News Article

Unconventional monetary policy and bank liquidity support returned to centre stage in September and early October. The US Fed commenced “Operation Twist”; the ECB broadened its liquidity supplying operations; and the BoE re-ignited its asset purchase programme. The global real economy weakened on a broad front over the month, with the most timely indicators describing a material deterioration in business activity. Commodity prices had a month to forget and asset prices that are highly leveraged to growth lost considerable value. Exhibit A: the Australian dollar. Exhibit B: Asian currencies. The initial salvoes in this renewed battle against contractionary forces have been fired on either side of the Atlantic. The Asia-Pacific, where policy normalisation has been the first order of business since mid-2010, will soon be recalibrating policy to reflect the sombre new reality.

Download the Westpac Market Outlook (PDF 2 MB)

Australia: The Reserve Bank has adopted an easing bias, reflecting the improved outlook for inflation, which in turn partly reflects widespread evidence of softening demand. With commodity prices losing ground, the unemployment rate rising and house prices falling, the argument for a cut is not difficult to make. Back on July 15 we predicted a 25bp rate cut by December 2011 to be followed by a further 75bps spread over the first three quarters of 2012. We remain comfortable with that call.

New Zealand: The downgrade of New Zealand’s sovereign credit rating by Fitch and Standard & Poor’s underscored the nation’s vulnerability to an increasingly ugly global environment. On the home front, domestic activity and confidence have held up but with more signs of conditions cooling. And there are indications that the Rugby World Cup’s net impact has been very mixed so far.

United States: The US economy is muddling along, with cyclical momentum increasingly elusive. The labour market is soft, house prices continue to lose value and the construction sector remains in an ice age. The business surveys imply positive but underwhelming activity growth, but the margin separating the economy from contraction is slim. We do not expect a huge impact on real activity from the Fed lengthening the maturity of its holdings (“Operation Twist”), indicating that more easing will be forthcoming in due course.

China: The September business surveys describe an economy that is still expanding, if at a sub trend pace, with the manufacturing sector possibly stalled. We have been at pains to argue over the last decade that China is investment led and that exports do not lead investment. That is different from arguing that sharp declines in export activity do not matter (aka the extreme decoupling view). They do. As a sub-aggregate cycle exports are secondary to only property and infrastructure.

Japan: Right at this moment, the economy is printing decent numbers as the reconstruction effort makes itself known in housing starts, machinery and construction orders, and the supply side revival process in the industrial sector plays itself out. The BoJ should ignore that and seek to alleviate the tightness of overall financial conditions. Deflation is back.

India: We disagreed with the RBI’s decision to raise interest rates in September, arguing it was a classic example of late cycle hawkish excess. The interest rate sensitive sectors are losing altitude already and the external environment is unsupportive. On the external financing front India saw combined net equity and debt outflow fall in both August and September.

Emerging Asia: Last month we argued that the region was in the midst of its first real growth setback since the dark days of the crisis. Since that time the activity side of the story has remained suppressed and capital outflow came to the fore. Regional currencies fell sharply against the US dollar in late September. We now expect rate cuts across the region in early 2012.

Europe: The ECB noted “intensified downside risks” to the economic outlook at the October 6 meeting: we maintain our call that recession is imminent. Liquidity support has been increased sharply as the sovereign/banking disaster unfolds. The Bank of England has announced a further £75bn of asset purchases over the next four months.