• The NAB business confidence index rose from -2.7 to +4.0 in January. The business conditions index slumped from +5.8 in December to -5.8 in January. Excluding Queensland the confidence reading rose by 2 points to +3.0, while conditions fell by 10 points to -1.0.
• Forward looking sub-indices remained decidedly weak despite modest improvements. Profits fell sharply, employment recorded a modest fall and the pace of contraction in new orders increased.
• Migration slumps to 34-year low. Net migation (permanent and long-term arrivals less departures) slumped to just 1,650 people in December – the lowest monthly result since June 1976.

What does it all mean?

• The latest NAB business survey reinforces the view that corporate Australia is remaining on the sidelines. The weakness in consumer spending, a slowdown in housing construction, and the multiple interest rate hikes of last year have all taken their toll on business confidence and conditions. Added to this, the devastating floods have robbed businesses of much needed optimism at a time of sluggish activity. In fact business conditions have now fallen to the weakest levels in just shy of two years.
• It’s important to highlight that the survey was conducted from 22 January – 2 February, effectively just under a fortnight after the December survey. And the resulting slide between the two results clearly highlights just how much of a devastating impact the floods have had on business conditions.
• More concerning is the added weakness in forward looking indicators. Business owners continue to trim future orders, while profitability has slumped to the weakest levels in 22 months. Given that retailers are aggressively discounting, borrowing costs are rising, and the higher Aussie dollar is curbing manufacturing exports, it is likely that activity will remain subdued in the near term. The negative momentum is clearly worrying, meaning that the Reserve Bank could face an extended stay on the interest rate sidelines.
• It is not all bad news, especially given that rates are likely to remain on hold over the next couple of months. And once businesses and consumers focus on the rebuilding phase following the floods and cyclone, growth and activity should rebound quite dramatically – as the Reserve Bank pointed out in the Monetary Policy Statement released last week.
• Simply, it doesn’t make sense. The job market is super-tight and employers are crying out for skilled workers. But net migration in December was the lowest in over 34 years. Clearly migration intake targets will needed to be lifted markedly over 2011 if we want to complete all necessary projects – both the rebuilding and repair work in Queensland and Victoria as well as the raft of mining and energy projects. To meet the demand for workers, the government will clearly need to look overseas or risk forcing wages and prices up.

What do the figures show?

National Australia Bank Business Survey:

• The National Australia Bank business confidence index rose from -2.7 to +4.0 in January.
• The business conditions index fell from +5.8 to -5.8 in January.
• Excluding Queensland the confidence reading rose by 2 points to +3.0, while conditions fell by 10 points to -1.0.
• The index of trading conditions deteriorated, down from +8.7 to –7.0; profitability recorded a sharp fall from +2.6 to -10.0; employment fell from +5.1 to +0; and forward orders remained weak sliding from -2.6 to -4.8.
• The monthly reading of labour costs rose modestly from 0.8 per cent to 0.9 per cent in January. NAB noted that annual growth of labour costs stands at 3.8 per cent.
• Inflationary pressures are well contained. Retail prices were flat in January after rising at a 0.2 per cent quarterly rate in December. Purchase costs jumped by a 0.8 per cent quarterly rate, however the annual rate of increase edged lower from 2.0 per cent to 1.9 per cent.
• Capacity utilisation eased from 82.3 per cent to 80.5 per cent in January – below the decade average of 81.6 per cent and the weakest reading since September 2009.

Overseas arrivals/departures

• Net permanent and long-term arrivals to Australia fell to 205,900 people in calendar 2010, down 32.2 per cent or 97,730 people on a year ago. Departures from Australia rose by 38,520 while arrivals plunged by 59,210.
• The net number of permanent settlers entering Australia (arrivals less departures) stood at just 1,650 in December – the lowest monthly result in over 34 years.
• Tourist departures rose by 0.2 per cent in December to 603,800 after rising by 0.8 per cent in November. It was the third rise in departures in four months. Departures are up 10.4 per cent on a year ago.
• Tourist arrivals rose by 0.3 per cent in seasonally adjusted terms in December to 505,800 after lifting by 1.1 per cent in November. It was the fourth rise in arrivals in five months. Arrivals are up 4.2 per cent on a year ago.
• In seasonally adjusted the tourism deficit – the gap between departures and arrivals – stood at 98,000 in December, unchanged on November and below the record (34-year history) deficit of 125,900 in June.
• In trend terms, tourism arrivals have risen for the past eight months. Tourism departures fell 0.2 per cent in trend terms in December.

What is the importance of the economic data?

• The monthly National Australia Bank business survey is valuable in providing a timely reading on the health of Corporate Australia. Key indicators of business conditions such as orders, employment, profitability and capacity use are covered together with a gauge on confidence levels.
• The Australian Bureau of Statistics releases data on overseas arrivals and departures is produced monthly and is an indicator of the health of the tourism sector.

What are the implications for interest rates and investors?

• Looking forward, business confidence and conditions should improve to a modest degree as long as the Reserve Bank remains on the interest rate sidelines.
• The continued easing in migrant numbers must be addressed by Government or it will risk a lift in inflationary pressures. But the increase in short-term tourism arrivals is certainly encouraging when you
  consider the heady levels of the Aussie dollar

• The NAB business confidence index eased from +8.1 to +6.2 in November. The business conditions index rose from +1.6 in October to +3.7 in November.
• Forward looking sub-indices remained decidedly weak despite modest improvements. Profits ticked higher from 17-month lows, trading conditions remained near nine-month lows and new orders are still
  contracting.
• Australian dwelling starts slumped by 13.2 per cent in the September quarter, after lifting for the previous four quarters. In the September quarter, starts rose in only three of the eight states and territories.
• In seasonally adjusted terms work started on 170,153 dwellings over the past year – the biggest annual result in almost six years.

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• Motorists need to prepare for higher petrol prices. The terminal gate or wholesale price of petrol leapt by over 3 cents a litre last week to 5-month highs. In addition the Singapore gasoline price soared 7 per cent last week to 25-month highs. CommSec expects petrol prices to rise 5 cents a litre by Christmas.
• Inflation is under control. The TD Securities-Melbourne Institute monthly inflation gauge rose by 0.4 per cent in November, but boosted by volatile elements like fruit and vegetable prices. Excluding volatile items, prices rose just 0.1 per cent – the fourth straight month of negligible growth.
• The job market is losing steam. The Advantage internet job index rose by 3.4 per cent in November but the number of job ads declined week by week in the month. The ANZ index of job ads rose by 2.9 per cent.

What does it all mean?

• Motorists need to prepare for higher petrol prices over the next fortnight. The wholesale price of petrol leapt by almost three cents a litre last week and more than likely the higher cost will be passed through to motorists over the next 7-10 days.
• While the natural tendency is to complain about oil companies, the simple fact is that Asian gasoline prices have lifted by A$13 a barrel, equating to 13 cents a litre, while the wholesale petrol price in Australia has lifted by 9 cents a litre from the lows. But the pump price has only risen – at this stage anyhow – by just 3 cents a litre. The risk is that prices could lift by 5 cents a litre by Christmas – and you can’t blame oil companies or service station operators – at least not this time.
• The bad news is that global oil prices have hit 2-year highs in response to cold weather in the Northern Hemisphere and a weaker US dollar. But the good news is that the Aussie dollar rebounded late last week, serving to offset some of the effects of higher global oil prices.
• The headline rate of inflation could rise further in coming months, boosted by the price of petrol. But more important is what is happening beneath the surface. At this stage underlying inflation is under control. Strip out volatile elements like fruit and vegetable prices and petrol and inflation is largely non-existent in Australia. But that is no surprise – retailers of all descriptions have been telling that is the case for some time. In the current environment businesses are trimming prices to get people to part with their cash, but with varying degrees of success.
• Once volatile items are excluded, the three month annualised rate of inflation is amazingly just 0.7 per cent. However the inflation gauge reveals that the headline rate of inflation is closer to 4 per cent. Clearly there is not a lot that the Reserve Bank can do about changes at the petrol bowser or the weather – a key driver of changes in fruit and vegetable prices. If underlying inflationary pressures remain contained, then the Reserve Bank can stay on the sidelines until well into 2011.
• Just as the Reserve Bank does, when it comes to readings of inflation you have to look below the surface. Clearly the Reserve Bank wouldn’t be hiking rates if fruit and vegetable prices are going up. But increases in petrol prices or key food prices cause people to further trim spending of other parts of the household budget. CommSec estimates that the average household could end up paying $16 a month more for petrol around Christmas-time than just three months ago.
• The job market remains in good shape but the downturn in the Advantage job index over the month of November is a concern. The Australian economy is losing momentum and the last thing we need at this stage is weakness to infiltrate the job market.

What do the figures show?

Inflation gauge:

• The monthly inflation gauge rose by 0.4 per cent in November after lifting by 0.3 per cent in October. The annual rate of inflation rose from 3.8 per cent to 3.9 per cent.
• Excluding volatile items like petrol and fruit & vegetables, the inflation gauge rose edged 0.1 per cent higher in November after being unchanged in October and rising 0.1 per cent in both August and September. The annual rate of core inflation remained at 3.2 per cent but the three-month annualised rate of inflation eased from 0.9 per cent to 0.7 per cent.
• The trimmed mean inflation measure rose by 0.3 per cent in November. The trimmed mean measure is up 3.0 per cent on a year ago while the three-month annualised rate rose from 1.3 per cent to 1.9 per cent.
• TD Securities noted that “Contributing most to the overall change in November were price rises for fruit and vegetables and communication. These were offset by falls in prices for audio, visual and computing, holiday travel and accommodation, and meat and seafood. The price of automotive fuel increased marginally, while rents increased by 0.6 per cent, the highest monthly increase since May.”

Petrol prices:

• According to the Australian Institute of Petroleum, the national average Australian price of unleaded petrol rose by 0.7 cents per litre to 125.7 cents a litre in the week to December 5. The metropolitan price rose by 1.1c/l to 126.0c/l, while the regional average price rose by 0.1c/l to 125.2c/l.
• Petrol prices across states in the past week were: Sydney (up 1.3 cents to 125.4c/l), Melbourne (up 0.8 cents to 125.8c/l), Brisbane (unchanged at 128.3c/l), Adelaide (up 2.2 cents to 125.2 c/l), Perth (up 2.2 cents to 125.1c/l), Darwin (down 3.0 cents to 127.6 c/l), Canberra (unchanged at 126.9c/l) and Hobart (up 0.9 cents to 129.8c/l).
• The national average wholesale (terminal gate) price today hit a 5-month low high of 120.4 cents a litre, up 3.4 cents over the week. Just two months ago the terminal gate price was at an 11-month low of 111.6c/l.
• Last week, the key Singapore unleaded petrol price rose by US$6.63 (7.0 per cent) to a 25-month high of US$101.28 a barrel. And in Australian dollar terms Singapore gasoline price rose by $6.57 (6.8 per cent) over the week to $103.79 a barrel.

Job advertisements:

• The Advantage internet job index rose by 3.4 per cent in November but the authors of the report note “the number of advertisements declined week by week signalling a slowing of the job market in the lead up to Christmas.” In November gains were recorded in transport (11.1 per cent), engineering (9.1 per cent) and legal (7.7 per cent) but losses were recorded by financial services and banking (-2.3 per cent). Across the states and territories, gains were strongest in South Australia (8.7 per cent), ACT (6.6 per cent) and Western Australia (6.2 per cent).
• The combined number of internet and newspaper job advertisements, as tracked by ANZ, rose by 2.9 per cent in November after a 0.7 per cent increase in October. Internet job ads rose by 3.0 per cent in the month, while newspaper job ads rose by 0.9 per cent. In annual terms job ads are up 33.2 per cent off a low base.

What is the importance of the economic data?

• The TD Securities/Melbourne Institute Monthly Inflation Gauge is designed to “provide a timely and accurate monthly measure of inflation in Australia”. The Bureau of Statistics only releases the Consumer Price Index on a quarterly basis.
• The monthly Job Advertisements release is a leading employment indicator. Employers only seek additional staff if business activity is strong, and more importantly, if they expect that conditions will remain favourable in coming months. It takes around 5-6 months for the new staff to be added to the payrolls. But a fall in job advertisements would have a more immediate impact on monthly employment estimates.
• Weekly figures on petrol prices are compiled by ORIMA Research on behalf of the Australian Institute of Petroleum. National average retail prices are calculated as the weighted average of each State/Territory’s metropolitan and non-metropolitan retail petrol prices, with the weights based on the number of registered petrol vehicles in each of these regions.

What are the implications for interest rates and investors?

• Inflation is under control at present but some of the volatile elements like petrol and fruit and vegetable prices are starting to move higher. This complicates the situation for the Reserve Bank. While the Reserve Bank can’t lift rates to respond to factors outside its control, the risk is that higher inflation may become entrenched, with businesses using the higher inflation base to justify price increases.
• The lift in the price of petrol is further bad news for motorists, taking precious spending dollars out of consumer pockets. Retailers already have to contend with the effects of La Nina on seasonal spending, consumer conservatism and higher utility prices.
• Filling up the car with petrol is the single biggest outlay that Aussie households make each week so changes in petrol prices have a big impact on the budget and spending patterns. The average household may end up paying $16 a month more on petrol this Christmas than just three months ago.
• The job market is still in good shape, but with the economy losing momentum employment may also prove to be a casualty, further dragging on consumer spending and economic growth.
• One thing is certain – the Reserve Bank won’t touch rates tomorrow.

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• While Ireland has now been granted financial assistance from the IMF and European Union, concerns remain regarding Portugal and Spain.
• Spain is a bigger risk as it is nearly 12% of the euro area economy and European banks have a higher exposure to it. While its small savings banks are a risk, fortunately its public finances are in better shape.
• The economic back drop is more supportive than during the mid year Greek crisis as the German economy is holding up well, supporting the rest of Europe.

Introduction

Public debt problems in peripheral countries in Europe have been a recurring issue all year. Earlier this year the worry was Greece, in the last month it has been Ireland, and investors still worry about Portugal and Spain.

Back in May there was concern European sovereign debt problems would lead to another freezing up of credit markets triggering a global double dip back into recession. Our view was that – because global monetary conditions were very easy, the global economy was stronger than at the time of Lehman’s demise and policy makers were moving fast with Europe announcing a 720bn euro support package – it would be more like the Asian crisis of 1997-98. In other words, European public debt problems would be an ongoing source of volatility in markets, but largely contained. So far this has been the case with no signs of the credit or economic stress that came with the GFC. But recent developments highlight that risks remain significant.

Why the recent flare up?

The recent flare-up seemed to start with Ireland admitting  it would need to raise 31bn euros (or 19% of Irish GDP) to provide capital support for its banks and this was made worse by European proposals that bond investors may need to share in the cost of debt restructurings and more upwards revisions to Greece’s public debt. This saw public sector bond yields in Ireland pushed up to new crisis highs and investors start to worry again about Portugal and Spain, with a renewed sharp rise in their bond yields as well. Fearing the consequences of renewed market panic, European authorities encouraged Ireland to apply for assistance. It has now been granted with a 67bn euro support package as Ireland undergoes another round of austerity measures.

However, speculation has remained that Portugal will need assistance. The good news is Greece, Ireland and Portugal are small, comprising only 6.3% of the euro area economy. So providing assistance for Portugal as well wouldn’t be a major stretch financially for Europe and these economies aren’t big enough to have a noticeable impact on the European economy. The trouble would be if Spain were also affected.

Why the concern over Spain?

Spain, and even Portugal, are very different to Greece. Prior to the GFC Spain was running a budget surplus. Its budget deficit now seems to be coming back under control and its public debt to GDP ratio is below that of Germany and the US (see the table below). In short it doesn’t suffer from the solvency issues that trouble Greece.

The public debt blow out

* 32% if the bank bailout is included. Source: OECD, IMF, Eurostat, AMP Capital Investors

Rather, the main concerns appear to be that its weak economy (with 20% unemployment) will lead to further real estate losses and more problems for its banking sector (notably its small savings banks – which account for a big chunk of Spanish banking sector assets), all leading to a worsening in its public sector finances, particularly if bank bailouts are required. There is also a degree to which concern over Spain (and indeed other countries in Europe) is becoming self-fulfilling in that investor panic is driving higher bond yields making it harder for Spain (along with Portugal) to service its public debt, forcing it closer to the need for assistance. Higher public sector bond yields also push up private sector borrowing rates making life tougher for private sector borrowers as well.

A bailout for Spain may be feasible in the context of the 720bn euro facility announced in May, but only just, although some European officials have said the facility could be increased in size. But it would come with much bigger political conflict in Europe and raise more serious questions about the future of the euro.

A full blown crisis in Spain would also have a much bigger economic impact as it is 11.8% of the euro area economy and German and French banks have a much greater exposure to Spanish debt than they do to Greek, Irish and Portuguese debt. (Fortunately, US banks have little exposure to debt in troubled European countries.) The Spanish exposure of German banks is equivalent to 1.8% of their assets and for French banks it is 1.5% of assets.

Some grounds for optimism

As such, it is critical the contagion flowing through Europe ends soon, before tipping Spain over the edge. On this front there are some grounds for optimism. First, European authorities have got the message and have been moving quickly to provide assistance to Ireland, and would probably do so quickly in the case of Portugal as well if required. Second, real estate loan losses in the case of Spain are likely to be far smaller as a proportion of GDP (maybe adding 10% to the public debt to GDP ratio) than in Ireland, suggesting far less risk to the Spanish banking system. This is likely to be confirmed by another round of bank stress tests for Spanish banks that Spanish authorities have committed to provide. Thirdly, although worth keeping an eye, so far there is little evidence of panic in money or credit markets with spreads remaining well contained compared to the situation in 2008. This includes bank borrowing spreads in Europe. Finally, if the crisis doesn’t soon settle down we are likely to see renewed buying of Government bonds in troubled countries from the European Central Bank, an action that helped stabilise the Greek crisis mid-year.

More broadly it is interesting to note that unlike at the height of the Greek crisis in May-June this time around there has been less weakness in share markets. This in part likely reflects better economic news out of Europe generally. In May, the European PMI, a survey of business conditions, was starting to fall helping fuel worries of a double dip. However, in recent months it has surprised on the upside. In particular, this reflects strength in Germany and other northern European countries offsetting softness in countries with debt problems. See the next chart.

Germany seems to have been a key beneficiary of the crisis via a weaker euro. The overall business climate in Germany as measured by the IFO survey is at an all time high and Germany’s unemployment rate is at its lowest since 1992. (Germany is 27% of the euro area economy).

Source: Bloomberg, AMP Capital Investors

More broadly, business conditions indicators globally, whilst generally falling in mid year now appear to have mostly stabilised or improved (with the exception of Japan).

Source: Bloomberg, AMP Capital Investors

Concluding comments

There are several points worth concluding on. First, while European public debt woes will likely remain a periodic source of fragility in the global economy and volatility in financial markets, policy action should be enough to prevent them becoming a full blown crisis. Spain is worth keeping an eye on in the short term though. Secondly, just as the outlook for the $US is bleak, the problems with debt in Europe suggest the same in relation to the euro. The experience of Iceland, which now seems well on the way to recovery thanks in part to a plunge in its currency, highlights the benefit of allowing a weaker currency in response to debt problems. Thirdly, the public debt problems in Europe are of course part of a wider debt problem in major advanced countries including the US and Japan – which will act as a constraint on their growth for many years to come in contrast to emerging countries where public debt is not really an issue. Finally, while Australia has little public debt and has little trade exposure to Portugal, Ireland, Greece and Spain, it is affected via financial market and economic sentiment. Fortunately, it is more exposed to strongly growing emerging countries. The main risk for Australia would come if the European public debt woes led to a renewed credit crunch which would again make it more costly for Australian banks and businesses to raise funds offshore. So far though this appears unlikely.

]]> Key points

• While Ireland has now been granted financial assistance from the IMF and European Union, concerns remain regarding Portugal and Spain.
• Spain is a bigger risk as it is nearly 12% of the euro area economy and European banks have a higher exposure to it. While its small savings banks are a risk, fortunately its public finances are in better shape.
• The economic back drop is more supportive than during the mid year Greek crisis as the German economy is holding up well, supporting the rest of Europe.

Introduction

Public debt problems in peripheral countries in Europe have been a recurring issue all year. Earlier this year the worry was Greece, in the last month it has been Ireland, and investors still worry about Portugal and Spain.

Back in May there was concern European sovereign debt problems would lead to another freezing up of credit markets triggering a global double dip back into recession. Our view was that – because global monetary conditions were very easy, the global economy was stronger than at the time of Lehman’s demise and policy makers were moving fast with Europe announcing a 720bn euro support package – it would be more like the Asian crisis of 1997-98. In other words, European public debt problems would be an ongoing source of volatility in markets, but largely contained. So far this has been the case with no signs of the credit or economic stress that came with the GFC. But recent developments highlight that risks remain significant.

Why the recent flare up?

The recent flare-up seemed to start with Ireland admitting  it would need to raise 31bn euros (or 19% of Irish GDP) to provide capital support for its banks and this was made worse by European proposals that bond investors may need to share in the cost of debt restructurings and more upwards revisions to Greece’s public debt. This saw public sector bond yields in Ireland pushed up to new crisis highs and investors start to worry again about Portugal and Spain, with a renewed sharp rise in their bond yields as well. Fearing the consequences of renewed market panic, European authorities encouraged Ireland to apply for assistance. It has now been granted with a 67bn euro support package as Ireland undergoes another round of austerity measures.

However, speculation has remained that Portugal will need assistance. The good news is Greece, Ireland and Portugal are small, comprising only 6.3% of the euro area economy. So providing assistance for Portugal as well wouldn’t be a major stretch financially for Europe and these economies aren’t big enough to have a noticeable impact on the European economy. The trouble would be if Spain were also affected.

Why the concern over Spain?

Spain, and even Portugal, are very different to Greece. Prior to the GFC Spain was running a budget surplus. Its budget deficit now seems to be coming back under control and its public debt to GDP ratio is below that of Germany and the US (see the table below). In short it doesn’t suffer from the solvency issues that trouble Greece.

The public debt blow out

* 32% if the bank bailout is included. Source: OECD, IMF, Eurostat, AMP Capital Investors

Rather, the main concerns appear to be that its weak economy (with 20% unemployment) will lead to further real estate losses and more problems for its banking sector (notably its small savings banks – which account for a big chunk of Spanish banking sector assets), all leading to a worsening in its public sector finances, particularly if bank bailouts are required. There is also a degree to which concern over Spain (and indeed other countries in Europe) is becoming self-fulfilling in that investor panic is driving higher bond yields making it harder for Spain (along with Portugal) to service its public debt, forcing it closer to the need for assistance. Higher public sector bond yields also push up private sector borrowing rates making life tougher for private sector borrowers as well.

A bailout for Spain may be feasible in the context of the 720bn euro facility announced in May, but only just, although some European officials have said the facility could be increased in size. But it would come with much bigger political conflict in Europe and raise more serious questions about the future of the euro.

A full blown crisis in Spain would also have a much bigger economic impact as it is 11.8% of the euro area economy and German and French banks have a much greater exposure to Spanish debt than they do to Greek, Irish and Portuguese debt. (Fortunately, US banks have little exposure to debt in troubled European countries.) The Spanish exposure of German banks is equivalent to 1.8% of their assets and for French banks it is 1.5% of assets.

Some grounds for optimism

As such, it is critical the contagion flowing through Europe ends soon, before tipping Spain over the edge. On this front there are some grounds for optimism. First, European authorities have got the message and have been moving quickly to provide assistance to Ireland, and would probably do so quickly in the case of Portugal as well if required. Second, real estate loan losses in the case of Spain are likely to be far smaller as a proportion of GDP (maybe adding 10% to the public debt to GDP ratio) than in Ireland, suggesting far less risk to the Spanish banking system. This is likely to be confirmed by another round of bank stress tests for Spanish banks that Spanish authorities have committed to provide. Thirdly, although worth keeping an eye, so far there is little evidence of panic in money or credit markets with spreads remaining well contained compared to the situation in 2008. This includes bank borrowing spreads in Europe. Finally, if the crisis doesn’t soon settle down we are likely to see renewed buying of Government bonds in troubled countries from the European Central Bank, an action that helped stabilise the Greek crisis mid-year.

More broadly it is interesting to note that unlike at the height of the Greek crisis in May-June this time around there has been less weakness in share markets. This in part likely reflects better economic news out of Europe generally. In May, the European PMI, a survey of business conditions, was starting to fall helping fuel worries of a double dip. However, in recent months it has surprised on the upside. In particular, this reflects strength in Germany and other northern European countries offsetting softness in countries with debt problems. See the next chart.

Germany seems to have been a key beneficiary of the crisis via a weaker euro. The overall business climate in Germany as measured by the IFO survey is at an all time high and Germany’s unemployment rate is at its lowest since 1992. (Germany is 27% of the euro area economy).

Source: Bloomberg, AMP Capital Investors

More broadly, business conditions indicators globally, whilst generally falling in mid year now appear to have mostly stabilised or improved (with the exception of Japan).

Source: Bloomberg, AMP Capital Investors

Concluding comments

There are several points worth concluding on. First, while European public debt woes will likely remain a periodic source of fragility in the global economy and volatility in financial markets, policy action should be enough to prevent them becoming a full blown crisis. Spain is worth keeping an eye on in the short term though. Secondly, just as the outlook for the $US is bleak, the problems with debt in Europe suggest the same in relation to the euro. The experience of Iceland, which now seems well on the way to recovery thanks in part to a plunge in its currency, highlights the benefit of allowing a weaker currency in response to debt problems. Thirdly, the public debt problems in Europe are of course part of a wider debt problem in major advanced countries including the US and Japan – which will act as a constraint on their growth for many years to come in contrast to emerging countries where public debt is not really an issue. Finally, while Australia has little public debt and has little trade exposure to Portugal, Ireland, Greece and Spain, it is affected via financial market and economic sentiment. Fortunately, it is more exposed to strongly growing emerging countries. The main risk for Australia would come if the European public debt woes led to a renewed credit crunch which would again make it more costly for Australian banks and businesses to raise funds offshore. So far though this appears unlikely.

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• NAB business confidence index eased from +10.1 to +8.1 in October. The business conditions index fell from +6.7 in September to +1.6 in October – a 15 month low.
• CommSec has been highlighting for some time that the economy was far softer than the Reserve Bank appeared to be suggesting. And that weakness was clearly evident in the business survey. Profits, orders and trading conditions are slumping with retailing and construction particularly hard hit.
• The Federal Government forecasts are clearly more optimistic about the longer term outlook for the economy. The budget deficit is expected to rise modestly over the coming year but be back in surplus by
  2012/13. The economy is tipped to grow by an upwardly revised 3.25 per cent this year, inflation is to hold at 2.75 per cent and unemployment is expected to fall to 4.75 per cent by June 2011.

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