• Australia’s record economic expansion is now well into the 20th year. The Australian economy grew by 0.7 per cent in the December quarter, after lifting by a downwardly revised 0.1 per cent in the September quarer (originally reported as growth of 0.2 per cent). Annual economic growth held steady at 2.7 per cent.
• For the calendar year 2010 the economy grew 2.6 per cent in 2010, below 15-year average of 3.25 per cent.
• The biggest contribution to growth came from the change in inventories (+0.8pp), followed by household consumption and government investment (both +0.2pp).
• Eight of the 19 industry sectors contracted in the December quarter. The strongest contributions to growth came from Professional, scientific and technical services, Administrative and support services, and Arts and recreation services.
• The data is entirely consistent with surveyed evidence and what we are hearing from businesses across the country. The Reserve Bank has previously indicated that it is comfortable with current interest rate settings and there is nothing in today’s result that is likely to see a shift from that view.
• A more accurate description of the performance of States and Territory economies is state final demand plus net exports. The Northern Territory (up 5.4 per cent), had the fastest growth in the December quarter, followed by South Australia (up 3.0 per cent),and Western Australia (up 1.6 per cent). Growth was weakest in Queensland (down 1.5 per cent).

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• Chinese consumer prices rose at a 5.1 per cent annual pace in November – the fastest pace in over two years but driven by higher food prices. Non-food inflation was just 1.9 per cent in November. China is using sales of state food reserves in an effort to cap food prices.
• Annual growth rates for industrial production and investment were slightly above market expectations but the latest data on retail sales was broadly in line with the consensus view. Chinese authorities are continuing to achieve success in controlling property prices.
• Ahead of the release of the data, the Peoples Bank of China increased bank reserve requirements for the third time in a month, with ratios lifted by 50 basis points, effective December 20.

What does it all mean?

• In Australia the Government and Reserve Bank would largely be powerless to address a sharp lift in food prices. They would conclude that the vagaries of weather are outside their control and lifting interest rates would be largely pointless given that inflation wasn’t generated by the strength of the economy. But in China, authorities take a different view. Food represents a bigger share of the household budget and authorities are also keen to prevent consumers becoming disaffected by higher living costs.
• So Chinese authorities are releasing state food reserves to keep a cap on food prices. And it is reported that the State Council is boosting efforts to increase the production of vegetables and other basic goods. The central bank is also determined to keep the broader economy in check, increasing bank reserve requirements for the third time in a space of a month. A lift in interest rates over the next few weeks also can’t be ruled out, but arguably production and retail sales are growing at sustainable rates and property inflation continues to moderate.
• Contrary to the belief of many investors, the fact that Chinese authorities are determined to restrain inflationary pressures is a positive, not a negative development. A much more negative development would be if inflation was allowed to grow unchecked. The main concern is if the authorities overdo the efforts to tighten the economy.
• Chinese authorities are continuing to achieve success in controlling property prices. Prices lifted just 0.3 per cent in November and the annual rate slowed to 7.7 per cent in November.
• China is Australia’s major trading partner. And we have reached the point where if China sneezes then Australia would be at the risk of developing a cold. Clearly the Chinese economy remains in strong shape but the battle over inflation is the main issue to watch.

What do the figures show?

• The annual rate of consumer price Inflation lifted from 4.4 per cent in October to a 28-month high of 5.1 per cent in November due to higher food costs (consensus 4.7 per cent). Food prices rose by 11.7 per cent over the year while non-food prices rose by just 1.9 per cent.
• The annual rate of producer price inflation rose from 5.0 per cent to 6.1 per cent in November (consensus 5.1 per cent) in response to higher costs for raw materials like cotton, fuel and cement.
• Industrial output expanded at a 13.3 per cent annual pace in November, up from the 13-month low of 13.1 per cent in October (consensus 13.0 per cent). Production is still well off the highs of 20.7 per cent annual growth in January/February.
• China’s urban fixed asset investment, such as spending on roads and power plants, grew at a 24.9 per cent annual pace in the 11 months to November (consensus 24.3 per cent), and up from 24.4 per cent over the 10 months to October.
• Retail sales grew at an 18.7 per cent annual rate in November (consensus 18.8 per cent), up from the 18.7 per cent annual pace in the year to October.
• Broad money supply (M2) rose at a 19.5 per cent annual rate in November, the fastest pace in six months.
• Chinese property prices slowed again in November. Urban property prices rose by 7.7 per cent in the year to November, down from 8.6 per cent in the year to October, and the 12.8 per cent peak in April.
• In November alone, property prices rose by 0.3 per cent after a 0.2 per cent lift in October.
• In the first 11 months of 2010, new property sales were up 9.8 per cent, up from 9.1 per cent in the first 10 months of the year.

What is the importance of the economic data?

• China’s National Bureau of Statistics releases its monthly economic statistics around the middle of each month. Quarterly GDP data is released around the 16th of January, April, July and October. China is Australia’s largest trading partner and changes in the Chinese economic have major implications for the Aussie economy.

What are the implications for interest rates and investors?

• Investors are worried about rising inflation in China. While the main issue is higher food prices – a temporary situation and outside central bank control – investors are worried that higher inflation may become entrenched. There also is the concern that authorities may make policy mistakes – either tightening policy too much or not enough.
• The Chinese economy continues to expand at a firm clip but growth rates of investment, retail sales and production are well off highs earlier in the year. Australia’s Reserve Bank will certainly keep a close eye on developments in China but there are no major concerns at present. The main focus is the efforts to keep inflation in check.

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• The Performance of Manufacturing index fell by 4.4 points in September to a nine-month low of 47.3.  Any
  reading below 50 means the manufacturing sector is contracting.
• Of more concern, the production sub-index fell to a nine-month low, employment is now at 11 month lows and new orders have slumped to 14 month lows. Eight of the 12 sectors weakened in September.

What does it all mean?

• The decline in the latest manufacturing gauge highlights just how patchy the Australian economy is at present. Not only is manufacturing activity once again contracting, but the key sub indices such as new orders, employment and production have turned sharply lower – a worrisome trend that does not bode well for coming months. Even selling prices are still falling, while input costs and wages rising – pointing to pressure on profits.
• As we have highlighted over the past couple of weeks, there are clear signs that the economy has lost momentum and looking forward activity is likely to be less robust – especially given that the recent strength of the Australian dollar will continue to make Aussie exports less competitive. The strong Aussie is likely to depress not just the manufacturing sector but tourism, and agricultural exports.
• Fundamentally the economy is still in good shape but near term rate hikes are likely to curb the activity and growth at a time when inflation is still well contained.

What do the figures show?

Performance of Manufacturing index

• The Performance of Manufacturing index hit a nine-month low in September, falling by 4.4 points to 47.3. A reading below 50 suggests that the manufacturing sector is contracting.
• Key activity components of the PMI were sharply lower in September. Production, new orders, employment and exports fell sharply. The production sub index dropped 5.3 points to 46.2. And new orders fell by 4.1 points to 46.5. And the employment index lost 6.5 points to 44.8. And exports fell by 1.9 points to 51.2. The index of selling
  prices eased modestly to 47.4 while input prices and wages recorded a slight increase.
• In seasonally adjusted terms eight of the 12 sectors recorded a decline in activity in September.

What is the importance of the economic data?

• The monthly Performance of Manufacturing Index is the Australian equivalent of the US ISM manufacturing gauge.  The PMI is one of the timeliest economic indicators released in Australia. The PMI is useful not just in showing how the manufacturing sector is performing but in providing some sense about where it is heading. The key ‘forward looking’ components are orders and employment.

What are the implications for interest rates and investors?

• The softening in manufacturing conditions would be negative for material suppliers and resources companies and could end up having knock-on effects for other businesses.

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