NAB Business View

Overall, Australian economic growth (GDP) is forecast to slow to about 3 per cent in 2008, following a rise of 3 per cent in 2007. The external stimulus from strong global growth and very high commodity returns will begin to fade cooling asset returns and, with tighter domestic financial and fiscal conditions, both business and household spending will slow and more generally, dampen demand and income growth.

Given follow-up rains post the recent falls in summer, farm production is expected to rebound and add about a quarter of a percentage point to the bottom line for overall output in 2008, after a drag of half a percentage point in 2007. NAB forecasts imply that non-farm business gains will peak, but overall growth will slow to only a bit below potential. Demand will also remain sufficient to keep unemployment relatively low in 2008 and business will continue to experience difficulties finding labour and managing cost pressures.

Broadly consistent with NAB’s view, the vast majority expect a sustained and strong performance. Less than 5 per cent of SMEs expect conditions to deteriorate significantly during the next year.

TACKLING INFLATION

There is an inflation problem, at least in the near term. NAB expects the Reserve Bank of Australia’s (RBA’s) core measures to rise to about 3.8 per cent in early 2008. Slower demand in 2008 will help ease inflationary pressures, but even so, core inflation will not be below 3 per cent until late 2008. In contrast, the RBA foresees price pressures for the next couple of years.

Against this domestic backdrop, the RBA is expected to raise cash rates another 25 basis points to 7.25 per cent to take out some further insurance on core inflation, moving back into its target band during 2008/2009. The new federal government is also expected to significantly tighten fiscal policy in its post election budget in May. However, this domestic policy adjustment is far from a certainty. The current liquidity and credit issues in global financial markets via their direct impact on the cost and availability of finance (debt, deposits and equity) could put the RBA into ‘wait and see’ mode. More critically, the nature of the economic slowdown underway in the US and prospects of softer global growth could mean that the RBA has already reached the peak of its current tightening phase.

By the end of 2008, the surprise for financial markets may well be an easing of cash rates back to a more neutral, but still firm position. Given the eventual peak and easing in both domestic cash rates and global commodity prices, the Australian dollar is forecast to return below 90 US cents during the next year.

MAINTAINING THE PACE

NAB’s base economic case for Australia and the world is another relatively strong performance in 2008. Fortunately, the financial losses and tightening of credit associated with US growth ‘recession’ (as well as higher oil prices) have emerged at a time of strong world trade and output growth driven by emerging countries – notably China, India, Latin America and the Middle East – and low global inflation as well as generally sound profits and business balance sheets.

The process of the re-pricing of credit and discovery of capital losses in the global financial system will be watched closely during 2008, while real economic activity is expected to be sustained at a bit below trend in Australia and abroad.

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Jeff Oughton is NAB’s Senior Australian Economist.