• 

  Petrol prices have fallen

  Lending soars. Total lending finance soared by 7.6 per cent in June, underpinned by a 12.1 per cent lift in business lending. Total new lending in June was $72.9 billion – the highest since January 2008.

• Petrol prices fall: According to the Australian Institute of Petroleum, the national average Australian price of petrol fell by 1.0 cent per litre to 148.3 cents a litre in the week to August 10 – the lowest since the week to December 1 2013. The wholesale price continues to slide, hitting a near 9-month low.

What does it all mean?

• Lending has returned to levels prior to the global financial crisis. In fact, in original terms, lending totalled $84.1 billion in June 2014, the second highest total on record behind June 2007 ($90.8 billion). While growth is being driven by business lending, both personal and housing loans are well up on a year ago. Simply, consumers and businesses are embracing cheap financing. And hopefully in the case of business, some of the extra dollars are being put to work in new investment, in turn leading to the hiring of more staff.
• It may be hard to gauge given the discounting cycles in many capital cities, but there is good news for motorists. The pump price is at 8-month lows and the wholesale petrol price continues to slide, reaching levels last seen in mid-November last year. If the lower prices can be maintained, motorists will save around $13 a month on filling their cars with petrol. Simply the world is well supplied with petrol and global oil demand remains soft.

What do the figures show?

Lending Finance:

• Total new lending commitments (housing, personal, commercial and lease finance) rose by 7.6 per cent in June to a 6½-year high of $72.9 billion. It was the biggest lift in lending in 27 months.
• Housing finance: The seasonally adjusted measure of construction and new purchases rose by 1.8 per cent in June while alterations & additions rose by 2.2 per cent. Home loans are up 10.8 per cent on a year.
• Commercial finance: The seasonally adjusted series for the value of total commercial finance commitments rose by 12.1 per cent in June. Revolving credit commitments rose by 38.4 per cent, the fourth straight gain. Fixed lending commitments rose by 0.9 per cent. Business loans are up 29.4 per cent over the year.
• Personal finance: The seasonally adjusted series for the value of total personal finance commitments fell by 1.8 per cent in June after rising by 8.5 per cent in May. Revolving credit commitments fell by 3.3 per cent and fixed lending commitments fell by 0.6 per cent. Personal loans are still up 11.4 per cent over the year.
• In terms of fixed personal loans, car finance was up by 5.5 per cent over the year; debt consolidation rose by 2.6 per cent; refinancing rose by 7.7 per cent; loans to buy land rose by 18.6 per cent; and “other” loans were up by 18.0 per cent. Overall, personal fixed loans were up by 9.7 per cent over the year.
• Lease finance: Lending rose by 1.2 per cent in June but fell by 12.9 per cent over the year.

Petrol prices

• According to the Australian Institute of Petroleum, the national average Australian price of unleaded petrol fell by 1.0 cent a litre to 148.3 c/l in the week to August 3. The slide in prices reflected cyclical lows in the discounting cycles that exist in southern and eastern capital cities. The metropolitan price fell by 1.1 cents to 145.5 c/l, while the regional average price fell by 0.6 cents to 154.0 c/l.
• Average unleaded petrol prices across states and territories over the past week were: Sydney (down by 3.0 cents to 140.9 c/l), Melbourne (up by 0.6 cents to 144.1 c/l), Brisbane (up by 4.1 cents to 149.8 c/l), Adelaide (down by 11.0 cents to 141.9 c/l), Perth (down by 2.5 cents to 148.3 c/l), Darwin (unchanged at 173.0 c/l), Canberra (down 0.1 c/l to 155.7 c/l) and Hobart (down 0.2 c/l to 160.5 c/l).
• Today, the national average wholesale (terminal gate) unleaded petrol price stands at 136.3 c/l, down around 2.5 cents over the week and the lowest level in almost nine months (November 18 2013).
• Last week the key Singapore gasoline price rose by just US6 cents to US$113.41 a barrel – just above the lowest levels seen in eight months. In Australian dollar terms the Singapore gasoline price rose by 70 cents barrel or 0.6 per cent last week to $122.66 a barrel or 77.14 cents a litre, just above the lowest levels seen in 8½ months.
• Figures from MotorMouth show that petrol prices in Melbourne and Brisbane hit the peak levels in the discounting cycle in the past few days. In Sydney, petrol prices have fallen for 28 days – well past the usual 12-14 days cycle. Adelaide petrol prices are near the lows, having fallen for 15 days.
• Lending Finance is released monthly by the Bureau of Statistics and contains figures on new housing, personal, commercial and lease finance commitments. The importance of the data lies in what it reveals about the appropriateness of interest rate settings, confidence and spending levels in the economy.
• Weekly figures on petrol prices are compiled by ORIMA Research on behalf of the Australian Institute of Petroleum (AIP). 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. AIP data for retail petrol prices is based on available market data supplied by MotorMouth.
• The economy has healthy momentum, being provided by recovering consumer confidence, increased lending and solid home construction. While the environment is especially favourable for businesses dependent on home construction and purchase, the outlook is improving for equipment and services businesses and discretionary retailers. The drop in the price of petrol removes one potential source of angst from Aussie consumers.

Why is the data important?

• Lending Finance is released monthly by the Bureau of Statistics and contains figures on new housing, personal, commercial and lease finance commitments. The importance of the data lies in what it reveals about the appropriateness of interest rate settings, confidence and spending levels in the economy.
• Weekly figures on petrol prices are compiled by ORIMA Research on behalf of the Australian Institute of Petroleum (AIP). 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. AIP data for retail petrol prices is based on available market data supplied by MotorMouth.

What are the implications?

• The economy has healthy momentum, being provided by recovering consumer confidence, increased lending and solid home construction. While the environment is especially favourable for businesses dependent on home construction and purchase, the outlook is improving for equipment and services businesses and discretionary retailers. The drop in the price of petrol removes one potential source of angst from Aussie consumers.

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• According to the Australian Institute of Petroleum, the national average Australian price of unleaded petrol rose by 1.2 cents per litre to 136.3 cents a litre in the week to February 27 – a fresh 28 month high.
• Motorists are likely to see a further increase in petrol prices. While the Singapore unleaded price rose by more than US$8 a barrel, it has only partially filtered through to the terminal gate (wholesale) price – which gained 3 cents a litre in the past week. CommSec expects pump prices to rise by a further 4-5 cents a litre in the next fortnight.
• The TD Securities-Melbourne Institute monthly inflation gauge rose by just 0.2 per cent in February. Excluding volatile items, prices were up just 0.1 per cent – the seventh straight month of negligible growth.
• Private sector credit rose by 0.3 per cent in January to stand 3.4 per cent higher than a year ago.
• Capital city home prices fell by 1.6 per cent in seasonally adjusted terms in January after rising by 0.3 per cent in December according to the RP Data-Rismark Hedonic Australian Home Value Index – the largest property database in Australia. Outside capital cities, prices fell by 1.2 per cent in January.
• Company profits fell by 2.8 per cent in the December quarter. Profits rose in just four of the 15 industry sectors. However sales rose in ten of the 15 industry sectors in the December quarter with aggregate sales up by 0.9 per cent. Inventories (stocks) held by businesses rose by 0.7 per cent in the December quarter in inflation-adjusted terms.

What does it all mean?

• All the data released today points to a soft economy that does not need any further interest rate hikes in the near term. Inflation remains well under control, consumers and businesses are still refusing to borrow, house prices are recording modest falls and the sustained rise in petrol prices will add further pressure to household budgets – further slowing down spending.
• After largely going sideways for the last month pump prices have resumed their upward trajectory. Petrol prices are now holding at fresh 28-month highs and unfortunately for motorists it is unlikely to get any better over the next couple of weeks.
• The political instability in the Middle East and North Africa has resulted in the Singapore unleaded price surging by over US$8 a barrel in the past week. And given that the Australian dollar was largely unchanged, the entire increase in the global oil price will need to filter through to domestic pump prices.

• Already the terminal gate price (wholesale) has started to react rising by a sizeable three cents a litre in the past week. But a further increase in the wholesale prices will take place over the rest of this week and given the lag effect motorists should see the impact on petrol signboards around Australia early next week. CommSec expects prices to increase by 4-5 cents a litre in the next fortnight, taking the national average price to above $1.40 a litre. At the high point of the discounting cycle petrol will be trading at well above a $1.50 a litre.
• The latest TD inflation gauge suggests that inflation remains well and truly under control at present. In February prices rose by 0.2 per cent. Interestingly the rise in fruit and vegetable prices may be the first indication of the impact from the floods. But strip out volatile elements like fruit and vegetable prices, and petrol and inflation is largely non-existent in Australia. Over the past seven months inflation has been negligible and the annualised core result is holding at a more sedate level of 2.3 per cent. Even the three month annualised rate of inflation is amazingly just 0.3 per cent.

• The latest lending data adds further weight to the view that interest rates should remain on hold in the near term. Overall lending ticked higher but the sub components suggest that activity levels are still shaky. Business credit fell for the seventh straight month, while consumer borrowings were unchanged after sliding in the prior month, and housing credit ticked modestly higher. Even within housing credit, lending to home owners continued to slide, with the annual growth rate at the weakest levels since records began 20 years ago.
• Australian home prices have completed a soft landing. In March 2010, prices were seemingly going gangbusters with annual growth standing at 14.1 per cent. But home prices are now tracking at just a 1.2 per cent annual rate – the slowest growth rate in 23 months and well below the long-term average pace of 8.0 per cent.
• The rate hikes delivered over 2010 have taken the heat out of the housing market, while the wet weather conditions has also added another degree of weakness to the result. Property prices across Australia fell by 1.6 per cent in January however it is important to highlight that sales volumes were less than 50 per cent of a typical months flows.
• It is likely that housing conditions will remain soft in the near term, however the long term fundamentals certainly look more attractive. The Reserve Bank is likely to remain on the interest rate sidelines in the near term, while healthy jobs growth, rising population and sliding rental vacancy rates will support housing activity in the medium term.

What do the figures show?

Petrol prices:

• According to the Australian Institute of Petroleum, the national average Australian price of unleaded petrol rose by 1.2 cents a litre to 136.3 cents a litre in the week to February 27. The metropolitan price rose by 1.0 c/l to 136.1 c/l, while the regional average price rose by 1.3 c/l to 136.6 c/l.
• Average petrol prices across states over the past week were: Sydney (up 2.1 cents to 136.6 c/l), Melbourne (up 0.9 cents to 135.2 c/l), Brisbane (up 0.1 cents to 137.7 c/l), Adelaide (up 1.1 cents to 134.7 c/l), Perth (up 0.2 cents to 135.6 c/l), Darwin (up 1.3 cents to 139.0 c/l), Canberra (down 1.7 cents to 133.7 c/l) and Hobart (up 0.3 cents to 141.0 c/l).
• Today, the national average wholesale (terminal gate) stands at a 28-month high of 130.0 cents a litre, up 3 cents a litre over the past week. The wholesale price has been hovering around 126-127 cents a litre since late January 2011.
• Last week, the key Singapore unleaded petrol price rose by US$8.67 (7.9 per cent) to US$118.77 a barrel – a 30 month high. And in Australian dollar terms the Singapore gasoline price rose by $8.47 (7.8 per cent) over the week to $117.20 a barrel.

Inflation gauge:

• The monthly inflation gauge rose by 0.2 per cent in February after lifting by 0.4 per cent in January. The annual rate of inflation rose from 3.4 per cent to 3.6 per cent.
• Excluding volatile items like petrol and fruit & vegetables, the inflation gauge rose by 0.1 per cent after remaining unchanged for the two prior months. The annual rate of core inflation remained steady at 2.3 per cent. The threemonth annualised rate of inflation rose eased from 0.4 per
  cent to 0.3 per cent.
• TD Securities noted that “Contributing most to the overall change in February were price rises for fruit and vegetables, meat and seafood, and automotive fuel. These were offset by a sharp seasonal fall in holiday travel and accommodation, and a fall in rents. The price of fruit and vegetables rose by 5.1 per cent in February, following the 12.1 per cent rise in January. Excluding a grocery chain milk price discount war, the Inflation Gauge rose by 0.3 per cent.”

Private sector credit

• Private sector credit (lending) rose by 0.3 per cent in January after rising by 0.2 per cent in December. Credit growth is up 3.3 per cent on a year ago.
• Housing credit grew by 0.6 per cent with lending to owner-occupiers rising by 0.5 per cent and investor housing up 0.6 per cent. Housing credit is up 7.3 per cent on a year ago – the weakest annual growth in 18 months. Owner occupier housing credit is up 7.0 per cent on a year ago – slowest pace in records going back 20 years. Investor housing lending was up 7.9 per cent on a year ago.
• Personal credit remained flat in January after sliding by 0.4 per cent in December. Personal credit was up 0.8 per cent over the year – still well below the rate of inflation. Business credit fell for the seventh straight month in January, easing by 0.2 per cent. Business credit is down 2.4 per cent on a year ago and has been consistently contracting for the past 19 months.

House price prices

• The RP Data-Rismark Hedonic Australian Home Value Index fell by 1.6 per cent in seasonally adjusted terms in Janaury after a 0.3 per cent rise in the previous month.
• House prices fell by 1.0 per cent in the month while apartments fell by 2.2 per cent.
• Capital city home (dwelling) prices are up 1.2 per cent on a year ago, the slowest growth rate in 23 months. House prices are up 0.9 per cent and apartment prices are up by 2.1 per cent.
• Prices rose in just one of the seven capital cities in January with Darwin prices up 3.3 per cent. Across the other cities prices fell most in Melbourne (down 2.3 per cent), followed by Sydney and Brisbane (down 1.8 per cent), Canberra (down 1.6 per cent), Perth (down 1.5 per cent), Adelaide (down 0.7 per cent). In Hobart, prices rose by 2.1 per cent in December (January data not yet available).
• Home prices are higher than a year ago across all capital cities except Perth (down 4.1 per cent), Brisbane (down 3.5 per cent), and Canberra (down 0.6 per cent). Prices are up most in Darwin (up 4.7 per cent), followed by Melbourne (up 3.8 per cent), Sydney (up 2.6 per cent), and Adelaide (up 2.2 per cent).
• January home prices aren’t available yet for Hobart. In the year to December, home prices in Hobart were up by 2.2 per cent.

Business indicators

• Company gross operating profits fell by 2.8 per cent in the December quarter. Profits now stand 14.7 per cent higher than a year ago.
• Profits rose in four of the 15 industry sectors, led by Financial and insurance service (up 201.6 per cent), Administrative and support services (up 26.9 per cent), and Accommodation & food services (up 8.5 per cent), Mining profits fell by 8.5 per cent following the 1.6 per cent fall in profits in the September quarter.
• Excluding the financial and insurance sector, profits fell by a much larger 4.6 per cent in the quarter.
• Profits fell 10.6 per cent in construction.
• Sales rose in ten of the 15 industry groupings in real (inflation-adjusted) terms in the December quarter. Of the major sectors, sales rose 1.4 per cent in accommodation and food services. Sales fell by 4.1 per cent in Rental, hiring & real estate services, and by 1.4 per cent in Mining.
• In real terms, aggregate sales rose by 0.9 per cent in the December quarter.
• In nominal terms sales fell most in December quarter in both Queensland (down 2.5 per cent). Sales rose most in both Victoria and South Australia (up 1.6 per cent) followed by Western Australia (1.4 per cent).
• Inventories fell in three of the six sectors, with overall stocks up by 0.5 per cent. Mining stocks fell by 3.5 per cent with retail trade up 0.7 per cent. Utilities fell 6.0 per cent.

What is the importance of the economic data?

• 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.
• 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.
• Private sector credit figures are released by the Reserve Bank on the last working day of the month. Credit is separated into three categories – housing, other personal and business. Private sector credit is effectively the amount of loans outstanding in the economy. If growth in lending is strong then it suggests that credit from financial institutions is freely available, underlying demand for assets such as cars and houses is firm and that the price of credit (interest rates) is attractive.
• The RP Data-Rismark Hedonic Australian Home Value Index is based on Australia’s biggest property database covering more than 340,000 sales during 2010. Unlike the ABS Index, which excludes terraces, semidetached homes and apartments, the RP Data-Rismark Hedonic Index includes all properties.
• The monthly RP Data-Rismark Hedonic Index compares month-to-month index results. Quarterly results are measured comparing end months rather than averaging each month in the quarter. For example, the first quarter of 2009 index results would compare the end of March index with the end of December index.

What are the implications for interest rates and investors?

• It is clear that rising petrol prices will boost the inflation rate in coming months. However there is not a lot that the Reserve Bank can do about changes at the petrol bowser or the floods in Queensland – 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.
• Businesses are still cutting debt at a faster rate than new loans are being taken out. Overall this is a good reason to remain cautious on the outlook for the economy.
• Home prices are off the Reserve Bank’s worry list – at least for now. A softening in home prices combined with the prospect of interest rates remaining unchanged until mid year is clearly positive for budding home buyers.

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• Lending rose in December. Total lending finance rose for the fourth consecutive month up by 2.4 per cent in December. Lending totalled $54.9 billion in December, up 4.1 per cent over the year but up a much healthier 10.5 per cent in the past four months.
• The Government’s commodity forecaster has downgraded its crop forecasts. ABARES has revised lower its forecast for the 2010/11 winter crop by 2.5 per cent. The flooding on the east coast was the driver behind the modest downgrade.
• While the latest forecast has been downgraded, ABARES still tips a record wheat crop with production up 20 per cent on a year ago.
• RBA Board on interest rate sidelines. The decision to leave interest rates on hold in February was due to an array of factors. The floods are expected to slash growth in the near term, while the subdued consumer spending and the lower-than-expected inflation outcomes have provided Board members additional time to assess economic conditions.

What does it all mean?

• Lending finance is effectively a forward looking indicator of economic activity – given that any rise in borrowings will eventually translate to a pickup in spending and activity. And while the conservative attitudes of consumers and businesses have kept borrowings weak, there are signs that things are thawing. Lending finance has risen for the fourth straight month with healthy growth of over 10 per cent in that period.
• No doubt a longer term historical view suggests that it is still early days. The pickup in activity is off a low base and in annual terms the growth rate is not looking overly flash at just 4.1 per cent. More importantly the weakness in consumer borrowings is still a major concern, especially given that consumer finance has fallen for four out of the last six months.
• The overall improvement in lending is only in its infancy, and given the November rate hike is yet to have a full impact on the economy, the argument for a period of interest rate stability remains the best outcome. CommSec would expects the Reserve Bank is likely to stay on the interest rate sidelines – especially given that inflation looks to be well contained at present.

• The release of the latest Reserve Bank Board minutes have highlighted that the weakness in consumer activity was a key factor in rates remaining on hold in February. And as the Reserve Bank has noted on recent occasions the lack of consumer activity, is not all bad news ensuring that inflationary pressures are contained in the near term. Even the Governor admitted at his testimony to parliament that “it is a difficult  environment for retailers. But not entirely unwelcome in the current circumstances” – given it would be harder to avoid the economy overheating if all sectors of the economy were firing.
• The minutes revealed that Board members were generally optimistic about the outlook, noting upward revisions to the near term outlook for Australia’s terms of trade and sustained improvement in labour market conditions. However given that interest rate were “mildly restrictive” – in other words tapping the breaks on the Australian economy – a rate pause seemed the most logical outcome. CommSec expects rates to remain on hold until mid year.
• Despite the devastating natural disasters, the Government’s chief commodity forecaster still believes that Australia will produce a record wheat crop this year. Overall ABARES has revised lower its forecast for 2010/11 winter crop production by a relative modest 2.5 per cent as the excessive rainfall flooding in the Eastern states were partially offset by an increase in the production estimate for Western Australia and South Australia.
• As always, conditions are far from uniform across the country but the outlook for the summer crop is also decidedly positive with cotton farmers to be amongst the key beneficiaries of abundant irrigation and higher prices. Overall there will be more money in the rural economy over the coming year, courtesy of the breaking of the drought – boosting the outlook for retail, manufacturing and services businesses in regional centres.

What do the figures show?

Lending Finance:

• Total new lending commitments (housing, personal, commercial and lease finance) rose by 2.4 per cent in December after rising 1.6 per cent in November. Lending totalled $54.9 billion in December, up 4.1 per cent over the year but up a much healthier 10.5 per cent in the past four months.
• All housing finance (owner occupier & commercial) rose by 2.5 per cent in December, the fourth straight monthly gain.
• Commercial finance rose by 3.3 per cent in December. Within commercial commitments, fixed lending rose by just 0.5 per cent but revolving credit surged by 9.7 per cent. Commercial loans are up 7.7 per cent on a year ago.
• Personal finance fell by 0.2 per cent in December – marking the fourth fall in the past six months. Within personal commitments, fixed lending fell by 0.4 per cent while revolving credit fell by 0.1 per cent. Personal loans are up 4.1 per cent on a year ago.
• Lease finance slumped by 8.7 per cent in December and loans are down 10.8 per cent over the year.

ABARES Crop Report:

• The Australian Government’s commodity forecaster, ABARES, has revised lower its forecast for 2010/11 winter crop production by 2.5 per cent to 42.1 million tonnes (Mt). The crop is now seen 19 per cent higher than 2009/10. ABARE highlighted that “Downgrades were applied to New South Wales, Victoria and Queensland, largely as a result of the widespread excessive rainfall and some flooding in late 2010 and early 2011. This
  decrease has been partially offset by an increase in the production estimate for Western Australia and South Australia, where harvest results have been better than earlier expected.”
• ABARES has also lifted its forecast for summer crop production by 66 per cent to 4.8Mt. Production of the summer crop in 2010/11 is expected to be the highest in nine years. Cotton production is tipped to soar by 117 per cent in 2010–11, to 839 000 tonnes, with reductions from floods in Queensland more than offset by higher production in New South Wales. ABARES notes that “High cotton prices and abundant supplies of irrigation water in most cotton growing regions” are the key driver of what will result in the largest Australian cotton harvest on record.

• ABARES expects that wheat production will hit a record high of 26.3Mt in 2010/11, up 20 per cent on the previous year. However the forecast is around 1.9 per cent lower than ABARES December forecast largely due to the extreme weather conditions on the east coast. Similarly Barley production is estimated to rise by 18 per cent to 9.3 million tonnes (5 per cent downgrade to December forecast) and canola production is estimated at 2.1 million tonnes (5 per cent upgrade on previous forecast) – 11 per cent higher than last year.

Minutes from the February 2011 Reserve Bank Board meeting

Consumer spending

• Members discussed developments in the household sector, where the restraint in spending was continuing despite solid growth in household income. Data on retail spending in October and November were soft and liaison suggested that this had continued for most of December.
  

Business conditions

• Another large LNG project in Queensland had received final investment approval in January and conditions in the resources sector remained positive. More broadly, overall business conditions in late 2010 were at around average levels, though there were significant differences across sectors. Non-residential construction remained weak. Business credit outstanding continued to contract, although other forms of external financing were growing.
  

Employment

• The labour market remained strong, with employment increasing by nearly 60,000 over November and December, and the unemployment rate falling to 5 per cent. Employment was estimated to have grown by 3.3 per cent over 2010. Forward-looking indicators of labour demand, including job vacancies and hiring intentions, continued to point to solid employment growth and some further tightening in labour market conditions.
  

The decision

• Given the medium-term outlook for the economy, and the limited amount of spare capacity that existed, members judged that this slightly restrictive policy stance remained appropriate. The continuation of subdued growth in consumer spending and the lower-than-expected inflation outcomes provided additional time for the Board to assess at future meetings the evolving balance of risks to both output and inflation.

What is the importance of the economic data?

• Lending Finance is released monthly by the Bureau of Statistics and contains figures on new housing, personal, commercial and lease finance commitments. The importance of the data lies in what it reveals about the appropriateness of interest rate settings, confidence and spending levels in the economy.
• ABARE releases its Crop Report four times a year. The report contains the latest estimates of crop conditions, yields as well as expected exports. The information is useful in gauging the health of the rural sector.
• The Reserve Bank releases minutes of its monthly Board meeting a fortnight after the event. The minutes give a guide to Reserve Bank thinking on interest rate settings.

What are the implications for interest rates and investors?

• Overall the latest minutes provide the Reserve Bank a degree of flexibility on the interest rate front. And while the near term domestic data looks patchy the Reserve Bank remains confident about the outlook. CommSec believes that interest rates are unlikely to be raised until May.
• Our CBA equity analysts indicate that GrainCorp is likely to benefit from the higher grain prices and volumes “East coast grain volumes are the far more important to GNC than rising grain prices, but higher global grain prices will continue to support east coast grain exports over the next 12-18 months. Farmers usually respond to high grain prices and GNC will also likely benefit from a 3-5% increase in crop planted area on the east coast for FY12 (planting in May-June).” Our analysts still have recommended a hold rating for Grain Corp.
• Of other stocks in the sector the analysts note: “Ridley Corporation (RIC) remains our preferred exposure in Food & Agribusiness sector and is set to benefit from strong protein demand as a result of herd rebuilding, and ample feed grain supply over the next two years. Strong rainfall / flooding over the past few months – while has negatively impacted both 1H11 and 2H11 overall – is a significant medium-term positive for all stockfeed demand (incl. supplementary feed). The FY12-13 outlook is strong for both AgriProducts and Salt divisions.”

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Many investors are cautiously bullish about the coming year, particularly following confirmation of extension of the Bush tax cuts and the surprise 2% cut in payroll tax. This is expected to boost US growth by 1% plus, which may take it to above potential levels and start to lower unemployment.

The chart below highlights the stark difference in the performance between the 1930s and current financial crises – these two episodes are circled on the left and right hand sides of the chart respectively. While US growth was flat in 2008 and dipped into negative territory (-2.6%) in 2009, last year saw a significant rebound (the 2010 figures in the chart are for periods to end September 2010). This is in stark contrast to the 1930s experience when growth averaged -9.4% during 1930-32. The other interesting difference lies in what happened to savings behaviour. In both cases total net savings (relative to GDP) declined but the extent of public sector dis-saving is today on a scale not seen in the 30s. It is this fiscal stimulus, together with the dramatic monetary policy response, which allowed the economy to expand last year.

The public sector stepped in to take up the slack as households increased savings, thus avoiding the paradox of thrift (in which more savings reduces demand and hence incomes which ends up increasing  debt). The difficulty with this strategy is, of course, spiralling public sector debt. For a time policy makers have to promise fiscal austerity while carrying on spending until the recovery becomes self sustaining…which hopefully occurs before bond holders lose confidence and grow wary of lending governments more money. Even if bond holders keep their nerve, policy makers know that as debt levels rise the risk is that GDP will slow down as the debt service burden grows. The US public sector debt is now US$14 trillion(!) and above the 90% of GDP threshold believed significant for growth rates.

US policy makers know they are in for a multi-year consumer deleveraging process, that will constrain growth unless there is an offset…hence they are chancing further fiscal stimulus, hoping that it will keep things going until the recovery is self sustaining. However, it’s not clear that the fiscal stimulus is being targeted in the right way. To fix a structural employment problem they likely need public sector infrastructure programs aimed at job creation (i.e. investment as opposed to short term boosts to consumption). All fiscal stimulus of course increases debt, the reverse of what eventually must happen. It is a difficult trade-off – is more shorter term growth worth more than longer term austerity? It is if there is sufficient risk of a Japanese style liquidity trap.

While the US has plenty of problems (at least the growth outlook for 2011 is encouraging. Elsewhere policy makers have opted for fiscal austerity. Consequently, growth potential in the UK, Euroland and Japan is likely to be sub 2% in 2011.

The Eurozone, a coalition of illsuited and (some) dysfunctional partners, is scrambling to avert a new crisis. Economic conditions are not uniform. The core countries are doing okay, partly because they benefit from a lower exchange rate due to the influence of the risky Euro periphery. In contrast the periphery suffers from too high an exchange rate, increasing pain for the real economy. This increases the need for more fiscal stimulus, except that this is difficult since it’s already clear that many Euro periphery bond holders will suffer a hair cut on outstanding sovereign bonds and would be reluctant to invest more. Hence the stronger core is left to finance the weaker periphery.

The problems here look like going on and on. It is unclear how Spanish problems will be resolved, it is both too big to fail and too expensive to save. Policy responses to date have been reactive, and aimed at muddling through rather than finding a final solution. The German voters are impatient and its policy makers have been accused of dithering and acting at the last minute when forced to avert a new crisis.
However, the German economy is doing well and there is some acceptance of the need to change behaviour and support weaker members. This suggests that despite all the problems the Euro may survive.

Clearly policy makers face a range of highly unpleasant risks.Identifying the best policy stance is extremely difficult. The path forward is still very uncertain and policy makers will continue to be forced to react to emerging conditions. An added danger is the fracturing of the post crisis policy coordination, and increased focus on beggar-thyneighbour policies. Protectionism will result in a poor outcome for all.

It is clear that in the near term the global economy is highly dependent on the US and the emerging world, particularly China. Unfortunately China also has issues. It is struggling with the flow on effects of an
inflexible exchange rate, in particular spill-over from the loose US monetary policy. This increases excess liquidity, boosts short term growth but also creates instabilities…in particular what may be a bubble in the (vast) property market. The challenge for policy makers is to reduce the bubble risks without derailing economic growth.

Stellar Chinese growth is also creating labour shortages and wages are rising rapidly (over 20% in 2010). Commodity prices too have risen strongly following the most extraordinarily massive Chinese fiscal stimulus. Oil is around $90 a barrel and many soft commodities are up by around 25% over the past six months. (Note that China is no longer a source of disinflation for the rest of the world…this is not an issue now, but will be later.) With inflation picking up (particularly food prices, which can have implications for social stability) there is concern that policy makers are acting too slowly. They may be overly worried about a property market decline, this is a planned economy and the impact on the real economy may be limited by strong infrastructure spending.

While China is trying to engineer a soft landing, more fundamentally it also needs to increase the consumption share of GDP and rebalance a highly skewed economy.However with China getting ready for a handover of power to a new generation of leaders, change is likely to be cautious.

It is worth mentioning China specific positives. A large surplus reserve exists that can be used to offset economic downturns and this provides policy flexibility. Centralised policy making potentially allows the focus to be on longer term solutions and the use of multiple tools/solutions (be it taxes, lending/trading restrictions, rate-setting, etc) that may not be available to other policy makers.

What are the implications for markets? This is a complex and confusing environment. There is the potential for a range of both positive and negative surprises. It is possible that the US manages to pull off a sustainable recovery, which is critical to the global economy. Also very much on the positive side, many US and other companies are cashed up and strong, and as confidence grows capex and (perhaps) labour hiring could both surprise. A wave of M&A activity is perhaps more likely in the near term, and that could bode well (at least selectively) for equity returns.

Returns depend not only on what happens but also on what’s priced in. At the moment there is a bit more optimism about the outlook which tends to push future returns down (because the good news is already in the price), but there is still an historically high yield gap, or risk premium, between US forward equity earnings yields and the 10yr bond rate. That highlights how deeply unattractive US bonds are. In general, the combination of a highly uncertain environment and somewhat complacent market pricing would suggest a move into more defensive assets. However, today traditional defensive assets (nominal bonds) look very expensive and hence risky.

MLC became wary last year and we switched our global sovereign debt mandate to a cash benchmark. This reflects the risks of spiralling public sector debt, but also recognises that yields will rise as confidence grows in a self sustaining recovery (the December quarter 0.8% rise in the US 10 year Treasury yield was likely mainly due to higher confidence in the sustainability of the growth cycle).

Given typical time horizons and real return objectives, most investors need a significant allocation to equities. We think that a key to future returns is the quality of the stock selection – likely dispersion in individual stock performance implies high alpha potential. On the asset allocation side we are highlighting the need for a sufficient foreign currency exposure in portfolios. One of the biggest valuation anomalies is in the current level of the Australian dollar and, unusually, it may be vulnerable in both a return to risk aversion and more positive global growth scenarios.

The Australian dollar has benefited from what seems like unshakeable confidence, supported by stellar Chinese growth. But an improving US may reduce the focus on China and Australia has an Achilles heel – extraordinarily high private sector debt which is very negative for growth potential. The high private sector debt burden that Australia carries is largely funded from offshore savers via our banking sector, which is highly reliant on offshore wholesale financing. This is a low probability tail risk but we all know what can happen when foreign lenders lose confidence and pull the plug: Iceland, Ireland, Greece, Portugal, Spain.

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Headline developments

• In a move that had been anticipated for some time, China raised one year lending and deposit rates by 0.25% as part of an ongoing effort to keep inflation expectations in check. Further tightening is likely over the next six months. The Chinese Government is also reportedly targeting 8% growth this year and 4% inflation. The 8% growth target is best seen as a minimum because this has been the target for several years now but for the last seven years growth has always come in above it. Moreover, the increase in the inflation target to 4% from a 3% target last year suggests that the Government will be flexible in giving inflation time to fall back. Overall, we remain of the view that tightening will not become aggressive as most of the rise in inflation has been due to weather related increases in food prices, China will likely continue to heavily rely on administrative measures to control lending and inflation and a fall in China’s manufacturing conditions index or PMI in December suggests that the economy is not overheating but rather growing at a sustainable pace around 9.5%. As such, and with interest rates remaining low for a country with 12% or so nominal GDP growth, we remain of the view that Chinese economic growth will remain solid this year at around 9.5%.
• In Australia, the main story has been the flooding that has wreaked havoc in much of Queensland. Coming on the back of recent floods in NSW and Victoria this will have a significant economic impact, which we estimate to be around a 0.5% detraction from GDP (or about $6bn) spread over the December and March  quarters. Disruption to Queensland coal exports will be the big driver, along with reduced agricultural production (both volumes and yield quality) and the disruption to industries such as tourism, retailing and transport. Inflation is also likely to see a short term boost in the March quarter (possibly of the order of +0.5%) mainly due to higher prices for fruit and vegetables and cereals and bread. Fruit and vegetable prices are likely to spike by 10 to 20%.
• However, while not to detract from the human suffering the floods have wreaked, there is a danger in exaggerating the economic impact (made easier by constant images of flooding on TV covering an area close to the size of France and Germany combined). The 0.5% GDP detraction is likely to be temporary with production likely to rebound sharply in the mining sector in the June quarter and in agriculture through the second half of the year. The cleanup and rebuilding (estimated to cost at least $5bn) will provide a boost to growth over time. Higher prices for coal and some soft commodities will provide an offsetting boost to national income. And to the extent that the floods underline the ending of the drought and a La Nina weather pattern they should usher in better growing conditions for farmers in the years ahead. So while the floods will likely lengthen the soft patch in Australian economic growth and further delay the next RBA tightening, possibly to May or June, they are unlikely to have a significant impact on growth this year as a whole, which we expect to be around 3.5% over the year to the December quarter. At this stage, we still see the cash rate rising to 5.5% by year end.

Major global economic releases and implications

• US economic data over the last two weeks has remained consistent with an acceleration in growth after the mid 2010 soft patch. Labour market reports have been strong, the ISM business conditions indicators rose in December, construction spending and vehicle sales rose solidly in November, holiday retail sales look to have been solid despite a slight fall in consumer confidence and while house prices fell in October a continuing recovery in pending home sales suggests that the housing sector has found a floor.
• Despite ongoing weakness in peripheral countries the recovery in Europe remains on track with gains in manufacturing indicators and broader economic sentiment in December and another very strong rise in German factory orders in November. Euro-zone retail sales remain soft though.
• Japanese economic data over the last two weeks has generally been consistent with continued recovery, with an improvement in industrial production, retail sales, housing starts, the ratio of jobs to applicants and manufacturing conditions. Consumer price deflation continued in November though, so don’t expect Bank of Japan tightening any time soon.
• The Asian growth story remains strong with a strong readings for GDP growth in Singapore (+12.5% through 2010) and exports in Korea, but inflation continued to creep higher in December in Korea, Indonesia and Thailand. At this stage it is mainly due to higher food prices but it nevertheless points to the need for higher interest rates across Asia.

Australian economic releases and implications

• Australian economic data over the last couple of weeks was generally soft with weak new home sales, a slight fall in house prices, a fall in building approvals and continuing soft growth in private sector credit. Meanwhile, commodity prices continued to surge higher in December according to the RBA’s commodity price index highlighting the ongoing boost to national income from higher export prices.

Major market moves

• Global shares have started the year on a positive note buoyed by solid economic data and increasing confidence in the sustainability of the global recovery. However, the Australian share market has been weighed down by worries about the economic impact of the floods and associated earnings downgrades.
• Commodity prices have fallen back a touch over the last week due to profit taking after huge gains in December and as the US dollar has strengthened in response to stronger US economic data.
• After ending 2010 on a 28 year high of $US1.023, the Australian dollar has slipped back below parity as the $US has strengthened and on concerns about the impact of the floods on export earnings.
• Government bond yields have generally pushed higher over the last week on the back of solid global data. Bond yields in debt troubled European countries also remain under upwards pressure in response to worries about increased bond issuance in the months ahead.

What to watch in the week ahead?

• In the US, data for December retail sales (due Friday) are likely to show reasonable growth and data for consumer sentiment and industrial production are likely to show gains. While higher gasoline prices will likely boost headline inflation (also due Friday), core inflation is likely to remain benign.  The Bank of England and European Central bank are likely to leave monetary conditions unchanged.
• In Australia, retail sales for November (due Monday) are likely to rise 0.5% but this will only partially retrace the sharp 1.1% fall seen in October leaving retailers still out in the cold. Employment data (Thursday) are likely to show another 20,000 new jobs in December pushing unemployment down to 5.1%. Data for the trade balance (Tuesday), housing finance (Wednesday) and job vacancies (Wednesday) are also due for release.

Outlook for markets

• Having had strong gains through December and more broadly since August, shares are at risk of a short term correction, particularly with many technical indicators showing shares to be overbought and short term measures of investor sentiment being very high.
• However, notwithstanding the risk of a short term correction, shares are likely to put in good gains through 2011 as a whole.  Shares are cheap, the run of better than expected global economic data is continuing suggesting that 2011 is on track for strong economic growth which should in turn drive another year of solid profit growth, the global liquidity backdrop is highly favourable underpinned by very low interest rates in key countries & quantitative easing in the US and the corporate sector is cashed up which is likely to result in a further pickup in merger and acquisition activity, share buybacks and dividends. By end 2011 we see the Australian ASX 200 index rising to 5500, once it shrugs off the current malaise which appears to reflect a combination of worries about the floods and Chinese tightening.
• Like shares, the Australian dollar also started the year at risk of a short term correction after some strong gains. However, the broad trend is likely to remain up as the $US and the euro remain under downwards pressure, interest rates in Australia remain relatively high and high commodity prices keep the terms of trade near early 1950s highs. By year end the $A is likely to have reached $US1.10.
• While low inflation, US Fed government bond purchases and the absence of any near term monetary tightening should help keep bond yields in key advanced countries reasonably controlled in the short term, the risk of a sharp back up in global bond yields at some point is very high. Bond yields in key advanced countries are still well below longer term sustainable levels and the record inflows into bond funds seen in recent years are at risk of becoming record outflows. Fortunately, bond yields in Australia are more in line with long term sustainable levels so the risk of a back up in yields and sharp capital losses for investors in Australian bonds is less than is the case for global bonds.

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• Private sector credit rose by 0.3 per cent in November to stand 3.6 per cent higher than a year ago.
• Housing lending to owner-occupiers stands 7.3 per cent higher than a year ago – the weakest reading in records going back 20 years (since 1990).
• Business credit fell for the fifth straight month, easing 0.2 per cent. Business credit growth stands 2.2 per cent lower than a year ago and has been consistently falling for 17 months.

What does it all mean?

• In 20 years of records, lending to home owners has never grown at a slower pace. It is a remarkable statistic, highlighting the impact that rate hikes have had over 2010. The Reserve Bank was determined to lift rates to “normal” levels but it has come at a cost. Not only have home prices weakened over 2010 but so has construction activity, pointing to weaker times ahead for builders, tradespeople and real estate agents alike.
• Overall the modest uptick in overall lending is encouraging, particularly the pickup in consumer loans. But the old adage of ‘one swallow does not a summer make’ is clearly appropriate. Lending will need to pick up further in coming months to get retailers and other consumer-focussed businesses more excited about the road ahead.
• Businesses are still cutting debt at a faster rate than new loans are being taken out. Overall this is a good reason to remain cautious on the outlook for the economy.

What do the figures show?

Private sector credit

• Private sector credit (lending) rose by 0.3 per cent in November after edging just 0.1 per cent higher in each of the previous three months. Credit growth is up 3.6 per cent on a year ago.
• Housing credit grew by 0.5 per cent with both lending to owner-occupiers and lending to investors up 0.5 per cent. Housing credit is up 7.5 per cent on a year ago – the weakest annual growth in 15 months. Owner occupier housing credit is up 7.3 per cent on a year ago – slowest pace in records going back 20 years. Investor housing lending was up 8.0 per cent on a year ago, down from 8.1 per cent in October.
• Personal credit rose by 0.5 per cent in November after rising by 0.2 per cent in October. Personal credit was up 2.4 per cent over the year – still below the rate of inflation. Business credit fell for the fifth straight month in November, easing by 0.2 per cent. Business credit is down 2.2 per cent on a year ago and has been consistently contracting for the past 17 months.

What is the importance of the economic data?

• Private sector credit figures are released by the Reserve Bank on the last working day of the month. Credit is separated into three categories – housing, other personal and business. Private sector credit is effectively the amount of loans outstanding in the economy. If growth in lending is strong then it suggests that credit from financial institutions is freely available, underlying demand for assets such as cars and houses is firm and that the price of credit (interest rates) is attractive.

What are the implications for interest rates and investors?

• There are glimmers of hope for consumer-focussed businesses in the latest credit data. On balance consumers seem to be taking on a bit more debt, albeit very cautiously. The runs aren’t on the board but it is a trend worth watching.
• The softness in housing lending and home prices gives the Reserve Bank more reason to stay on the interest rate sidelines. We argued that the Bank was slightly too aggressive in lifting rates in 2010 and that is borne out by the weakness in recent economic data.
• Not even in the past recession was lending to home owners this weak – it clearly shows a re-assessment by young Aussies about whether to buy or rent.

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• Lending to build new homes was flat in October. A key leading indicator for home construction barely moved in October – ahead of the November rate hike. Loans for the construction of dwellings rose by just 0.1 per cent in October – only the second increase in a year.
• First home buyers exit. The proportion of first home buyers in the market hit six-year lows in October.
• Home loans rose ahead of the November rate hike. Overall, the value of housing loans rose by 2.2 per cent in October with the number of loans to owner occupiers up 1.9 per cent. But the number of home loans is 20.6 per cent lower than a year ago.
• Actual loans advanced hit 8-month lows: Lending commitments that were actually advanced in October hit eight month lows of $12.5 billion in October and were 17.6 per cent lower than a year ago.

What does it all mean?

• Blind-sided by the Reserve Bank’s preoccupation on the terms of trade, some analysts can’t believe that the Australian economy barely grew over the September quarter. Still, if you run through all the evidence, probably the big surprise is that the economy grew at all. Key sectors of the economy such as services and manufacturing are going backwards and certainly the housing market is very much becalmed. And that clearly is in evidence with the latest home loans data.
• For the home construction market one of the key forward-looking indicators is lending for construction of homes and apartments. And the latest news is not good. Lending grew just 0.1 per cent and this negligible increase was only the second monthly gain in a year.
• It’s important to note that the latest home loan data is for October – that is, it precedes the double-whammy rate hike in November. The bottom-line is that lending for home construction was already weak ahead of the last rate hike. So an extended period of interest rate stability will be required to breathe life into the home construction market.
• The number of loans to people wanting to live in homes, rather than invest in them, encouragingly grew in October. However the key question is how many budding buyers were merely attempting to lock in finance ahead of an expected rate hike.
• What is being measured in the home loan data is new commitments made to borrowers. But while a lender may make a commitment, the borrower may end up not proceeding with the loan. That has certainly been happening in recent months with the value of loans actually advanced at eight-month lows. And given the double-whammy rate hike in November, there is a greater chance that budding buyers will let the lending commitment lapse.

What do the figures show?

Housing Finance

• The number of new owner-occupier housing loans edged further away from 9-year lows in October, lifting by 1.9 per cent to 49,307 new commitments. The number of loans is 20.6 per cent lower than a year ago.
• Loans for the construction of homes rose by just 0.1 per cent in October, only the second rise in 12 months. Loans for the purchase of established dwellings (ex refinancing) rose by 1.8 per cent, while loans for the purchase of newly erected dwelling rose by 9.4 per cent after falling by 2.6 per cent in September. Refinancing commitments were higher by 2.4 per cent.
• Loans rose in five of the eight states and territories in October. Lending rose the most in Queensland (up 3.6 per cent) but fell most in Northern Territory (down 22.2 per cent). Loans also fell in Western Australia (down 0.9 per cent) and South Australia (down 0.8 per cent).
• The value of new housing commitments (owner occupier and investment) rose by 2.2 per cent in October. Owner/occupier loans rose by 2.8 per cent while investment loans rose by 1.1 per cent.
• The value of loan commitments actually taken up fell by 2.4 per cent in October to an eight-month low.
• The proportion of first home buyers in the market hit a six-year low of 15.4 per cent of all lending in October – well below the record high of 28.5 per cent set in May 2009. Fixed rate loans accounted for 6.9 per cent of all loans, up from 4.4 per cent of loans in September and 3.4 per cent of loans in August. And the average home loan across Australia stood at $286,500, up 5.3 per cent on a year ago.

What is the importance of the economic data?

• Housing Finance data is produced monthly by the Bureau of Statistics and shows commitments by lenders, such as banks, to provide finance for housing purposes. The lending figures relate to those looking to buy or build homes to live in as well as those seeking to buy or build homes for investment purposes. Generally people get their finance organised first, so the figures are regarded as a leading indicator on the housing market.

What are the implications for interest rates and investors?

• The latest figures on home lending further raise questions about the validity of the Reserve Bank rate hike in November. Still that is old news now. The important thing is that rates were kept on hold yesterday. And the good news is that the Reserve Bank Governor is signalling an extended period of interest rate stability. Certainly we believe that the RBA will need to stay on the sidelines until well into 2011 if budding home builders become more confident to advance their plans.

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In a Tri-Securities lending arrangement, the lender is able to take a blended portfolio of securities as collateral in a highly automated and risk mitigated environment. The innovative structure allows loans to be fully collateralised to lender specification and then held for safekeeping by the collateral agent. Daily reports are provided on the market value and the adequacy of the collateral against previously agreed limits, providing greater security than traditional bilateral agreements.

“We are thrilled to be involved in another industry first,” said Jane Perry, Chief Executive Officer for Treasury & Securities Services Australia and New Zealand. “J.P. Morgan’s Tri-Party Securities Collateral Management service provides the market with an innovative, sophisticated platform built for Australian and New Zealand institutional requirements,” she said.

J.P. Morgan’s Tri-Party Securities Collateral Management service offers clients a sophisticated suite of tools to effectively manage exposures of most forms of secured lending, such as securities lending, repo and foreign exchange swaps, as well as other financial instrument exposures. The offering also provides distinct benefits by using local legal agreements, local service management expertise and on-the-ground support during the transaction.

Ms Perry said: “Tri-Party transactions across all forms of secured lending are common in North America, Europe and Asia and we believe our offering will assist Australian firms in efficiently collateralising exposures in line with overseas practice. We have taken our global expertise and world class collateral management platform and made it accessible for local institutional investors.

“Our unique technology combines sophisticated collateral testing and concentration controls with a proprietary algorithm that determines the optimal use of diverse collateral pools across a range of counterparty exposures. The result is that the needs of both sides of a transaction can be met within one secure, risk-managed process,” she said.

Organisations with large balance sheet exposures to securities and short supply of liquid cash are now able to use their securities more effectively through the Tri-Party structure. By using a third party as the collateral agent, Tri-Securities Lending can supplement the more traditional cashbased securities lending market.

“Where companies have long assets the ability to use securities through an independent collateral agent can ensure balance sheet assets are being used in a more effective manner,” said Greg Keyser Managing Director for Equity Finance at UBS Australia, “We believe Tri-party will entice many new domestic entrants into the secured finance market.”

“Receiving securities as collateral instead of cash is an important element of securities lending, and working with an independent third party to manage the collateral helps give us as a lending agent confidence that collateral and other risks are being managed appropriately,” said Francesco Squillacioti, Regional Director Asia Pacific for Securities Finance at State Street Bank and Trust.

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Headline developments of the past week

• While there was good news at the start of the week in terms of Ireland agreeing to accept a bailout from the European Union and the IMF, the worry list for investors actually expanded. It now includes worries about whether Ireland will deliver on its austerity package, concerns that Portugal will need a bailout too, an insider trading case in the US, ongoing issues with US mortgages, renewed tensions on the Korean peninsula, worries that China will tighten too much and concerns that rising inflation in emerging countries will become a problem. With this list of worries its little wonder investors are skittish.
• However, there are some positives worth noting. Firstly, the flow of economic data in Europe tells us that Germany and other core European countries are providing an offset to the weakness in peripheral countries. And at least Europe is now moving quickly to provide assistance to troubled countries. Secondly, US economic data is looking healthier. Thirdly, while North Korea is an ongoing worry, over the years it has a habit of doing provocative acts only to settle down again. Fourthly, while we are seeing almost a daily flow of news regarding tightening measures to combat inflation in China there is nothing in any of this to suggest that the Chinese authorities are going to crunch their economy, particularly with the pick up inflation essentially due to weather related food prices increases. Similarly, higher food prices accounts for most of the rise in inflation rates in other emerging countries and so is not a reason for aggressive monetary tightening. And finally, investors would be wise to remember the old saying that “shares climb a wall of worry”, in that its often when the worry list seems the longest that shares do their best, because invariably some of the worries start to fade which then prompts investors to close shorts and/or buy shares.
• In Australia, RBA Governor Glenn Stevens indicated that once allowance is made for the additional increase in bank lending rates and the strong Australian dollar, the current level of the cash rate is appropriate for the “period ahead”. This is pretty much in line with market expectations that rates are on hold for now. However, the Governor’s assessment that the medium term risks to inflation are that it will be too high on the back of only modest amounts of spare capacity and the need to accommodate a huge expansion in mining investment indicate the Reserve retains an inclination to continue raising interest rates next year. This was reinforced by the Governor’s observation that growth in labour costs is now rising. Our view is that the cash rate is likely on hold until March, but that it will rise to a cyclical peak of 5.5% in a year’s time.

Major global economic releases and implications

• US economic data came in on the positive side on balance. Data for home sales were weak and house prices also fell in September, but against this, weekly mortgage applications for new homes rose strongly suggesting that there is some light at the end of the housing tunnel.  While durable goods orders fell in October this may reflect a seasonal distortion. On the clearly positive front though, September quarter GDP growth was revised up, manufacturing surveys in the Richmond and Kansas areas both rose solidly, consumer sentiment rose and there was another sharp fall in weekly unemployment claims taking them to the lowest level since July 2008. The basic message from the flow of US economic data is that the recovery is continuing.
• European economic data was also mostly positive with rises in consumer confidence and business conditions. Germany remains a standout with business conditions rising to their highest level on record according to the IFO survey. Business confidence also rose in Belgium, France and Italy.
• In China, we saw more signs of tightening, including indications that banks will have to wind down lending in the last two months of the year in order to stay within the Government’s 7.5 trillion Renminbi target for new loans this year, given that so far 6.9 trillion has been lent out, indications that this target will be wound back down to 6.5-7 trillion RMB for next year and indications from the central bank that it will “normalise” monetary policy after running stimulatory monetary policy for several years. However, even if the new lending target is wound back to 6.5 trillion RMB this will still see credit growth of around 14%% & because monetary conditions are coming from very easy currently we remain of the view that such moves won’t crunch the economy.
• Across Asia, growth rates have slowed from the double digit pace seen earlier this year as activity bounced back from the GFC, but are still around 5 to 10%. Moderation is necessary to avoid overheating.

Australian economic releases and implications

• Australian economic data was somewhat mixed. Construction activity unexpectedly fell in the September quarter due to a fall in housing activity. While business investment rose in the September quarter, intentions for 2010-11 were scaled back. However, it’s worth noting that based on long term realisation ratios investment is still expected to surge by around 20% this financial year, which compares to the Governments forecast for an 8% rise. The scaling back from a previously implied rise of 25% may simply reflect capacity constraints rather than any loss of confidence. Mining investment looks like rising around 45%.
• An agreed large increase in pay for aviation workers secured by the Transport Workers Union averaging around 4.5% pa over three years has added to concerns about upwards pressure on wages. This will no doubt serve to maintain the Reserve Bank’s inclination to raise interest rates further next year.

Major market moves

• Share markets had another volatile week, initially being affected by the North Korean attack on South Korea and ongoing debt concerns in Europe, but settled later in the week after positive economic news out of the US and Europe lifted spirits.
• Commodity prices rose on the back of stronger global economic data, but the Australian dollar slipped back on softer than expected economic data in Australia and RBA comments that rates are appropriate for the period ahead. The euro also weakened further against the $US.

What to watch in the week ahead?

• In the US, key to watch will be the ISM manufacturing conditions index (due Wednesday) which we expect to remain solid and employment data (Friday) which is expected to show another 150,000 gain in payrolls but unemployment remaining high at 9.6%. Consumer confidence data (Tuesday) is likely to show a small improvement as are pending home sales (Thursday) and the ISM non-manufacturing index (Friday) is likely to remain solid. Against this house price data (Tuesday) is likely to show further weakness lagging the earlier fall in housing activity indicators. The Fed’s Beige Book of anecdotal evidence on the economy will also be released.
• In China, the official and HSBC PMIs, or business conditions indicators, (due Wednesday) are likely to remain solid but show a small fall back after recent strong gains.
• The European Central Bank meets on Thursday but is likely to leave interest rates on hold at 1%, and may signal a slower exit from its liquidity boosting measures given public debt problems in Europe.
• The week ahead in Australia will see an avalanche of data releases. The main focus will be on September quarter GDP growth (due Wednesday) which is likely to show growth of around 0.5%, or 3.4% year on year after an unexpectedly strong rise of 1.2% in the June quarter. Consumer spending is likely to be a key driver, with flat business investment and a fall in dwelling investment. Other data to be released includes: profits, inventories and new home sales (all due Monday), building approvals (Tuesday) which are likely to show a bounce after a sharp fall in September, private credit (Tuesday) which is likely to remain soft and retail sales (Wednesday) which are expected to show growth of around 0.2%. A couple of speeches by RBA officials, including Governor Stevens, will also be closely watched.

Outlook for markets

• It’s too early to say whether the share market correction we have seen since early November is over or not. However, we continue to expect solid gains in shares into year end and through next year. Shares are cheap, particularly relative to government bonds, the run of better than expected economic data globally is continuing suggesting that the global recovery remains on track, the global liquidity backdrop is highly favourable underpinned by QE2 in the US and the corporate sector is cashed up which is likely to result in a further pickup in merger and acquisition activity, share buybacks and dividends. The period from US Thanksgiving to May is normally strong for shares, particularly December and January.
• Notwithstanding normal bumps along the way, the $A is likely to head higher as the $US and the euro remain under downwards pressure, interest rates in Australia continue to trend up, and commodity prices resume their rising trend. It’s likely that the $A will settle around $US1.10 in the year ahead.
• Deflation worries, along with central bank government bond purchases in the US and elsewhere, are likely to keep bond yields low in the short term. However, medium-term returns are likely to be poor, reflecting low yields and excessive public debt levels in many developed countries.

The post Weekly market & economic update – 26 November 2010 appeared first on AdviserVoice.

• The outlook for home builders remains sluggish. New dwelling approvals fell for the fourth time in the past
  five months – down by 4.7 per cent in August.
• Lending barely grew last month. Private sector credit rose by only 0.1 per cent in August – marking the
  slowest growth in nine months. Credit growth stands 3.1 per cent higher over the year.
• Employers are looking for new staff again. The number of job vacancies rose by 9.9 per cent to 181,300 in
  the three months to August. By industry, the biggest lift in job vacancies was in Accommodation and food
  services (up 77.9 per cent) with Healthcare & social assistance up 34.9 per cent.

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