Global Economic Overview 9.2008 - IRIS Research Economic Overview 9... · Global Economic Overview ... & 3m th overnight indexed swaps Latest: 19 Sep '08 Previous Aus peak ... December

1

Alan Oster - Group Chief Economist

Global Economic Overview

- Global Financial Instability & Outlook- Ramifications for Australia

2

Recent developments have cast concerns about what is happening globally and its local implications…

Key drivers include– How bad is the USA and how far is it spreading;– And how should monetary authorities respond – inflation v growth??

Fear also about US and global recession rising. Consumers globally lose confidence and housing markets suffer.

Financial conditions very volatile. More capital being written off and concerns about what happens next re financial fragility. Amazing few weeks;– Fannie Mae and Freddie Mac look more secure– But Lehman Brothers in bankruptcy protection– Merrill Lynch brought by Bank America & AIG by the Fed (effectively)– HBOS brought by TSB Lloyds

3

USA Treasury response – no one allowed to fail if it has systemic implications

Lehman Brothers – judgment is that its not systemic, with doubts around it for a long time & can organise a orderly sell offUS package– Temporary (2 years) ability for Treasury to purchase $US 700b of “mortgage related

assets” from USA (and then extended to non US) firms– Discount window opened (up to $US 250b) on money market mutual funds – to stop

runs on these firms. Fed will take their non liquid assets– Short selling on 799 financial firms and banks prohibited for 10 days (can be extended

to 30 days)– Goldman Sachs & Morgan Stanley now “banks”

Global co-ordination on short selling (UK, France, Germany, Switzerland & Canada. In Australia:

– Short selling (all kinds) of any stock prohibited for 30 days

4

Clearly this has seen very volatile markets – equity bonds and currency

Equity and currency markets almost back to where they wereBut govt bond yields lower and cost of funds to banks higher

Obviously operating in heightened risk environment.

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M a y - 0 7 J u l - 0 7 S e p - 0 7 N o v - 0 7 J a n - 0 8 M a r - 0 8 M a y - 0 8 J u l - 0 8 S e p - 0 8

P r i c e o f L i q u id i t y f o r B a n k s

S o u r c e s : B l o o m b e r g , n a b C a p i t a l R e s e a r c h

A u s t r a l i a 7 7

U S 1 2 9b p s s p r e a d o f 3 m t h b a n k b i l l s & 3 m t h o v e r n ig h t i n d e x e d s w a p s

L a t e s t : 1 9 S e p '0 8

P r e v io u s A u s p e a k ( B e a r S t e a r n s b u s t )

5

Global equity markets fell around 20 % early in 2008 and another leg down (around 10% through June / July). Last week or so volatile. And some (China Hong Kong India) down further but others ….

C h a n g e in G lo b a l E q u ity M a rk e ts S in c e J u n e 2 0 0 7

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4/06

/200

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18/0

6/20

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28/0

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8/09

/200

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C H IN AJ ap an a llIn d iaU S S & PU KA u s tH o ng K o ng

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Recent credit crisis dropped commodities by another 10% bringing total falls from the peak to around 30%. Helping ease concerns about inflation

C R B R eu ters In d exes o f C o m m o d ity P rices

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C R BIN D U S T R IA LSG R A IN SLIV E S T O C K & M E A TE N E R G YP R E C IO U S M E T A LSS O FT A G R

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Recent big picture on the economyMore signs of a co-ordinated slowdown globally China still the exception

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9 2

9 4

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1 0 2

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1 0 6

Jul-2

008

Jun-

2008

May

-200

8

Apr

-200

8

Mar

-200

8

Feb-

2008

Jan-

2008

Dec

-200

7

Feb-

2007

Jan-

2007

Apr

-200

7

Mar

-200

7

Jul-2

007

Jun-

2007

May

-200

7

Aug

-200

7

Sep

-200

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Nov

-200

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Oct

-200

7

A u s tra liaU n ite d K in g d o mU n ite d S ta te sE u ro a re a C h in aJa p a nN e w Z e a la n d

O E C D L E A D IN G IN D IC A T O R S

T R E N D L IN E

8

Recent big pictureIn the USA activity held up but only via net exports. GNE near zero.Weak USD taking others growth – especially Europe and Japan

-2 .00%

-1 .00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

Mar

-85

Mar

-86

Mar

-87

Mar

-88

Mar

-89

Mar

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Mar

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-08

-1 .50%

-1 .00%

-0 .50%

0.00%

0.50%

1.00%

1.50%

2.00%

C O N S U M P T IO NG D PG N EN E T E X P O R T S C O N T R IB U T IO N R H S

D R IV E R S O F U S AC T IV ITY - C onsum ptio n , G N E and N E T E xports 12 M ths to %

9

A few general observations on the global outlook

For 2008 really a story of switch in growth – USA v the restBut going forward key drivers of global outlook in 2009 are:– The lagged impact of further weakness in equity markets– Further weakness in housing markets globally (especially USA, Ireland, NZ,

UK and parts of Continental Europe)– Credit rationing in USA and Europe– The lagged impact of higher oil prices– Lower consumer and business confidence

• Especially caution spurred on by event risk

Indeed the chances of a very hard landing probably risen – 30% chance

10

Globally: GDP to slow to 2.5% in 2009 from around 3.2% in 2008.Some major economies moving into recession – most of the G-10 stalledNo fundamental recovery till late 2009. China slowing but….

Real output growth % change yoyGlobal GDP Forecasts December year annual average % change

2006 2007 2008(f) 2009(f) 2010(f)

US 2.8 2.0 1.6 0.7 2.5 Japan 2.4 2.0 0.4 0.4 2.2 UK 2.9 3.1 1.0 0.6 2.2 eurozone 2.9 2.6 1.3 0.7 2.0 Canada 3.1 2.7 0.8 1.1 1.9 Australia 2.5 4.2 2.5 2.2 2.6 New Zealand 1.6 3.1 0.4 1.7 3.8 China 10.7 11.4 9.5 8.3 7.6 India 9.8 9.3 7.7 6.5 6.8 World 4.6 4.3 3.2 2.5 2.8 Emerging E Asia 5.3 5.2 4.8 4.2 4.6 Latin America 5.1 5.3 4.7 4.0 4.4

World GDP Growth

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2

3

4

5

6

7

8

9

10

Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10%

ann

ual c

hang

e to

qua

rter

sho

wn

Forecast

Global growth

Developed economies

Emerging economies

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Look to the USA

Key concerns are– Housing overbuild– House price wealth effects– Negative equity market wealth effects– Financial flow ons from Sub prime (notably increased funding

and capital costs, credit availability and capital losses – Oil (and other commodity) prices– And the will the credit crisis package work

12

Our forecasts show a “economy stalled” - with growth no better than 2001 Key issue is will it become a “major” recession. Clearly worst yet to come ( Oil and wealth effects from housing & equities)

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Mar

-85

Mar

-86

Mar

-87

Mar

-88

Mar

-89

Mar

-90

Mar

-91

Mar

-92

Mar

-93

Mar

-94

Mar

-95

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

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Mar

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Mar

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Mar

-10

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0 .0 0 %

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C O N S U M P T IO NG D PG N EN E T E X P O R T S C O N T R IB U T IO N R H S

D R IV E R S O F U S A C T IV IT Y - C o n s u m p tio n , G N E a n d N E T E x p o rts 1 2 M th s to %

13

Another perspective on the US is by using a Mini model of US economy. Model wants flatter for longer (oil prices and credit crunch).Deep recession still possible but still not the most likely outcome

Model based on- real rates- house prices- equity markets- oil prices- currency - credit crunch

What does the model need to get recession in 2009

- HP down 20% from here- Equities down 20% - Oil $140USD

How likely – possible but still not the most likely

US Quarterly GDP v Model

-1

-0.5

0

0.5

1

1.5

2

Jun-

86D

ec-8

6Ju

n-8 7

Dec

-87

Jun-

8 8D

ec-8

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n-8 9

Dec

-89

Jun-

9 0D

ec-9

0Ju

n-9 1

Dec

-91

Jun-

9 2D

ec-9

2Ju

n-9 3

Dec

-93

Jun-

9 4D

ec-9

4J u

n-95

Dec

-95

Jun-

96D

ec-9

6Ju

n-97

Dec

-97

Jun-

98D

ec-9

8Ju

n-99

Dec

-99

Jun-

00D

ec-0

0Ju

n-01

Dec

-01

Jun -

02D

ec-0

2Ju

n -03

Dec

-03

Jun -

04D

ec-0

4Ju

n -05

Dec

-05

Jun -

06D

ec-0

6Ju

n -07

Dec

-07

Jun-

0 8D

ec-0

8Ju

n-0 9

Dec

-09

Jun-

1 0D

ec-1

0

ACTUAL

Interest rate/ Los Model

14

Banks have acted to tighten lending criteria and hence supply ofbusiness lending – both in the US and Europe…

Bank Standards for Business Lending in USA / Europe

In Australia not rationing – other than at top end, as capital markets remain either closed or very expensive.

Net Percentage of Banks Tightening Lending Standards to Medium and Large Non-Financial Corporates

-40

-20

0

20

40

60

80

1991 1993 1995 1997 1999 2001 2003 2005 2007

Net

Per

cent

age

United States Euro area

Sources: US Federal Reserve and European Central Bank

15

On second round impact of sub prime – global higher funding costs- Was some local improvement given rate expectations but all changed in latest crisis- Now back to Bear Steins peaks

Near term liquidity costs (30 -90 days) very high and its global. Raising risk of non action from the banks even if RBA moves (or RBA will need to be more aggressive)

16

On second round impact of sub prime- Medium term funding costs for all banks (local and global)

Not a lot of change in Australia for medium term funding

And globally somewhat worse.

M e d iu m T e r m F u n d in g C o s ts

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O c t 0 5 A p r 0 6 O c t 0 6 A p r 0 7 O c t 0 7 A p r 0 8 O c t 0 8

D o m e s t ic B a n k s

D o m e s t ic b a n k s p r e a d to s w a p -

2 - 3 y e a r

17

Chinese economic growth still very strong -10.1% in year to June. Leading Indicators still different to the rest of the OECD but slowing.And are signs manufacturing is also slowing – production down to 12.8%

Chinese lead indicators still strongBut are slowing

But may be first signs of slowing in industrial production in recent months –but Games disruption hard to untangle

Industrial Production - Total / Heavy/ LightAnnual Growth %

0

5

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25

30

Aug

-98

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Feb-

99M

ay-9

9A

ug-9

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9Fe

b-00

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-00

Aug

-00

Nov

-00

Feb-

01M

ay-0

1A

ug-0

1N

ov-0

1Fe

b-02

May

-02

Aug

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-02

Feb-

03M

ay-0

3A

ug-0

3N

ov-0

3Fe

b-04

May

-04

Aug

-04

Nov

-04

Feb-

05M

ay-0

5A

ug-0

5N

ov-0

5Fe

b-06

May

-06

Aug

-06

Nov

-06

Feb-

07M

ay-0

7A

ug-0

7N

ov-0

7Fe

b-08

May

-08

Aug

-08

0

5

10

15

20

25

30TOTALHEAVY MANUFACTURINGLIGHT MANUFACTURING

18

More obvious is the slowing in exports – especially in local currency terms. Equity market falls have been among the largest (-60% y/y).Past significant policy tightening have started to eased somewhat.

Policy Measures- Tightening• Borrowing rate (1 year capital) progressively raised to 7.47% - Implying real rate of 6%• Lifted the bank reserve ratio to a record

17 ½ %•Oil subsidy lowered from 20 June –increasing prices by around 20%• EASING• But in late August credit limits to SMEsincreased• On 25 September

- Borrowing rate lowered by 27points to 7.2%•Reserves ratio lowered by 1%.

Export growth - % change year on year

0

5

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15

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25

30

35

40

45

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Export deliveries(Yuan)

Export receipts (US$)

19

Part of that easing reflected slower growth but also lower inflation.But China is no longer exporting deflation – rather adding to global pressures on the supply side (in addition to demand).

CPI inflation and contribution to growth

-3

-1

1

3

5

7

9

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Non-food contribution

CPI

Contribution from food

Chinese trade price inflation % yoy

-6

-4

-2

0

2

4

6

Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07

US import pricesfrom China

Hong Kong re-export prices

Price of HongKong importsfrom China

20

But need to put all this in perspectiveBusiness investment is still very strong – above 20% in real terms 20%While real retail sales accelerating to 16½% .

Retail trade activity % change year on year

-5

0

5

10

15

20

25

Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

RETAIL INFLATION RETAIL VALUES RETAIL VOLUMES

Investment indicators % change year on year

0

5

10

15

20

25

Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-0810

15

20

25

30

35

40

45

50

Fixed investment spending(RHS axis)

Value of fixed assets(LHS axis)

21

Chinese growth to slow moderately But we are comfortable with China growth slowing to around 8¼% in 2009 and around 7½ 2010 (from 9½% in 2008)

Tighter policy and slower global growth has slowed the economy in 2008 and more so in 2009

– Real rates are still high– As are reserve requirements

As will oil prices and equity markets– Oil up 20% as subsidy reduced– Equity markets down 60% (from mid 2007)

And no doubt timing of Olympics are distorting figures. But authorities are taking out some insurance via recent easing

And lots of policy flexibility if more is needed

Risks are probably for 2009/10 – especially if US stays flatter for longer.

22

On commodities we expect further falls in rural commodities.Oil basically we assume unchanged at around $115 per barrelBut see further moderate increases in iron ore / coal / steel.

Rural Commodities Non Rural Commodities

0

100

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500

600

SQ 1996 SQ 1998 SQ 2000 SQ 2002 SQ 2004 SQ 2006 SQ 2008 SQ 2010

Non-rural Base Metals Energy Carbon SteelUS$ Index

Source: ABARE, Datastream, NAB Group Economics0

50

100

150

200

250

SQ 1996

DQ 1997

MQ 1999

JQ 20

00SQ 20

01DQ 20

02MQ 20

04JQ

2005

SQ 2006

DQ 2007

MQ 2009

Dairy Beef WoolWheat Cotton Sugar

US$ Index

23

AUD / USD Model: Model wants around 90c (+/- 5c). Hence current lows probably an overshoot. But unlikely to recovery until global outlook more certain. We see AUD moving down to around 77c by early 2009 before recovering to mid 80c

Model driven by:Commodities;

USD / EURO – as a measure of USD weakness

Long run rates;

Relative unemployment;

Stk break for late1990s (around 13c).

Relative Equity Mkts

Model AUD and Forecasts v Actuals

0.4

0.5

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1

Feb-

85

Feb-

86

Feb-

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Feb-

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Feb-

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Feb-

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Feb-

99

Feb-

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Feb-

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Feb-

10

ACTUALPlus 1 std errorLess 1 std error

24

AUSTRALIA

25

Clearly global developments and rates have hurt confidence a good deal. Actual business outcomes slowing very sharply from May. Slowing faster than any time since early 1990s and already at 2001 lows

I n d e x

B u s i n e s s C o n f i d e n c e & C o n d i t i o n s

Sep-

90M

ar-9

1Se

p-91

Mar

-92

Sep-

92M

ar-9

3Se

p-93

Mar

-94

Sep-

94M

ar-9

5Se

p-95

Mar

-96

Sep-

96M

ar-9

7Se

p-97

Mar

-98

Sep-

98M

ar-9

9Se

p-99

Mar

-00

Sep-

00M

ar-0

1Se

p-01

Mar

-02

Sep-

02M

ar-0

3Se

p-03

Mar

-04

Sep-

04M

ar-0

5Se

p-05

Mar

-06

Sep-

06M

ar-0

7Se

p-07

Mar

-08

Sep

07N

ov 0

7Ja

n 08

Mar

08

May

08

Jul 0

8

-40-35-30-25-20-15-10

-505

10152025303540

-40-35-30-25-20-15-10-50510152025303540

C o n d i t i o n s

S e a s o n a l l y a d j u s t e d b y N a bI n d e x

C o n f i d e n c e

Q u a r t e r l y : S e p 9 0 t o J u n 2 0 0 8 M o n t h l y :A u g 0 7 t o A u g 0 8

• At least in August some stabilisation – but not broadly based

26

By sector all sectors fell except mining – which has started to recover after surprisingly weak numbers. Other sectors all still falling – especially wholesaling, transport, and finance business & property services.

B u s i n e s s C o n d i t i o n s b y I n d u s t r y

Nov

-05

Feb-

06

May

-06

Aug

-06

Nov

-06

Feb-

07

May

-07

Aug

-07

Nov

07

Feb

08

May

08

Aug

08

-10

0

10

20

30

40

50

Trans & UtilMining

Fin Bus & PropRec&Pers

I n d e x I n d e xM o n t h l y , S e a s o n a l l y A d j u s t e d 3 m o n t h M o v i n g A v e r a g e *

Nov

-05

Feb-

06

May

-06

Aug

-06

Nov

-06

Feb-

07

May

-07

Aug

-07

Nov

07

Feb

08

May

08

Aug

08

-10

0

10

20

30

40

50

MfgConstruction

RetailWholesale

27

What the Survey means is that since the accounts demand has slowed much more. To around 1¼ % annualised (or around 0.3% in the quarter). And non farm GDP is now around 2%.

-6

-4

-2

0

2

4

6

8

10

Mar

-90

Mar

-91

Mar

-92

Mar

-93

Mar

-94

Mar

-95

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

-6

-4

-2

0

2

4

6

8

10DOMESTIC DEMANDNAB

Domestic Demand 6mth Annualised v NAB Conditions (Change & Level)

-4

-2

0

2

4

6

8

10

Mar

-90

Mar

-91

Mar

-92

Mar

-93

Mar

-94

Mar

-95

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

-4

-2

0

2

4

6

8

10

NF-GDPNAB Business Conditions

Non Farm GDP 6 Mthly Annualised v NAB Conditions (Level & Change)

28

We also know that business does not see any sign of recovery in the December quarter. And that forward orders are still falling.

Index

Business Conditions Quarterly & Monthly, Seasonally Adjusted

Index

Mar

-00

Sep-

00

Mar

-01

Sep-

01

Mar

-02

Sep-

02

Mar

-03

Sep-

03

Mar

-04

Sep-

04

Mar

-05

Sep-

05

Mar

-06

Sep-

06

Mar

-07

Sep-

07

Mar

08

Sep-

08

-15

-10

-5

0

5

10

15

20

25

-10

-5

0

5

10

15

20

25

30

35

Quarterly Expectations RHS

Monthly Actuals LHS

Monthly Trend LHS

Index

New Forward Orders

Aug

-99

Aug

-00

Aug

-01

Aug

-02

Aug

-03

Aug

-04

Aug

-05

Aug

-06

Aug

-07

Aug

08

-15

-10

-5

0

5

10

15

-15

-10

-5

0

5

10

15Monthly - SA & TrendIndex

* Seasonally adjusted by NAB

Trend

Seasonally adjusted*

Average

29

And that reflects on confidence and especially outcomes by region. NSW a real concern. That is after falling in June quarter, Sept quarter looks worse. SA confidence looks to have deteriorated sharply recently.

Business Confidence by State

-20

-15

-10

-5

0

5

10

15

20

Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08

Inde

x, s

a 3m

ma

WAQueenslandAustraliaSAVictoriaNSW

Business Conditions

-10

-5

0

5

10

15

20

25

30

35

40

Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08

Inde

x, s

a 3m

ma

WA Victoria AustraliaSA Queensland NSW

30

Consumption OutlookKey drivers of model are incomes (employment /wages) wealth effects from house prices

(indirectly interest rates) and equity prices. RBA past rate rises and lower equities will hurt . Model points to downside risks in the next 12 months – despite rate adjustments.

Assume flat equity markets in 2008 and 6% in 2009

House prices overall slow to around zero%

Rate cuts another 1 % by mid 2009

Real Consumption - Annual Growth

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Dec

-88

Dec

-89

Dec

-90

Dec

-91

Dec

-92

Dec

-93

Dec

-94

Dec

-95

Dec

-96

Dec

-97

Dec

-98

Dec

-99

Dec

-00

Dec

-01

Dec

-02

Dec

-03

Dec

-04

Dec

-05

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%Model lhsActual plus f

Forecasts

Model

31

House Prices very important to consumption. Australian house prices models work well (incomes, population & rates). We expect growth rates going forward will slow back to around 0% but very different by state.

NATIONAL HOUSE PRICES: MODEL AND FORECASTS (to Dec'10)

-20%

-10%

0%

10%

20%

30%

40%

50%

Mar

-83

Mar

-84

Mar

-85

Mar

-86

Mar

-87

Mar

-88

Mar

-89

Mar

-90

Mar

-91

Mar

-92

Mar

-93

Mar

-94

Mar

-95

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

NO

MIN

AL

YOY

%

ACTUAL

MODEL

MODEL +1SE

MODEL-1SE

(F)

32

And its worth noting that relative to population Australia is inundersupply in housing starts (NSW even more so). But weaker economy means housing construction will struggle until 2010.

Dwelling Investment Growth Cycle

-35

-25

-15

-5

5

15

25

35

Mar-88

Mar-89

Mar-90

Mar-91

Mar-92

Mar-93

Mar-94

Mar-95

Mar-96

Mar-97

Mar-98

Mar-99

Mar-00

Mar-01

Mar-02

Mar-03

Mar-04

Mar-05

Mar-06

Mar-07

Mar-08

Mar-09

Mar-10

-35

-25

-15

-5

5

15

25

35

Quarterly 12 MTH TO

Private Dwelling Approvals To Population - Aust v NSW

0.0008

0.0013

0.0018

0.0023

0.0028

0.0033

Sep-

84

Sep-

85

Sep-

86

Sep-

87

Sep-

88

Sep-

89

Sep-

90

Sep-

91

Sep-

92

Sep-

93

Sep-

94

Sep-

95

Sep-

96

Sep-

97

Sep-

98

Sep-

99

Sep-

00

Sep-

01

Sep-

02

Sep-

03

Sep-

04

Sep-

05

Sep-

06

Sep-

07

0.0005

0.001

0.0015

0.002

0.0025

0.003

NSW

33

However need to keep a balanced viewAnd not all things have downside potential

In particular Australia better placed than most to weather storms:– Australian financial system still strong– Tax cuts are still coming– Higher than expected commodity price rises (around $40b)– Farm sector bounce– And there is lots of policy flexibility re rates and government

spending

34

Forecasts see growth slowing from 4% to 2 ½% in 2008 and even slower 2¼% in 2009. Even lower for non farm GDPLonger term recovery in 2010 as global growth picks up & rate cuts work

R ea l O u tp u t & D o m estic D em an d - 1 2 M th s to %

-2 %

-1 %

0 %

1 %

2 %

3 %

4 %

5 %

6 %

7 %

8 %

Mar

-90

Mar

-91

Mar

-92

Mar

-93

Mar

-94

Mar

-95

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

D o m estic D em an d N o n -fa rm G D P G D P

S ou rce s : A B S & N A B E co n om ics

35

And ex Farm and Mining the GDP forecasts are for growth in 2009 of only around 1%.

A n n u a l C h a n g e in G D P v E x F a rm & R e s o u rc e S e c to rs

-2 %

-1 %

0 %

1 %

2 %

3 %

4 %

5 %

6 %

Dec

-86

Dec

-87

Dec

-88

Dec

-89

Dec

-90

Dec

-91

Dec

-92

Dec

-93

Dec

-94

Dec

-95

Dec

-96

Dec

-97

Dec

-98

Dec

-99

Dec

-00

Dec

-01

Dec

-02

Dec

-03

Dec

-04

Dec

-05

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

a v e ra g e a n n u a l % g e c h a n g e

G D P -R H S

G D P e x R e s - R H S

36

And that means employment growth will slow dramatically (around ¾ % over the next year and unemployment will move up in 2009 noticeably– to around 6 % by late 2009.

A u stra lian L ab o u r M arke t

-0 .5 %

0 .0 %

0 .5 %

1 .0 %

1 .5 %

2 .0 %

2 .5 %

3 .0 %

3 .5 %

4 .0 %

4 .5 %

Mar

-96

Dec

-96

Sep

-97

Jun-

98

Mar

-99

Dec

-99

Sep

-00

Jun-

01

Mar

-02

Dec

-02

Sep

-03

Jun-

04

Mar

-05

Dec

-05

Sep

-06

Jun-

07

Mar

-08

Dec

-08

Sep

-09

Jun-

10

% c

hang

e - 1

2 m

onth

s to

3 .5

4 .0

4 .5

5 .0

5 .5

6 .0

6 .5

7 .0

7 .5

8 .0

8 .5

% -

rate

E M P L O Y M E N T - L H S U N E M P L O Y M E N T R A T E - R H S

37

Wages reasonably well behaved. A key near term driver now is increasing purchase costs. In turn driven by oil, shortages in mining and food. That is also causing a profit squeeze

Annual -%

C osts & P ricesA

ug-9

9

Feb-

00

Aug

-00

Feb-

01

Aug

-01

Feb-

02

Aug

-02

Feb-

03

Aug

-03

Feb-

04

Aug

-04

Feb-

05

Aug

-05

Feb-

06

Aug

-06

Feb-

07

Aug

-07

Feb

08

Aug

08

0

1

2

3

4

5

6

0

1

2

3

4

5

6

La bour costs

R eta i l pr i c es

Annual -%

Purchase costs

12 M onths ended, original data

E conom y-w ide p rices

38

Near term outlook for inflation still very highCore CPI higher than expected – and not much improvement till 2009.

Inflation momentum higher than we all expected – and clearly going higher given oil / food prices.We see Financial sector treatment as biasing the CPI up (around ¾ %)But we see core inflation rising to 4 ½% & remaining around 4 % in late 2008And not back into range till late 2009.RBA More pessimistic

Inflation (CPI) - Nab's Headline & Core v RBA Forecast & Target Through the year percentage change

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Jun-02

Dec-02

Jun-03

Dec-03

Jun-04

Dec-04

Jun-05

Dec-05

Jun-06

Dec-06

Jun-07

Dec-07

Jun-08

Dec-08

Jun-09

Dec-09

Jun-10

Dec-10

Core CPICore CPI RBAHeadline CPI

RBA Target

39

On short term interest rates dynamics…RBA more worried about demand risks in 2009 than inflation

Now that the RBA has started we see the timing and extent of each adjustment down as being heavily dependent on the data flow. However fundamental we still see the RBA as reaching the same spot by mid 2009 as previously expected. That is:– We still see the RBA as cutting at least once more before end 2008 – with at

this stage the most likely timing still being October; and

– By mid 2009 the RBA will have the official cash rate back to at least 6 per cent (i.e. 100 points of easing over the next year);

These adjustments would bring policy settings back to a more neutral, but still a firm policy stance

40

On short term interest rates dynamics…RBA more worried about demand risks in 2009 than inflation

Whether more is needed or not will depend on a number of considerations:

– Banks funding costs reflect both RBA actions and the state of financial markets. To the extent that banks do not fully pass on RBA cuts due to deteriorating credit markets, the RBA would be more aggressive; and

– The extent of the current slowing in demand and inflation. For example, a Taylor rule perspective – based on NAB’s demand and inflation forecasts -points to the possible need to lower rates more aggressively than we have currently forecast.

41

A Taylor’s Rule Perspective. More aggressive cuts could be in order

Taylor’s rule - a formula that implies a cash rate given inflation and growth outcomes vis a vis the central banks views of the relevant target.

Our forecasts for GDP and inflation point to the scope for even more cuts than we are forecasting

Australian Cash Rate

0

2

4

6

8

10

12

14

16

18

20

Sep-

85Se

p-86

Sep-

87Se

p-88

Sep-

89Se

p-90

Sep-

91Se

p-92

Sep-

93Se

p-94

Sep-

95Se

p-96

Sep-

97Se

p-98

Sep-

99Se

p-00

Sep-

01Se

p-02

Sep-

03Se

p-04

Sep-

05Se

p-06

Sep-

07Se

p-08

Sep-

09Se

p-10

%

0

2

4

6

8

10

12

14

16

18

20

Cash - actual + forecasts

Cash - Taylor's rule gdp

Cash - Taylor's rule dd

42

Financial markets: Summary

Economy to slow significantlyRBA to cut– 25 before Xmas at least– Another 75 pts before mid 2009 (cash at 6%)– Risks to growth and rates down

Long bonds broadly unchanged at around 6% – following global developments– Again some limited downside risks if cash rates fall below our expectations

Currency has over corrected but no recovery soon– Risks that AUD/USD goes to 77c by early next year– Recovery not this risks of global hard landing seen as overblown– AUD into mid 80c by late 2009

43

WHAT IF….

44

Another way to check our forecasts is to look at reduced form models of Australia

Our Australian reduced form model drives off: farm GDP – as a drought proxy - yield curves, commodity prices in AUD, the ASX, house prices and USA GDP – with each variable having its own estimated lag structure).

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

Mar

-88

Mar

-89

Mar

-90

Mar

-91

Mar

-92

Mar

-93

Mar

-94

Mar

-95

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Quarterly GDP & Forecasts MODEL

Quarterly GDP and Reduced Form Model

45

But what happens if get US recession not dissimilar to 1980s. That is US growth falls by around 2% in 2009 (rather than grows around ¾ %). We get something worse than 2000 but not quite as bad as 1990s.

Clearly hurts a lot and the message really is - “how bad the US”

Model suggestsHit really is 2009/10With big spill over to

equities, house & commodity prices

Takes all of the 2% off growth in 2009

RBA in rate cutting mode – down to 4% or lower

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

Mar

-88

Mar

-89

Mar

-90

Mar

-91

Mar

-92

Mar

-93

Mar

-94

Mar

-95

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Quarterly GDP & Forecasts

MODEL

Model with US Recession

Quarterly GDP and Reduced Form Model