Australian Slowdown Intact

July 10, 2008

A bigger-than-expected 29,800 rise of jobs in June was reported for June earlier today.  Taking downward revisions to previous months into account, the actual advance was about 2.5 times street forecasts, and it was accompanied by a dip in the unemployment rate to 4.2% from 4.3%, which also had not been expected and occurred despite a greater labor force participation rate.  The jobless rate averaged 4.15% in 1H08, lowest since around 1974.  The July 1st Australian central bank statement had mentioned tentative signs of an easing in labor market conditions, and that still seems accurate.  Jobs grew less than half as rapidly in 1H08 as in 2007.  New job ads posted monthly drops of 1.7% in May and 3.0% in June.  Job vacancies fell 3.7% m/m and 8.2% y/y in June.  The labor market component of the PMI-mfg index fell by 5 points to 43.8 in June.  June’s advance in jobs followed a big decline in May.

Australia’s housing market has weakened sharply.  The construction PMI had a reading below 50 in each of the last four months and an average score of 39.9 during the past three months.  New housing sales dropped in five of the past six months.  Building approvals in May fell more than twice what was forecast.  Housing finance dived 7.9% in May and by 21.5% y/y.  House prices slumped 2.7% in the first quarter below the level in 4Q07.  Consumer confidence is reeling, with a drop of 6.7% in the latest data release to the lowest level since the start of 1992Business confidence, which dropped 5 points to -9 in June, is at a 7-year low.  Australia’s equity market index, the S&P/ASX 220, has slumped to a 2-year low.

Australia is grappling with several of the economic headwinds that most countries face: elevated energy costs, a global credit crunch, and higher inflation.  In addition, Australia has relatively high nominal and real interest rates.  A dozen increases of the central bank cash rate since May 2002, including four compressed between August 2007 and March 2008, have lifted such to a 12-year peak of 7.25%.  The ten-year yield exceeds 6.0%.  Monetary conditions have been tightened additionally by a strengthening Aussie dollar, which hit a 25-1/2 year peak of US$0.9667 at end-June, traded in the first third of July between $0.9477 and $0.9650, and was as elevated at $0.9618 earlier today.  Central bank officials consider financial market conditions to be now substantially tighter than they were in mid-2007 and expect this to produce a significant slowdown of domestic demand.  Monetary policy is presently in a wait-and-see mode, while officials determine if demand is indeed slowing enough to rein in above-target inflation to the 2-3% target corridor in the medium term.  GDP growth in 1Q of 0.6% from 4Q and 3.6% from 1Q07 surpassed expectations.  The May 2008-over-May 2007 expansion of exports (19.5%) and imports (17.0%) was very brisk.  Government spending growth in 1Q of 1.5% surpassed expectations, and large tax reductions were implemented at the start of this month.  The biggest growth stimulant, however, is the surge of export prices relative to import prices, which will give a huge lift to disposable incomes. CPI inflation hit 4.2% y/y in 1Q08.

While monetary officials wait for their medicine to work, consumer price inflation is likely to get even worse.  The commodity price index posted back-to-back surges of 9.4% in April and 7.0% in May.  Consumer prices for 2Q08 due July 23rd will not read well.  RBA officials know this and have pretty much indicated that a bad number will be tolerated so long as they remain convinced that demand is slowing significantly.  A single month of strong employment growth isn’t going to modify that thinking, coming against the background of a considerable body of contrary evidence including forward-looking labor market data.  Investors need to watch all forthcoming measures of demand and production.  If the gestalt of such indicators starts to tip back toward balance or worse toward reintensifying demand, markets will discount a higher probability of another rate increase around 4Q08.



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