the latest move by the ECB is not as momentous as its efforts in 2011 and 2012 (the first LTRO, “whatever it takes” and the Outright Monetary Transactions program) that ended the Eurozone crisis. It would also have been better to see a US style quantitative easing program straight away and there are doubts about how successful each of the measures announced by the ECB will individually be. But the ECB has more than met market expectations as reflected in the rally in shares and the decline in bond yields in Spain and Italy etc, the scatter gun approach of deploying virtually everything at once adds to confidence that the whole should be worth more than the sum of the parts in terms of its impact on bank lending and the clear impression is that while interest rates have hit bottom it stands ready to do more if needed and this is likely to involve the purchase of private sector asset backed securities. Finally, there are signs that bank deleveraging in Europe that has occurred in the run-up to this year’s asset quality review and stress tests has already run its course. If so the ECB’s measures aimed at boosting bank lending have a good chance of succeeding.
• The bottom line is that the ECB’s measures – and commitment to do more if needed – add to confidence that the Eurozone economic recovery will pick up pace over the year ahead and that deflation will be avoided. This in turn is good for global growth and since Europe is China’s biggest single export destination, also good news for China, which in turn of course is good news for Australia. All of which explains why shares got a boost and even the $A had a bit of a spike.
• In Australia, there were no surprises from the RBA which left interest rates on hold for the ninth month. Given the range of conflicting indicators it referred to in its post meeting statement along with the mixed readings on the economy seen recently the most likely outcome remains an extended period of rates remaining on hold.

Major global economic events and implications

• US economic data was mostly good with strong readings for the ISM business conditions indicators, April factory orders and vehicle sales and a solid Beige Book of anecdotal evidence from the Fed adding to confidence of a growth rebound in the current quarter. A further 1.9% gain in household net worth in the March quarter and a decline in the ratio of household debt servicing costs to disposable income to the lowest on record augur well for consumer spending. A poor April trade report is a bit of a dampener though.
• Eurozone data was a bit mixed. Retail sales and German factory orders were stronger than expected, but slight downwards revisions to PMIs for May highlight that the recovery remains gradual. This along with unemployment falling just 0.1% to a still high 11.7% in April and May inflation falling to just 0.5% year on year, all served to support the ECB’s decision to provide more monetary stimulus.
• A bounce back in Japan’s composite business conditions PMI index for May to 49.2 from 46.3 adds to confidence that the impact from the sales tax hike will be temporary.

Australian economic events and implications

• Australian data presented a rather confusing picture, but on balance more good than bad. March quarter GDP growth was far better than expected a week or so ago and suggests the economy is adjusting to the mining investment wind down extremely well with increased resource export volumes, housing construction and consumer spending helping to rebalance the economy. The export surge, helped by the completion of new mines also saw the current account deficit as a proportion of GDP fall to its lowest in 34 years and an improvement in the AIG’s business conditions PMIs for May are welcome. Of course, while the March quarter growth figures are fantastic the rebalancing away from mining investment won’t be as smooth as the latest GDP data suggests. Growth is likely to slow back below trend in the short term as the hit to confidence from the May Budget flows through to consumer spending and the pace of growth in resource exports settles down. Softer April building approvals, albeit due to volatile multi-unit approvals, along with a fall in house prices in May, which likely signals slowing momentum in house prices and recent weakness in the iron ore price also add a bit of short term uncertainty. But cutting through all the noise, the big picture is one of the economy adjusting to the end of the mining investment boom without the collapse many had feared.
• Given the diverse array of indicators currently being seen the most likely outcome is an extended period of interest rates being left on hold. Clear evidence that the economy has been rebalancing has seen the number of economists looking for another rate cut dwindle to now just three, whereas the threats to growth from the Budget and the lower iron ore price means that those looking for rate hikes are pushing them into 2015.
• The past week also saw the minimum wage in Australia boosted by 3% or $18.70 a week. While it’s great to see low income earners get ahead I fear that this may be a case of a well-intentioned adjustment having the opposite impact because it will push Australia’s minimum wage to the highest level in the world in US dollar terms, further damage Australia’s international competitiveness and ultimately cost jobs for low income workers. Another reason why the $A needs to fall.

What to watch over the next week?

• In the US, expect a 0.4% gain in May retail sales (Thursday) and a moderation in producer price inflation (Friday)
• In the Eurozone, expect a bounce back in April industrial production (Thursday) and continued modest employment growth for the March quarter (Friday).
• Chinese economic data for May will likely be the global focus in the week ahead. Inflation data (Tuesday) is likely to show a rise to 2.4% year on year but only due to a bounce in food prices, but more importantly expect to see a slight pick-up in growth in industrial production, retail sales and investment (Thursday) consistent with the modest improvement seen in recent PMI readings. Money supply growth is likely to have picked up slightly.
• In Australia, the focus is likely to be on the May NAB business survey (Tuesday) to see how the Budget has affected business conditions & confidence and the June consumer sentiment reading (Wednesday) for signs of a bounce back after the initial negative reaction to the Budget. Expect to see a slight rise in housing finance (Tuesday) and a 10,000 gain in employment (Thursday) not being enough to prevent a unemployment rising to 5.9%. A speech by RBA Governor Stevens will likely repeat the rates on hold message.

Outlook for markets

• Shares remain vulnerable to a mid-year correction, just as we have seen in each of the last four years now. However, in the absence of global monetary shocks such as the ending of QE1 in 2010 and QE2 in 2011 or Bernanke’s taper talk in May/June last year and with shares having been in a bit of a stealth correction through much of this year, any pull back may well be mild. In any case the broad trend in shares is likely to remain up. Share market fundamentals remain favourable with reasonable valuations, global earnings improving on the back of rising economic growth and monetary conditions set to remain easy for some time. So any dip should be seen as a buying opportunity. Our year-end target for the ASX 200 remains 5800.
• Bond yields are likely to resume their gradual rising trend as it becomes clear that US inflation has bottomed and this combined with low yields is likely to mean pretty soft returns from government bonds. Cash and bank deposits continue to offer poor returns.
• With $A short positions now largely unwound, we remain of the view that the $A will resume its downtrend. Commodity prices including the iron ore price are relatively soft, RBA interest rate hikes are getting pushed out and the $A is likely to revert to levels that offset Australia’s relatively high cost base.

By Dr Shane Oliver, Head of Investment Strategy & Chief Economist

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Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

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