Economics: Perspective

16 September 2011

The Week Ahead

Concerns in Europe remain. Markets remain volatile, driven by headlines and sentiment. The FOMC meets on Wednesday. Further policy easing measures are expected. Operation Twist is the likely option. RBA meeting minutes are released on Tuesday. New Zealand QII GDP, released Thursday, to show modest growth. Financial markets remain volatile. Headlines are driving market direction, fundamentals are taking a back seat. This was particularly evident in the past week. The already fragile markets were rocked early in the week by the news ECB Executive Board Member Stark, a somewhat reluctant supporter of the ECBs recent policy decisions, had resigned. Adding to the poor sentiment, European sovereign debt issues continue to play out. Greek bond yields remain historically high. Expectations of a near-term default are building. Two-year Greek yields reached astronomical highs early in the week, hovering around 70%. In an effort to ease anxiety, French President Sarkozy and German Chancellor Merkel reiterated their support for Greece to remain a part of the Euro, and for the assistance measures pledged in July. In turn, Prime Minister Papandreou stressed Greece remains committed to meeting its deficit reduction targets. In combination the moves boosted market confidence that the Troika (EU/ECB/IMF) would approve the next tranche of Greeces assistance package in the coming weeks. While Greece remains an obvious focus, the negative impact on the banking system is a developing concern. Some measures of funding stress in the European banking system remain near levels last witnessed in late 2008. In an effort to alleviate some of the stress, the ECB, in conjunction with the Bank of England (BoE), US Federal Reserve, Bank of Japan, and Swiss National Bank, announced that they would offer European banks three-month USD liquidity to ensure that the banks have enough USD funding through year-end. Risk sentiment was further boosted by this coordinated and proactive approach taken by the major global central banks. But some participants remain wary of how long this sentiment will last. Underlying issues in the Eurozone remain. The EU Finance ministers and Central Bankers meeting in Poland over the weekend is likely to be a key driver of market sentiment early next week. The key focus of markets next week will be Wednesdays US Federal Open Market Committee (FOMC) meeting (Thursday morning Australian time). The move by the FOMC to expand the meeting to a two day affair, when coupled with the recent deterioration in the US economic data, has raised expectations of further policy easing measures. We expect the FOMC to announce Operation Twist, which is a move by the Fed to run down its short-term US Treasury holdings and buy long-term Treasuries. Significantly, this process does not increase the size of the Feds balance sheet. Further expansion of the Feds balance sheet, via an additional round of asset purchases, appears some way off given the lift in US inflation and the vocal dissenters on the FOMC. Our Currency Strategist, Joseph Capurso, provides further detail on Operation Twist from page two. In addition to the FOMC, the BoE releases the minutes of the September Monetary Policy Committee (MPC) meeting on Wednesday. Given the weakness in the UK and European economies, a move to an even more dovish slant by the MPC would not be a surprise. Closer to home, the minutes of the September Reserve Bank of Australia (RBA) meeting will be released on Tuesday. The minutes are likely to provide further detail on the RBAs thinking on the recent global events and where the risks to the domestic economy reside. We still expect the next move by the RBA to be a hike in February 2012, but given the uncertainty in global markets the risk of an extended pause cannot be discounted. In addition, the announced changes to the CPI are also likely to remove some of the pressure for the RBA to hike rates. Seasonal adjustments undertaken by the ABS have lowered the QII underlying inflation prints. Our Chief Economist, Michael Blythe, examines the changes to the CPI from page five. Further changes to the CPI will be announced on 22 September. Furthermore, it is undisputable that recent natural disasters have had a negative impact on the domestic economy. Our Chief Economist also provides some colour on just how the economy has been affected; view the results of the latest addition of the CBA Viewpoint from page six. Across the Tasman, the decision by the Reserve Bank of New Zealand (RBNZ) to remain on hold was not surprising given the global uncertainties. The RBNZ also revised down its growth and inflation outlooks for the domestic economy. When coupled with the strong NZD and global concerns, we now expect the RBNZ to remain on hold until March 2012. New Zealand QII GDP figures are released on Thursday, we expect only modest growth. Our FX Economist, Chris TennentBrown, provides a preview of the QII GDP figures and a review of the RBNZ decision from page eleven.

Michael Blythe Chief Economist T. +612 9118 1101 E. michael.blythe@cba.com.au James McIntyre Economist T. +612 9118 1100 E. james.mcintyre@cba.com.au Joseph Capurso Currency Strategist T. +612 9118 1106 E. joseph.capurso@cba.com.au Peter Dragicevich FX Economist T. +612 9118 1107 E. peter.dragicevich@cba.com.au Chris Tennent-Brown FX Economist T. +612 9117 1378 E. chris.tennent-brown@cba.com.au
Important Disclosures and analyst certifications regarding subject companies are in the Disclosure and Disclaimer Appendix of this document and at www.research.commbank.com.au. This report is published, approved and distributed by Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945.

Global Markets Research

Economics: Perspective

International Economic Perspective Operation Twist: Fed to introduce more policy easing
We expect the FOMC to announce further monetary policy support at its policy meeting on 21 September. We expect the Fed to run down its short-term US Treasury holdings and buy long-term Treasuries, known as a twist. The effect on the USD is neutral because US two-year bond yields are likely to be unaffected.
US CONSUMER CONFIDENCE
(University of Michigan)

Come on let's twist again like we did last summer Yea, let's twist again like we did last year Do you remember when things were really hummin' Yea, let's twist again, twistin' time is here Excerpt from The Twist, Chubby Checker, 1960

120 Points

100

80

Recent and prospective economic trends

60

Since Federal Reserve chair Bernankes speech at Jackson Hole on 27 August, the US economy has shown few signs of improvement. Consumer confidence has slumped and the labour market has remained weak. One of our favourite leading indicators for the US labour market, temporary workers, suggests the weakness evident in the August payrolls report has further to run. A literal reading of our indicator suggests payrolls may decrease in coming months. While personal spending increased smartly by 0.8% in July, it mainly reflected a drawdown of savings. This performance is unlikely to be repeated in coming months. We think the FOMCs forecast of core PCE inflation of 1.7%pa by the end of 2012 contain some downside risks. The US economy is weaker than the FOMC projected in June. We expect the Fed to revise down their forecasts and indicate core inflation peaks later in 2011 and eases in 2012. In our view, an extended period of below trend economic growth in the US may increase excess capacity and bear down on future inflation. A projection of core inflation easing below the Feds implicit tolerance band of 1.7-2.0% in 2012 implies there is a case for the Fed to deliver further policy support.

40 Jan-78 Jan-85 Jan-92 Jan-99 Jan-06 Jan-13

US LABOUR MARKET INDICATORS

(3-month moving average)
'000 600 Payrolls (lhs) '000 60

300

30

-300

-30

-600

Temporary workers (Advanced 3 months, rhs) Jan-00 Jan-04 Jan-08 Jan-12

-60

-900 Jan-96

-90

Operation Twist
We think the US economy has deteriorated enough since the FOMCs policy meeting in August to encourage the majority of FOMC members to vote for further policy stimulus at its next meeting on 21 September. At the August meeting, there was some support within the FOMC to provide more stimulus than what was delivered. The minutes from that meeting indicate the majority of members thought the decision to provide guidance about how long the funds rate would remain unchanged was a measured response. The minutes also reveal that a few members of the FOMC felt that recent economic developments justified a more substantial move. The FOMCs next policy meeting in September has been extended to two days. In our view, the extension implies the FOMC will publish a new set of economic forecasts, one meeting earlier than scheduled, and these forecasts will be published in the minutes of the meeting. We also expect the FOMC to consider a wider range of policy options than the four options considered in August. At the September meeting, we expect the FOMC to re-consider three of the four options they discussed in August.
EVOLUTION OF FED'S FORECASTS
(Core PCE inflation forecasts)
% 2.5 2011 2.0 2011 1.5 2013 2012 1.0 Expected revisions 0.5 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Month forecast prepared 0.5 1.0 1.5 2012 2013 2.0 % 2.5

Global Markets Research

Economics: Perspective
Lengthen the average maturity of their securities holdings by altering the composition of the balance sheet. Increase the size of its balance sheet, ie, QE3. Decrease the interest rate the Fed pays to banks on excess reserves. We also expect the FOMC to consider some creative policy options, such as the introduction of an explicit inflation target, price level targeting or targeting yields on long-term government bonds. The FOMC may also consider linking its policy stance to inflation or unemployment rate targets. On balance, we expect the FOMC to lengthen the average maturity of its securities holdings at its September meeting. This policy, known in the market as Operation Twist, can be implemented by the Fed replacing its short-term US Treasury holdings with long-term Treasuries. Operation Twist could lower long-term yields and despite some selling of short term securities, it would leave short-term yields unaffected. Short-term US yields have been anchored by the FOMCs previous guidance to leave the funds rate unchanged until at least mid-2013. We favour Operation Twist over QE3 because it would not involve expanding the Feds balance sheet. Operation Twist may placate the three dissenters on the FOMC, though we do not think the dissenters are a major obstacle to further easing. We think Operation Twist would deliver more stimulus to the US economy than a cut to the interest rate the Fed pays to banks on their excess reserves. We expect the FOMC is not yet willing to implement the more creative policy options noted above, although it may consider their merits and costs at its policy meeting this month. Operation Twist is not without risks. The Fed already owns 18% of the US government bonds outstanding with a maturity longer than ten years. Operation Twist would increase further the Feds ownership share of longer term Treasuries. The higher the Feds ownership share of Treasuries, the more difficult it will be for the Fed to reduce its exposure without disrupting the Treasury market when the FOMC decides to remove its policy stimulus.
40

SHARE OF US BONDS HELD BY FED

% 50

30

20 Weighted average

10

0
2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041

LENDING TO US CORPORATES
pts 90 Lending standards to large corporates (lhs) -90 pts

60

-60

30

-30

-30 Demand for loans from large corporates (rhs) -60 Jan-95 Jan-99 Jan-03 Jan-07 Jan-11

30

60

YIELD CURVES
% 4

(Selected economies)

% 4

3 UK 2 Germany 1 US 0 Cash 2 Year 5 Year 10 Year

Implications for currencies

On its own, further policy easing by the FOMC should lead to downward pressure on US long-term bond yields. But our fixed income colleagues believe much of this is already priced in and are wary that the positive impact on sentiment could be more powerful (as we saw with QE2). They are forecasting yields on US 10-year bonds to now remain in a 2.02.2% range this year. In any case, the USD is more sensitive to shortterm bond yields so we do not believe there will be a major effect on the USD. The slow-down in the US economy, the convergence of European bond yields towards US yields and the re-emerging risks in Europe have made the USD a more attractive safe-haven currency. In addition, intervention, both threatened and real, by the Swiss National Bank and the Bank of Japan, has raised the potential risks of holding these safehaven currencies. The USD is quickly regaining safe-haven enthusiasm, despite the problems in the US economy. The OIS market continues to price in rate cuts by the ECB over the next year. The German two-year bond yield, at 0.60%, is well below the ECBs policy rate of 1.50%. Yields in Europe have converged down towards US levels and removed an area of support for European currencies. Stresses in Europe have contributed to an increase in demand for USD. This has led us to revise our near-term currency forecasts (please see: Foreign Exchange Strategy: Adjustments to our

BANK DEPOSITS WITH ECB

EUR bn 600 EUR bn 600

450

450

300

300

150

150

0 Jan-06 Jan-08 Jan-10

0 Jan-12

Global Markets Research

Economics: Perspective
currency forecasts, published 14 September 2011).
These stresses in Europes banking system, particularly the scramble for USD funding following further European bank stress and the Feds abolishment of regulation Q, are also influencing currencies (see FX Strategy - What really cause the recent global sell-off? published 17 August 2011). The three-month EUR/USD basis swap, the rate which floating rates are exchanged across currencies, has blown out to more than 80 points (it had been above 100 points). The blow-out of the EUR basis swap is the largest since late 2008. European banks continue to deposit large amounts of EUR with the ECB rather than lend to other banks. Our indicator of inter-bank risk in Europe is near levels experienced in the early stages of the GFC in late 2007 and early 2008. European banks are offering rates 80bps above repo to attract cash. We believe the downside risks to EUR are rising. Consequently, we see little negative implication for the USD from Operation Twist. (Note: these stresses have led to coordinated central bank efforts to provide USD funding to European banks, as discussed on page one).
Joseph Capurso Currency Strategist T. +612 9118 1106 E. joseph.capurso@cba.com.au
pp 2.5

EUROPEAN INTER-BANK RISK

(3-month deposit rate minus repo rate)
pp 2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

0.0 Jan-06 Jan-08 Jan-10

0.0 Jan-12

Global Markets Research

Economics: Perspective

Australian Economic Perspective Changes to the CPI

The ABS is moving to seasonally adjust key components of the CPI. Underlying inflation rates over the past few years will be a little higher as a result although QII 2011 was revised down. A better starting point for the inflation trajectory from here will leave the RBA more comfortable with standing still. The ABS is working through its recent review of the Consumer Price Index as part of the process of moving from the 15th series CPI to the 16th series. One outcome of the review is that the seasonal adjustment methodology used in producing the underlying inflation measures will change. Another outcome is that a seasonally-adjusted headline CPI estimate will also now be published. The ABS has just released a snapshot of what the current CPI readings will look like when the new system takes over with the release of the QIII CPI (due 26 October). The main changes at the headline CPI level are: QI CPI growth will typically be a little lower and QIV CPI growth typically a little higher than the old data shows; annual growth rates will be little changed; and the not-seasonally-adjusted CPI will remain the official measure of inflation. The main changes at the underlying CPI level are: the ABS will now seasonally adjust 64 of the 90 expenditure classes that make up the CPI (compared with 20 currently); the main impact on the RBAs preferred underlying CPI measures is to slightly lift annual growth rates relative to the old estimates. One significant exception to this general pattern of revisions is the latest CPI readings for QII 2011. QII will show a smaller rise. The average rise in the trimmed mean and weighted median CPIs now stands at 0.6% (previously 0.9%). The big picture here is that the Australian inflation story did turn around in the first half of 2011. But the rate of deterioration is less marked. The fundamental factors expected to drive underlying inflation rates remain in place. So there are no immediate implications for monetary policy. A better starting point for the inflation trajectory from here will, however, leave the RBA more comfortable with standing still on the rates front. One caveat. As part of the move to the 16th series CPI the ABS will update the weights for the various expenditure classes. These revisions have the potential to further change the underlying CPI numbers. That revised weighting pattern will be released on 22 September.
CONSUMER PRICES
%

UNDERLYING CPI
%
%

(annual % change)

(6mnth ended annual rate)

Old 4 4

Old

2 RBA target New 1 Sep-04 Sep-06 Sep-08 Sep-10 Sep-12

New 0 Sep-02 Sep-04 Sep-06 Sep-08 Sep-10 Sep-12 0

1 Sep-02

Michael Blythe Chief Economist T. +612 9118 1101 E. michael.blythe@cba.com.au

Global Markets Research

Economics: Perspective

Australian Economic Perspective Commonwealth Bank Viewpoint

The impact of natural disasters on the Australian economy are more pervasive than thought. These disasters have weighed on sentiment and affected consumer financial perceptions. The latest Commonwealth Bank Viewpoint examines these issues in more detail. Natural disasters are a factor depressing sentiment. What feels like a never ending spate of disasters natural and manmade contributed to the dampening of global optimism evident at the start of 2011. Floods and cyclones in Australia, earthquakes in New Zealand, earthquakes, tsunamis and a nuclear emergency in Japan, and unrest in the Middle East were all unexpected and have had major economic consequences. In short, they are all classic black swan events. The human tragedy should always be the centre of attention. This piece, however, looks at information generated by the Commonwealth Banks Viewpoint project on the economic impact of natural disasters in Australia. Natural disasters are not rare. It may feel different this year because some of these disasters have happened on our own doorstep. Or involve countries that are economically important to us. But natural disasters are, unfortunately, not unusual. The organisations that monitor such events report that 350-550 such disasters have occurred each year over the past decade. These disasters do involve some economic cost. And the frequency of such shocks means that there is a certain base level of economic damage that has to be dealt with each year. That economic damage has averaged about 0.2% of global GDP per annum over the past thirty years. Periods of peak natural disaster, such as the Kobe earthquake in 1995 and Hurricane Katrina in 2005, have involved a damage bill of around 0.5% of global GDP. The regularity of natural disasters means that there is little, if any, correlation between such events and changes in global growth rates. This conclusion holds even in peak disaster years. And it supports the usual rule-of-thumb that any activity loss is largely recouped in the subsequent rebuild. Current IMF projections have the global economy expanding by about 4% in 2011 and 2012, significantly above the long-run average of 3%pa. Recent events will probably see these forecasts lowered. But a disaster with an economic cost equal to the worst case outcome of the past thirty years, and the recent Japanese earthquake and tsunami will certainly fall into that category, would still leave the

No 600

NATURAL DISASTERS

No 600

400

400

200

200

Source: EM-DAT

0 1980 1985 1990 1995 2000 2005 2010

NATURAL DISASTERS
% 0.6

(estimated damage, % of world GDP)

Source: EM-DAT/IMF/CBA

% 0.6

Wenchuan quake Hurricane Katrina 0.4

They do involve some economic cost.

0.4 Kobe quake

0.2

0.2

0 1980 1985 1990 1995 2000 2005 2010

0.0

The regional cost is large but little impact is evident on global growth rates.

MAJOR DISASTERS: ECONOMIC DAMAGE

(% of country GDP)
Hurricane Ike (US, 2008) Northridge earthquake (US, 1994) Hurricane Katrina (US, 2005) Wenchuan earthquake (China, 2008) Kobe earthquake (Japan, 1995) Yangtze floods (China, 1998) Maule earthquake (Chile, 2010) 0 6 12 18

Global Markets Research

Economics: Perspective
global economy running at close to trend. Natural disasters have only a limited impact on global trends because they are local in nature. The flip side of this is that disasters can have a large impact on the regions affected. Looking at the worst examples of the past twenty years, for example, shows that Hurricane Katrina caused economic damage equivalent to 1% of US GDP in 2005. And the economic damage from the Maule earthquake and tsunami in 2010 amounted to 15% of Chilean GDP. The broader conclusion, however, still holds at the regional level. The impact on economic activity tends to be relatively shortlived. The recovery phase tends to be relatively rapid and compensates for the initial loss of activity. The top chart uses industrial production as a proxy for overall economic activity around the time of major disasters. In some cases (eg the Wenchuan quake in China in 2008) it is difficult to see any effect at all. In others where there was a significant impact (eg the Kobe quake in Japan in 1995) activity was back at pre-disaster levels within a few months. Hurricane Ike in 2008 is an exception where an output recovery failed. The recovery phase after that disaster coincided with the onset of the global financial crisis. The Australian economic story has been a pretty easy one to sell over the past few years. Our track record is well established. And global investors are happy to acknowledge that record. At the start of this year it looked like more of the same. But some of that earlier optimism has dissipated. The economy has lost momentum and the debate about our economic resilience has resurfaced. Australian disasters have weighed on domestic consumer sentiment. The initial trigger was the natural disasters that hit the economy earlier in the year. In many respects, the impact of these disasters is playing out in line with the global historical experience. There was a bigger impact on regional economies than the national economy. And recovery has been quite swift in some areas. Data collected as part of the Viewpoint project illustrates the point. Salary payments into CBA accounts are a proxy for employment and income trends. Swift action by governments obviously helps. Looking at the trajectory of those payments around the times of various disasters ranging from the Victorian bushfires in early 2009 to the Queensland floods in 2009, 2010 and 2011 reveals: a large downturn during the disaster period and its immediate aftermath; and a reasonably rapid bounce back to something like pre-disaster levels over a period of 4-8 months.

INDUSTRIAL PRODUCTION
(month before disaster=100)
Index 110 Wenchuan quake (China'08) Hurricane Katrina (US'05) Index 110

100 Kobe quake (Japan'95) 90 Northridge quake (US'94)

100

90 Hurricane Ike (US'08) 80

80 Maule quake (Chile'10) 70 -2 -1 0 1 2 3 4 5 Months from disaster 6

70

Index

REAL GDP
(Sep'08= 100)

Index

105 Australia US

105

NZ 100

100 Europe UK

95 Lehman collapse 90 Mar-08 Mar-09 Mar-10 Mar-11 Japan

95

90

CBAs Viewpoint project illustrates the point.

Global Markets Research

Economics: Perspective
But there are also some important differences from the global experience with natural disasters. The Queensland floods and WA cyclones, for example, had an outsized impact on two of Australias key exports coal and iron ore. Disruptions to production and transport were enough to drag the economy backwards in the first quarter of 2011. Nevertheless, the broad conclusion holds good. This export pothole will be filled in. Iron ore exports are near normal levels and coal is on the way back. The economy will eventually reach the same end point even though the path taken is somewhat different. A return to end 2010 coal export levels will add ppts to GDP growth in HII 2011. This boost will be a significant offset to whatever drag may eventuate from current uncertainties and risks. The impact on sentiment is another channel that distributes and extends the impact of natural disasters. The Commonwealth Bank survey of consumer perceptions, for example, shows that the proportion of respondents who think the economy is going downhill has some tendency to lift around major natural disasters. Very high readings were recorded after the Victorian bushfires and North Queensland floods in early 2009. Some impact of these disasters was no doubt captured in the data. But the elevated nature of these readings was more a reflection of the global financial crisis. This edition of the Commonwealth Banks Viewpoint surveyed households directly on their perceptions about natural disasters. The results suggest again that the impact on the broader economy was more pervasive than first thought. A surprisingly large share of the population believes they have been affected by natural disasters. When quizzed on whether they were affected by the floods, the majority (64%) indicated they were not affected. But a surprisingly high proportion of respondents indicated they were affected either directly (9%) or indirectly (27%). These proportions are quite high relative to the regional concentration of the disasters. The perceived impact on personal finances was greater still: some 45% of respondents believe that recent natural disasters had a negative impact on their personal financial situation; about 39% saw no impact; and a small proportion (about 10%) described the floods as having a positive impact on personal finances. One puzzling aspect of the Australian economic story for a while now has been the reluctance of consumers to spend. Household ability to spend is quite good. Incomes are growing quickly and savings are at elevated levels. But the appetite to spend is missing. This lack of
25 25

CBA: SALARY RECIPIENTS

Index 120

A return to end 2010 coal export levels will add ppts to GDP growth in HII 2011.

(disaster month=100)
Source: CBA Viewpoint

Index 120

110

SW Qld floods (Jan'11)

SW Qld floods (Mar'10) Nth Qld floods (Feb'09)

110

100

100

90

Brisbane floods (Jan'11)

90 Vic Bushfires (Feb'09) 80

80 -6 -4 -2 0 2 4 6 8 Month before disaster=0 10 12

Index 120

EXPORT VOLUMES
(Oct'10=100, nsa)
Iron Ore Coal Coking Fines

Index 120

100

100

80 Thermal Lump 60 Oct 10 Feb 11 Jun 11 Oct 10 Feb 11 Jun 11

80

60
Source: ABS

CBA: CONSUMER PERCEPTIONS

% 75

(% seeing economy going downhill)

Vic bushfires/ NQ Qld floods SW Qld floods SW Qld/ Brisbane floods

% 75

50

50

Source: CBA Viewpoint

0 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

Global Markets Research

Economics: Perspective
appetite is largely a reflection of concerns about personal finances. And, in turn, these concerns partly reflect the spate of natural disasters in recent times. Other factors are also weighing on sentiment. Natural disasters are not the only factor weighing on sentiment at the moment. Households generally are not happy. The evidence is there in the very real fears that households have about the state of their finances. Our surveys show that most feel their personal circumstances are worse than six months ago. And the proportion expecting some improvement in the next six months is falling quickly. This outcome is despite the fact that disposable income is growing strongly (up 7.4% over the past year)! The disconnect between sentiment and finance is surprising. Household fears are typically financial in nature. Our surveys indicate that the greatest fears have a cashflow aspect (such as losing a job or paying the mortgage) or an investment theme (such as building up savings for retirement). Low sentiment levels are contributing to consumer caution. Ongoing consumer restraint is a key objective for policy makers. Such restraint is necessary to deal with the inflation risks and resource allocation issues in a fully-employed economy facing rapid income growth and an unstoppable mining boom. In a perverse way, the depressing influence of natural disasters on household sentiment earlier in the year helped. This influence will, however, wane over time. And recent global events have injected some additional uncertainty into the policy debate. But higher interest rates will be required at some point. Interest rate fears are receding a little. There are some indications that the impact of earlier rate rises is starting to recede. The Commonwealth Bank survey of consumer perceptions, for example, shows a strong correlation between the proportion of respondents who worry about housing costs and the change in the mortgage rate. But extended pauses in the policy cycle, such as so far in 2011, has seen these fears recede. While the general trend is for regional economies to get back to something like predisaster levels reasonably quickly, the aggregate picture conceals a degree of variation between regions. There are some lingering after-effects from such disasters. There are some lingering aftereffects from natural disasters. Commonwealth Banks unemployment indicators, based on Newstart data collected as part of the Viewpoint project, highlight the issue. All disaster-affected regions in our survey show an initial spike in this unemployment indicator. But the speed of the
IMPACT OF NATURAL DISASTERS
(% of respondents)
% 120
Source: CBA Viewpoint

Directly 90 Indirectly 60 Positive No 30 None 0 Affected by disatser Unsure Negative

Impact on personal finances

%pa 16

SENTIMENT & INCOME

200 Disposable income (lhs)

165 Index

130

-8

Consumer confidence* (rhs)

* Source: WBC/Melbourne Institute

95

-16 Mar-90 Mar-95

60

Mar-00

Mar-05

Mar-10

PERSONAL CIRCUMSTANCES
% 40

(net % of respondents)

% 40

20 Better in six months time 0

20

Better than six months ago

-20

-20

Source: CBA Viewpoint

-40 Apr 09 Oct 09 Apr 10 Oct 10 Apr 11 Oct 11

-40

% 30 Losing job

GREATEST FEAR
(% of respondents)
Unable to pay mortgage/rent Inability to provide necessities

% 30

20

20

10

Investment losses

10

Retirement provision 0 Apr 09 Oct 09 Apr 10

Giving up luxuries 0 Apr 11 Oct 11

Oct 10

Source: CBA Viewpoint

Global Markets Research

Economics: Perspective
subsequent pull back has varied. Based on this metric, the aftermath of the Victorian bushfires and the floods in North Queensland have had a more enduring impact on those regions than other disasters. Various forces seem to be at work. There are, for example, some indications in the Viewpoint data that the cumulative effect of a series of natural disasters takes a toll. Successive floods in North Queensland have contributed to more enduring negatives in that region. The type of disaster is important in determining the ultimate economic impact. Research by NATSEM, as discussed in Viewpoint, suggests that the type of disaster is important in determining the impact. The rate of migration from bushfire-affected regions exceeds that of flood-affected regions. So the population outflow after the Victorian bushfires probably weighed on recovery in those regions. The proximity to a major centre (Melbourne) no doubt accentuated the shift. Flood-affected regions in Queensland, in contrast, are further removed from major centres. Industry structure is also important. Natural disasters hit hard in areas where agriculture and tourism (retail, accommodation & food) are major parts of the local economy.
INTEREST RATES & "FEAR"
% of 24 respondents 1.0 %pts Change in mortgage rate (over 3 months, rhs) 0.5

21

18

0.0

15

Source: CBA Viewpoint

Greatest fear: unable to pay mortgage or rent (lhs)

-0.5

12 Apr 09 Oct 09 Apr 10 Oct 10 Apr 11 Oct 11

-1.0

UNEMPLOYMENT AVERAGES
Index 180

(based on newstart payments)

Pre disaster Disaster period Post disaster

120

60

0 Vic Bushfires (Feb'09) N Qld Floods (Feb'09) SWQ floods (Mar'10) Brisbane floods (Jan'11)

About Viewpoint: The Commonwealth Banks business generates a vast array of data on financial transactions, savings and spending patterns. From this mass of data a confidential sample of 1.3 million consumers has been selected that closely matches the structure of the Australian population. This sample allows us to investigate topical issues and track trends in incomes, spending, saving - when the economy is speeding up or slowing down. This hard-edged financial data is overlayed with a survey of consumer perceptions and experiences that we run each month with over 2,000 individuals. The report is then analysed and commented on by the independent economic research body the National Centre for Social and Economic Modelling (NATSEM) based in the University of Canberra. The actual report can be found at: http://www.commbank.com.au/about-us/ourcompany/viewpoint/default.aspx

SALARY RECIPIENTS BY INDUSTRY

Index 150

(start of disaster=100)
Bushfires
Vic Feb'09

NQ Floods
Feb'09

SWQ Floods
Mar'10

Index 150

100 Retail Accom & food Public admin

100

50

50 Agriculture
Source: CBA Viewpoint

0 Months from disaster start

Michael Blythe Chief Economist T. +612 9118 1101 E. michael.blythe@cba.com.au

10

Global Markets Research

Economics: Perspective

New Zealand Economic Perspective NZ QII growth may falter, but economy will strive on
Economy likely grew by just 0.1% over QII, following 0.8% growth in QI. Underlying trend remains firm, although perhaps less upbeat than initially thought. RBNZ remains optimistic on the domestic growth outlook, but global risks have near-term rate hikes off the agenda. NZ QII GDP data expected to show growth has slowed. NZ QII GDP data are released on 22 September. We expect GDP growth of just 0.1% over QII, following a robust 0.8% increase over the first quarter of 2011. The strength of the QI increase was particularly impressive given the disruption caused by the February earthquake. While QI growth was led by a strong increase in manufacturing production, the GDP increase was relatively broad based (with the exception of a decline in construction). The result, combined with the upward revision to QIV, revealed the economic recovery was stronger and faster than previously thought. Initial indicators had pointed to growth maintaining momentum over QII. Confidence remained buoyant while spending data were strong. However, more recent data have revealed a sharper pull back in manufacturing and wholesale trade than thought. Meanwhile, further declines in construction activity will prove to be a large drag on overall activity in QII. Underlying growth story remains positive. The underlying story remains buoyant, although perhaps less upbeat than initially thought following the QI GDP result. Over the first half of the year, the economy probably grew at an average quarterly pace of 0.4-0.5%, which is consistent with where business confidence was prevailing. In addition, the outlook for the second half of 2011 remains solid. We expect to see continued gradual recovery in the household sector and business investment. Many of the industries that will be underpinning the QII decline are unlikely to remain weak Retail spending and real estate-related services are expected to be the main contributors to QII growth. Retail spending volumes lifted 1.5% (on a GDP basis), following on from the previous quarters strong growth. The increase was reasonably broad-based across regions, although the strongest growth was in other South Island, which suggests there was a noticeable impact of displaced activity as many Cantabrians relocated following the quake. Nonetheless, the strength of spending growth over the first half of the year indicates an improvement in underlying household demand. Reinforcing the improvement in household demand, house sales lifted 13% over the quarter which will underpin a lift in real estate% 2.0 1 .5 1 .0 0.5 0.0 -0.5 -1 .0
Source: Stat s NZ, ASB

NZ GDP GROWTH
(per quarter, seas adj)
(f)

% 2.0 1 .5 1 .0 0.5 0.0 -0.5 -1 .0 -1 .5

-1 .5 M ar-02 Dec-03 Sep-05 Jun-07 M ar-09 Dec-1 0

qpc 3

EXPERIENCED OWN ACTIVITY GDP FORECAST

G D P qua rt e r %

qpc 3 2 1 0 -1

2 1 0 -1 -2 -3 Q ua rt e rly G D P f o re c a s t ba s e d o f f E xpe rie nc e d O wn A c t iv it y

Source: NZIER, St ats NZ

-2 -3

M ar-90 M ar-94

M ar-98

M ar-02

M ar-06

M ar-1 0

Retail spending picks up.

% 7

NZ GDP GROWTH
7 A nnual average % (f) 5

-1 P er quarter -3 M ar-89 M ar-93 M ar-97 M ar-01 M ar-05 M ar-09 M ar-1 3

Source: Stat s NZ, ASB

-1

-3

11

Global Markets Research

Economics: Perspective
related services. The recovery in housing turnover has started to stall more recently. However, as Red Zone payouts in Christchurch begin to be finalised, we expect this to generate a further increase in housing market activity. Manufacturing, wholesale trade, construction weak. Declines in manufacturing, wholesale trade and construction are expected to be the main drag on GDP growth over QII. The decline in manufacturing and wholesale trade activity is likely to be temporary. NZ data are inherently volatile, and to see a decline following 2 strong quarters of growth in manufacturing was not out of the ordinary. Manufacturing confidence remains relatively upbeat, with the high AUD/NZD providing support to many NZ manufacturing exporters. In addition, recovering NZ demand was expected to provide further support for domesticallyfocused manufactures. Construction activity is expected to decline 6% over QII, led by a sharp 12% drop in residential construction. The extent of the decline was surprising. However, we expect residential construction activity to begin to stabilise over the second half of 2011. Dwelling consents have started to show tentative signs of recovery. In addition, from 2012 onwards reconstruction activity in Canterbury should see residential construction increase around 50% from current lows. Growth expected to pick up after QII blip. The recent weakness in certain sectors highlights that the underlying pace of recovery may be more modest than initially thought . Nonetheless, despite the blip in activity over QII, the economy continues to gradually recovery. Over the second half of 2011, the Rugby World Cup will provide a boost to activity and confidence. Then from mid-2012, reconstruction activity will augment the gradual underlying recovery. RBNZ remains optimistic on the domestic growth outlook, but has revised down its growth forecasts based on the weaker global outlook and a higher NZ dollar assumption. The blip in QII activity reduces some of the urgency for OCR increases. This allows the RBNZ to take more time to assess the impacts of the Eurozone debt crisis and slowing global growth on the NZ economy. . Increases in the OCR are now largely dependent on the global outlook, and specifically developments in Europe. The key to the timing is when the European financial crisis dies down sufficiently (assuming it does that before triggering another global crisis!). While there is much uncertainty about both the timing and size of the first OCR increase, for now we see a 50 basis point OCR increase in

Q2 2011 PRODUCTION GDP FORECAST

(pp contribution to quarterly % change)
-0.4 -0.2 0.0 0.2 0.4

A griculture

Fo rest/Fish/M ining

M anufacturing

Elec/Gas/Water

Co nstructio n

Who lesale Trade

Retail Trade

Transpo rt/Co mmunicatio n

Finance

Go vernment

Educatio n etc

% p.a.

OCR FORECASTS
Source: CBA

% p.a.

(vs. pricing of overnight index swaps)

8.0 7.0 6.0 CBA Economics Forecast 5.0 4.0 3.0 2.0 1.0 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 5.0 4.0 3.0 2.0 1.0 8.0 7.0 6.0

Current market pricing

RBNZ sidelined by offshore risks, but local flat spot reduces urgency.

INTERBANK FUNDING PRESSURES (spread between interbank rates and expected policy rates)
200
Source: Bloomberg

E uro a re a

1 50

We now expect the RBNZ to remain on hold until March 2012.

1 00 NZ 50

0 Jan-07 Jan-08 Jan-09 Jan-1 0 Jan-1 1

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Global Markets Research

Economics: Perspective
March as the most likely scenario. Beyond that, we continue to expect 25bp increases at the subsequent meetings to an OCR peak of 4%.
Chris Tennent-Brown FX Economist T. +612 9117 1378 E. chris.tennent-brown@cba.com.au

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Global Markets Research

Economics: Perspective

The Week Ahead

Calendar - Australasia, Japan and China
Time Date Mon 19 Sep AEST 08:00 08:30 Tue 20 Sep 11:30 15:00 15:00 Wed 21 Sep 08:45 08:45 08:45 09:50 09:50 09:50 09:50 10:30 12:00 13:00 23:00 23:20 Thu 22 Sep 08:45 Econ Event NZ NZ AU JN JN NZ NZ NZ JN JN JN JN AU CH NZ NZ AU NZ Westpac NZ consumer confidence Performance services index Reserve Bank's Board September minutes Coincident index CI Leading index CI Current account balance Current account to GDP ratio Net migration s.a. Merchandise trade balance total Adjusted merchandise trade balance Merchandise trade exports Merchandise trade imports Westpac leading index Conference board China July leading economic index Credit card spending Aug m%ch 1.0 ~ ~ Period QIII Aug Sep Jul F Jul F QII QII Aug Aug Aug Aug Aug Jul Unit Index Index ~ Index Index NZD bn ytd ~ bn bn y%ch y%ch m%ch Last 112.0 54.5 ~ 109.0 106.0 -0.1 -4.3 -220.0 70.0 -130.5 -3.4 9.9 0.1 Forecast Market ~ ~ ~ ~ ~ -0.7 -4.0 ~ -196.3 -22.1 8.0 14.3 ~ CBA ~ ~ ~ ~ ~ -0.6 -4.0 ~ ~ ~ ~ ~ ~

RBNZ Governor Bollard speaks at a Euromoney conference in New York RBA Deputy Governor Battellino speaks at a Euromoney conference in New York GDP QII q%ch y%ch 0.8 1.4 0.5 1.7 0.1 1.3

09:00 11.30 Fri 23 Sep 10:00 11.30 Thu 22 Sun 25 Sep

AU AU AU AU

RBA's Lowe speaks at Australian economic forum in Sydney ABS announces further changes to Australian CPI Conference board leading index Financial Stability Review Jul % -0.8 ~ ~

CH

HSBC Flash China Manufacturing PMI

Sep

Index

Calendar North America & Europe

Please note all days and times are UK time, not local release day/times UK Date Mon 19 Sep Time 00:01 00:01 10:00 11:00 14:30 18.45 Econ Event UK UK EC EC EC CA Bank of England publishes quarterly bulletin Rightmove house prices Construction output ECB's Gonzalez-Paramo speaks in Frankfurt ECB announces bond purchases Bank of Canada Deputy Governor Lane speaks at Sibos Conference in Toronto Sep Jul m%ch m%ch -2.1 -1.8 ~ ~ ~ ~ Period Unit Last Forecast Market CBA

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Global Markets Research

Economics: Perspective
Tue 20 Sep 06:45 07:00 07:00 07:00 07:00 10:00 10:00 13:30 13:30 13:30 13:30 16:30 Wed 21 Sep ~ 00:01 09:30 09:30 12:00 12:00 15:00 19:15 Thu 22 Sep 10:00 10:00 11:00 13:30 13:30 13:30 15:00 15:00 15:00 Fri 23 Sep 15.00 08:30 08:30 09:00 09:00 09:00 18.30 21.30 Sat 24 Sep Sun 25 Sep 15.00 15.00 SZ GE SZ SZ SZ GE EC CA CA US US CA GE UK UK UK CA CA US US EC SZ UK CA CA US EC US US US SZ GE EC EC EC US EC US US SECO September 2011 economic forecasts Producer prices Trade balance Exports real Imports real ZEW survey (current situation) ZEW survey (econ. sentiment) Leading indicators Wholesale sales Housing starts Building permits Aug Aug Aug Aug Sep Sep Aug Jul Aug Aug m%ch CHF bn m%ch m%ch Index Index m%ch m%ch 000 000 0.7 2.8 -3.0 0.1 53.5 -40.0 0.2 0.2 604.0 597.0 0.1 ~ ~ ~ 37.5 -37.6 ~ 0.3 590.0 588.0 ~ ~ ~ ~ ~ ~ ~ ~ ~ ~

Bank of Canada Governor Carney Speaks in Saint John, New Brunswick Germanys Budget Committee has final meeting on Greece, EFSF Nationwide consumer confidence Aug Index 49.0 48.0 ~

Bank of England releases Monetary Policy Committee minutes from the September meeting Public finances (PSNCR) CPI Bank Canada CPI core Existing home sales FOMC rate decision Industrial new orders s.a. Credit Suisse ZEW survey (expectations) CBI trends total orders Retail sales Retail sales less autos Initial jobless and continuing claims Consumer confidence Leading indicators House price index Aug Aug Aug Aug Sep Jul Sep Sep Jul Jul Sep Sep A Aug Jul bn y%ch y%ch mn % m%ch Index Index m%ch m%ch 000 Index m%ch m%ch -5.6 2.7 1.6 4.7 0.25 -0.9 -71.4 1 0.7 -0.1 ~ -16.5 0.5 0.9 ~ 2.9 1.6 4.8 0.25 ~ ~ ~ -0.3 0.2 ~ -17.5 0.1 ~ ~ ~ ~ ~ 0.25 ~ ~ ~ ~ ~ ~ ~ ~ ~

International Monetary Fund World Bank hold annual meeting Swiss National Bank publishes quarterly bulletin PMI manufacturing PMI composite PMI manufacturing PMI services Feds Dudley to speak on panel in Washington ECBs Trichet speaking in Washington International Monetary Fund World Bank hold annual meeting International Monetary Fund World Bank hold annual meeting Sep A Sep A Sep A Sep A Index Index Index Index 50.9 50.7 49.0 51.5 50.5 50.5 49.0 51.0 ~ ~ ~ ~

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Global Markets Research

Economics: Perspective

Calendar Key Events To Watch

Australia and New Zealand
Monday 19 September
NZ CONSUMER CONFIDENCE SURVEYS

NZ Consumer Confidence, QIII, Index (112 prev) Consumer confidence has generally held up in recent months. While the Christchurch earthquakes in June saw a drop in sentiment in July, there was a rebound in the following month. The general improvement in household sector conditions has helped to support consumer confidence. A recovery in the labour market is taking place, and this is starting to flow through to a recovery in wage growth. Meanwhile, recent housing market data points to a gradual recovery in housing market activity taking place. With more households indicating now was a good time to purchase a major household item, retail spending improved over the first half of 2011. Nonetheless, with household debt levels still at high levels and the global risks escalating in recent months, a degree of caution is likely to remain in the household sector. Tuesday 20 September AU RBA September Board Meeting Minutes In contrast to the August meeting, the RBA board is unlikely to have considered raising interest rates in September. The post-meeting statement made it clear that the RBA is assessing the potential risks to the Australian growth and inflation outlook from the current global financial market turmoil. We expect the minutes to highlight the RBAs thinking on the potential linkages between current market uncertainty and the outlook for domestic growth and inflation. The RBA has been enunciating a wait and see approach to the unfolding troubles in Europe. The minutes may lay out some clear markers on what the RBA sees as benchmarks for progress towards a resolution. The RBAs bi-annual Financial Stability Review will be released next week as well, and is likely to have a significant focus on the European banking and sovereign situation. Wednesday 21 September NZ Current Account Balance, QII, NZD mn, (f) 600 (-97 prev) NZ Current Account to GDP Ratio, QII, %, (f) -4.0 (-4.2 prev) We expect a current account deficit of $600 million in QII, bringing the annual deficit back to 4% of GDP. In seasonally-adjusted terms, the deficit is likely to be unchanged from the previous quarter at $1.7 billion. Underpinning the QII deficit is an improvement in the goods balance. Export receipts surged 4.5%, underpinned by strong prices for meat and dairy and a lift in manufactured exports. Meanwhile we expect the services balance to deteriorate, weighed by lower export receipts as visitor arrivals were weak over the quarter. Over QI, the income deficit was reduced, due to reduced earnings on foreign-owned NZ companies as a result of insurance-industry losses arising from the Canterbury earthquake. We expect further realisation of losses will weigh on foreign earnings in QII, although to a lesser extent than QI.

1 40 1 30 1 20 10 1 Ro y M o rgan Research (rhs)

1 50 1 40 1 30 1 20 10 1

1 00 90 80
Source: Roy M organ,West pac-M cDermott M iller survey

Westpac-M cDermo tt M iller (lhs)

1 00 90 80 70

70 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-1 0

% 8

RBA CASH RATE

% 8

CBA (f)

Mkt pricing 15/9/2011 2 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 2

$b

CURRENT ACCOUNT BALANCE (annual total)

% o f GD P

-4

-4

-8 T o tal -1 2

-8

-1 2

-1 6

-1 6

-20 M ar-95 M ar-99

Source: St ats NZ

-20 M ar-07 M ar-1 1

M ar-03

James McIntyre Economist T. +612 9118 1100 E. james.mcintyre@cba.com.au Chris Tennent-Brown FX Economist T. +612 9117 1378 E. chris.tennent-brown@cba.com.au

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Global Markets Research

Economics: Perspective

Thursday 22 September NZ GDP, QII, q/y%ch, (f) 0.1/1.4 (0.8/1.4 prev) We expect GDP growth of just 0.1% over QII. This follows a robust 0.8% increase over the first quarter of 2011. The strength of the QI increase was particularly impressive given the disruption caused by the February earthquake. Over QII, we expect growth in retail spending and housing relatedactivity will be offset by declines in construction manufacturing and wholesale trade. Despite the expectation of weak growth over QII, the underlying story remains buoyant, although perhaps less upbeat than initially thought following the QI result. Over the first half of the year, the economy probably grew at an average quarterly pace of 0.4-0.5%, which is consistent with where business confidence was prevailing. In addition, the outlook for the second half of 2011 remains solid. Many of the industries that will be underpinning the QII decline are unlikely to remain weak and we expect to see continued gradual recovery in the household sector and business investment.

% 2.0 1 .5 1 .0 0.5 0.0 -0.5 -1 .0

NZ GDP GROWTH
(per quarter, seas adj)
(f)

% 2.0 1 .5 1 .0 0.5 0.0 -0.5 -1 .0

Source: Stats NZ, ASB

-1 .5 M ar-02 Dec-03 Sep-05 Jun-07 M ar-09 Dec-1 0

-1 .5

James McIntyre Economist T. +612 9118 1100 E. james.mcintyre@cba.com.au Chris Tennent-Brown FX Economist T. +612 9117 1378 E. chris.tennent-brown@cba.com.au

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Global Markets Research

Economics: Perspective

International
Tuesday 20 September SZ Trade Balance, Aug, CHF bn, (2.81 prev) The Swiss National Bank (SNB) and Swiss government remain concerns about the impact the strong CHF is having on the domestic economy, particularly on exports. Exports play an important role in the Swiss economy, equating to approximately 58% of GDP. Driven by the downside risks to the domestic outlook, brought on by the CHF strength, the SNB has acted in recent weeks, via policy easing and setting a minimum level for the EUR/CHF. Despite the moves by the SNB, headwinds remain for the Swiss trade sector. Approximately 20% of Switzerlands exports are sent to the heavily indebted nations in Europe, (65% of exports are sent to the Eurozone). The fiscal austerity measures in some of these economies, coupled with a broader economic slowdown, are likely to act as a headwind to Swiss export growth in coming months. In the near-term, Swiss trade is likely to continue to experience downside risks because of the lingering effects of the CHF outperformance, while a slowing domestic economy is expected to weigh on import demand. Wednesday 21 September JP Merchandise Trade Balance, August, bn, (72.5 prev) The March natural disaster negatively impacted Japanese production and exports in QII, but the situation appears to be improving. Having recorded trade deficits in April and May, Japan posted a surprise 70.7bn surplus in June, and a 72.5bn trade surplus was recorded in July. Despite the recovery, exports were still down 3.3% on year-ago levels in July. We expect exports to gradually recover as the supply chain issues are resolved. However, given the extent of the damage caused by the recent events, and the ongoing logistical issues, it is likely that Japanese exports will continue to be hampered in August. The Bank of Japan (BoJ) has indicated the domestic economy is unlikely to commence its recovery until later in the year.
Index 140
% 35

SWISS EXPORTS
(% by destination)
% 35

% sent to Germany 28 % sent to indebted Europe 21 % sent to nonEurope 14 % sent to US 7 Dec-95 Oct-98 Aug-01 Jun-04 Apr-07 7 Feb-10 Nov-12 14 21 28

JAPAN EXPORT VOLUMES & INDUSTRIAL PRODUCTION

Total Export Volumes (3MMA)

Index 140

120

120

100

100

80 Industrial Production (3MMA) Base 2005 = 100 60 Jun-03 Jun-05 Jun-07 Jun-09 Jun-11

80

60

Wednesday 21 September UK Bank of England September Meeting Minutes As expected the Bank of England (BoE) left the bank rate and its target for asset purchases unchanged at the September meeting. The UK economy is clearly still in a soft patch at present and has yet to show signs of meaningful re-acceleration. With a significant negative output gap still prevalent, there is no reason to expect any move towards policy tightening any time soon. Indeed, to the extent that there will be any near-term shift in bias, it is much more likely to be towards easier monetary policy settings and additional QE. As always this will be data dependent, conditional on the evolution of the economy and subject to various risks. Further asset purchases by the BoE are not our central case assumption at this stage, but the risks are increasing. The MPC minutes will reveal whether there was a further shift towards more QE on the Monetary Policy Committee.

UK INTEREST RATES
10 % 10 %

8 Mortgage rate 6

4 Bank of England official rate 2

0 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10 Jan-13

Joseph Capurso Currency Strategist T. +612 9118 1106 E. joseph.capurso@cba.com.au Peter Dragicevich FX Economist T. +612 9118 1107 E. peter.dragicevich@cba.com.au Chris Tennent-Brown FX Economist T. +612 9117 1378 E. chris.tennent-brown@cba.com.au

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Global Markets Research

Economics: Perspective

Wednesday 21 September CA CPI, Aug, m/y%ch, (0.2/2.7 prev) CA Bank Canada Core CPI, Aug, m/y%ch, (0.2/1.6 prev) Canadian consumer prices lifted 0.2% in July, after a 0.7% fall in June. Annual inflation has eased from a peak of 3.7% in May to 2.7% in July. The May result was the highest annual rate of inflation since September 2008. The recent high headline CPI was largely due to higher energy and food prices, and the transitory impact of provisional tax increases. Falling fuel costs has helped lower headline CPI inflation since May, with gasoline prices falling 3.7% in June. In July, the impact of provincial sales tax increases faded from the annual result, and mortgage costs declined. Over June and July automobile costs have also fallen. The Bank of Canada (BoC) moderated its inflation outlook at the September policy review. The BoC expects the recent negative global developments will dampen domestic resource utilization and inflationary pressures. The BoC expects CPI inflation to continue to moderate, and core inflation is also expected to remain wellcontained. Wednesday 21 September US FOMC Policy Meeting, Sep, % (f) 0.25 (0.25 prev) Following soft growth in the first half of 2011, the US economy has deteriorated further. We expect the FOMC to deliver further policy stimulus to support the economy in the form of Operation Twist. Operation Twist refers to the Federal Reserve (Fed) selling its shortterm holdings of US treasuries to buy long-term Treasuries. The economy is stimulated because corporates and households borrowing interest rates are linked to long-term US treasury yields. If the FOMC determines the US economy requires further support, the FOMC may also cut the interest rate paid to banks on their excess reserves to encourage banks to lend.
2.50 %
3 % 5

CANADA INFLATION
BoC's 1-3% total Inflation target range for CPI

% 5

1 Core CPI

Headline CPI -1 Jan-00 Jan-03 Jan-06 Jan-09 Jan-12 -1

FEDERAL FUNDS RATE

2.50 %

2.00 CBA (f) 1.50

2.00

1.50

1.00 Market (f) 0.50

1.00

0.50

0.00 Jan-11 Jan-12 Jan-13

0.00

Thursday 22 September CA Retail Sales, July, m%ch, (0.7 prev) CA Retail Sales Less Autos, July, m%ch, (-0.1 prev) A lift in auto sales helped boost overall retail sales in June. Retail sales (excluding autos) contracted 0.1% in the month of June, and grew by only 0.3% in the quarter. Canadian consumer confidence dropped for the fourth consecutive month in August. The lack of confidence can in part be attributed to uncertainty about job prospects. Employment growth has slowed since April, and other economic indicators have weakened recently, and this may be contributing to the caution. High fuel costs have also been an issue for consumers, although prices have eased recently. We expect consumer caution to continue in the coming months, given the global uncertainties, and softening consumer sentiment.
Index 150

CANADA RETAIL SALES AND CNSUMER CONFIDENCE

% 15

Retail Sales Growth (Ex- Auto, YOY, rhs) 125 10

100

75 Consumer Confidence (rebased Aug 2002 = 100, lhs) Jul-04 Jan-07 Jul-09 Jan-12

50 Jan-02

-5

Joseph Capurso Currency Strategist T. +612 9118 1106 E. joseph.capurso@cba.com.au Peter Dragicevich FX Economist T. +612 9118 1107 E. peter.dragicevich@cba.com.au Chris Tennent-Brown FX Economist T. +612 9117 1378 E. chris.tennent-brown@cba.com.au

19

Global Markets Research

Economics: Perspective

Friday 23 September EZ PMI Services, Sep A, Index, (51.5 prev) EZ PMI Manufacturing, Sep A, Index, (49.0 prev) EZ PMI Composite, Sep A, Index, (50.7 prev)
60 Index 70

MANUFACTURING PMIs

Index 70

Germany 60 Global 50 Eurozone 40 Italy France 30 Apr-06 Feb-08 Nov-09 Sep-11 30 Greece 40 50

Eurozone PMI indices dropped in August as the financial market stress weighed on the outlook for the service and manufacturing sectors. The manufacturing PMI for Eurozone dropped to 49 in August from 50.4 in July. A reading below 50 indicates contraction for the sector. The German Manufacturing PMI remained in expansionary territory last month, but the indicators for French and Italian manufacturing printed below 50, suggesting future contraction for manufacturing in these countries. The Eurozone Services PMI is faring slightly better, printing at 51.5 in August. But the reading has drifted significantly lower from its peak back in March of 57.2 Flash estimates for September manufacturing and services PMIs are published for Germany, France and the Euro-zone on 23 September. Based on the ongoing turmoil in financial markets during September, further downside moves look possible.

Joseph Capurso Currency Strategist T. +612 9118 1106 E. joseph.capurso@cba.com.au Peter Dragicevich FX Economist T. +612 9118 1107 E. peter.dragicevich@cba.com.au Chris Tennent-Brown FX Economist T. +612 9117 1378 E. chris.tennent-brown@cba.com.au

20

Global Markets Research

Economics: Perspective

Monetary Policy
OFFICIAL INTEREST RATES
%
NZ 8 Australia 6 6
4.5 Cash rate 4.5

% 5.5

RBA CASH RATE PRICING

3 months ahead

% 5.5

8
5.0

5.0

UK

4.0

4.0

Euro US Japan Canada

3.5
Source: Reuters

12 months ahead

3.5

3.0

3.0 Mar 11 May 11 Jul 11 Sep 11

0 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

Jan 11

Country Australia (RBA)

Last Move 25bpt rise to 4.75% on 7 November 2010.

Next Meeting and Forecast 4 October, 2011

Sep 11 4.75% Dec 11 4.75% Mar 12 5.00% Jun 12 5.00%

CBA View The QII CPI confirmed the inflation trend has turned up. Rate rises are likely. We expect a rate rise in February. The cash rate is expected to reach 5.50% by 2013. Given the loss of momentum in the US economy, particularly in the labour market, we expect the Fed to maintain the size of its balance sheet until early 2013. The first Fed funds hike is not expected until mid 2013. The recent deterioration in Eurozone economic indicators suggests that the ECB will pause its process of monetary policy normalisation. We expect the ECB to remain on hold until QII 2012. The stance of the MPC has shifted; elevated inflation does not appear overly concerning. Given the J subdued outlook for the UK 1 economy, we expect the BoE to remain on hold until QIII 2012. The escalating debt crisis in Eurozone is dominating the RBNZs outlook, and we expect the RBNZ will leave the OCR on hold until March next year. We expect a 50bpt OCR increase in March. Softness in the US economy is likely to effect the Canadian economy given the strong trade ties. We expect the BoC to remain on hold until mid 2012 before it embarks on a slow and steady removal of policy accommodation. In response to the recent natural disasters, the Bank of Japan has implemented further quantitative easing measures. Monetary policy in Japan is likely to remain accommodative for some time.

US (FOMC)

75-100bpt cut to 0-0.25% on 16 December 2008.

21 September, 2011
Sep 11 0-0.25% Dec 11 0-0.25% Mar 12 0-0.25% Jun 12 0-0.25%

Eurozone (ECB)

25bpt rise to 1.50% on 7 July 2011.

6 October, 2011
Sep 11 1.50% Dec 11 1.50% Mar 12 1.50% Jun 12 1.75%

UK (MPC)

50bpt cut to 0.5% on 5 March 2009.

6 October, 2011
Sep 11 0.50% Dec 11 0.50% Mar 12 0.50% Jun 12 0.50%

NZ (RBNZ)

50bpt cut to 2.5% on 10 March.

27 October, 2011
Sep 11 2.50% Dec 11 2.50% Mar 12 3.00% Jun 12 3.50%

Canada (BoC)

25bpt rise to 1.00% on 8 September 2010.

25 October, 2011
Sep 11 1.00% Dec 11 1.00% Mar 12 1.00% Jun 12 1.25%

Japan (BoJ)

0-10bpt cut to 0-0.1% on 5 October 2010.

7 October, 2011
Sep 11 0-0.10% Dec 11 0-0.10% Mar 12 0-0.10% Jun 12 0-0.10%

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Global Markets Research

Economics: Perspective

Forecasts - Economic

CBA AUSTRALIAN ECONOMIC FORECASTS: Sep 2011

Fiscal Years 2007/08 (a) 2008/09 (a) 2009/10 (a) 2010/11 (a) 2011/12 (f) 2012/13 (f) Calendar Years 2006 (a) 2007 (a) 2008 (a) 2009 (a) 2010 (a) 2011 (f) 2012 (f)

Economic Activity Private final demand Of which: Household spending Dwelling investment Business investment Public final demand Domestic final demand Inventories (contrib to GDP) GNE Exports Imports Net exports (contrib to GDP) GDP Prices & Wages CPI Underlying CPI AWOTE WPI Real h/hold disposable income Labour Market Employment Unemployment rate External Accounts Current Account: $bn % of GDP 6.4 4.7 1.2 15.8 4.2 5.9 0.0 5.9 4.0 14.6 -2.1 3.8 0.1 0.2 -1.9 1.4 3.6 0.9 -0.4 0.4 2.6 -3.3 1.4 1.4 0.8 2.1 2.1 -4.9 6.7 2.1 0.3 2.4 5.3 5.1 0.1 2.3 3.5 3.3 2.6 6.2 4.5 3.8 0.4 4.1 0.2 10.7 -2.4 1.9 4.8 2.8 2.2 13.4 1.5 4.0 -0.2 3.8 8.3 9.3 -0.4 3.5 5.2 3.1 -1.1 14.2 -0.1 4.0 0.1 4.0 7.6 8.6 -0.4 3.7 3.6 3.4 -3.0 8.5 3.7 3.7 -0.4 3.2 2.2 6.9 -0.9 2.6 7.1 5.5 3.0 16.1 3.4 6.3 0.6 6.9 2.4 12.2 -2.0 4.6 3.1 1.9 2.1 9.6 6.3 3.8 -0.3 3.5 4.7 11.5 -1.5 2.6 -0.7 1.0 -4.2 -5.4 1.8 -0.1 -0.4 -0.5 2.6 -9.0 2.7 1.4 2.2 2.8 4.2 -0.1 9.1 3.8 0.4 4.2 5.7 13.7 -1.6 2.7 4.6 3.1 3.3 11.6 1.8 3.9 0.4 4.2 -0.1 10.1 -2.4 2.0 5.0 2.9 0.0 14.1 0.5 3.9 -0.3 3.6 10.4 8.6 0.0 4.0

3.4 3.7 4.9 4.1 3.0

3.1 4.3 5.5 4.1 8.6

2.3 3.1 5.6 3.0 0.9

3.1 2.4 4.2 3.8 5.2

2.9 3.2 4.8 4.0 2.9

3.1 3.2 3.9 3.9 2.8

3.5 2.8 3.4 4.1 5.6

2.3 2.9 4.8 4.0 6.3

4.4 4.4 4.8 4.2 4.9

1.8 3.7 5.7 3.6 5.8

2.8 2.5 4.9 3.3 2.1

3.3 2.8 4.5 3.9 4.8

2.9 3.2 4.2 4.0 2.4

3.0 4.2

1.6 4.9

1.4 5.5

2.9 5.1

0.9 5.2

1.8 5.0

2.6 4.8

3.1 4.4

2.8 4.3

0.7 5.6

2.7 5.2

1.8 5.1

1.2 5.2

-74.5 -6.3

-38.5 -3.1

-53.4 -4.2

-33.8 -2.4

-21.6 -1.4

-23.1 -1.4

-55.2 -5.3

-70.3 -6.2

-55.3 -4.5

-52.9 -4.2

-36.0 -2.7

-29.6 -2.1

-21.5 -1.4

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Global Markets Research

Economics: Perspective

Forecasts - Financial
Interest Rates End Period Cash Rate 6.75 7.25 7.25 7.00 4.25 3.25 3.00 3.00 3.75 4.00 4.50 4.50 4.75 4.75 4.75 4.75 4.75 5.00 5.00 5.25 5.25 90-day Bank Bill 7.24 7.86 7.84 7.32 4.15 3.14 3.19 3.38 4.28 4.49 4.92 5.01 5.04 4.93 5.03 4.80 4.90 5.10 5.20 5.40 5.50 180-day Bank Bill 7.36 7.96 7.96 7.04 0.00 3.06 3.31 3.78 4.47 4.76 5.00 5.20 5.23 5.01 5.07 4.70 5.00 5.20 5.30 5.50 5.60 3-year Bond 6.80 6.16 6.72 5.07 3.29 3.37 4.75 5.04 5.06 5.39 4.56 4.82 5.30 5.07 4.78 3.80 4.50 4.65 4.90 5.05 5.15 10-year Bond 6.33 6.05 6.45 5.40 3.99 4.42 5.52 5.36 5.64 5.78 5.09 4.96 5.55 5.49 5.21 4.40 4.70 4.70 4.80 4.90 5.00 USD versus AUD JPY Exchange Rates EUR GBP NZD

Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12

0.88 0.91 0.96 0.79 0.70 0.69 0.81 0.88 0.90 0.92 0.84 0.97 1.02 1.03 1.07 1.03 1.04 1.07 1.08 1.08 1.08

111.7 99.7 106.2 106.1 90.7 99.0 96.4 89.7 93.0 93.4 88.4 83.5 81.1 83.1 80.6 76.8 77.0 77.0 77.0 78.0 79.0

1.46 1.58 1.58 1.41 1.40 1.33 1.40 1.46 1.43 1.35 1.22 1.36 1.34 1.42 1.45 1.39 1.39 1.43 1.44 1.44 1.43

1.98 1.98 1.99 1.78 1.46 1.43 1.65 1.60 1.62 1.52 1.49 1.57 1.56 1.60 1.61 1.58 1.60 1.62 1.64 1.64 1.62

0.77 0.79 0.76 0.67 0.58 0.56 0.65 0.72 0.72 0.71 0.68 0.73 0.78 0.76 0.83 0.82 0.82 0.83 0.84 0.84 0.84

Forecast

23

Global Markets Research

Economics: Perspective

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