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Global Research

Macro Australian Economics

Australias immunity to be tested

Data published this month will be critical
Financial market volatility is grinding down local confidence Effect on activity is not clear, but downside risks are rising This months confidence, employment and CPI indicators will be critical for assessing the RBAs next move

Just how immune?

A cold we can deal with, but pneumonia is another thing altogether. As we have highlighted recently, Australia is not entirely immune to the global woes (see Asian Economics Quarterly: Will Asia Crack, 6 October). This months confidence, employment and CPI indicators will be critical for assessing the level of immunity and the RBAs next move. Recall that in early August the RBA was on the cusp of raising interest rates to deal with Australias prospective inflation problems. Faced with a mining boom, weak productivity growth and rising inflation the RBA had been hawkish all year. Things have changed. This week the RBA have given us their first signal that they would now consider moving rates in the other direction. The intense period of financial market volatility over the past couple of months with as yet no definitive resolution is the clear catalyst. As we have been saying for some time, in order to cut rates the RBA would need to credibly revise down underlying inflation forecasts (published in early August) from above the target band, at 3.25%, to the lower half of the target band, below 2.50%. This is a high hurdle. But the longer financial market volatility persists, the more it grinds down confidence, and the more likely it is that economic activity slows and inflation comes down. RBA rhetoric has shifted from concern about the medium-term outlook for inflation to suggesting the path for inflation may now be more consistent with the 23 per cent target in 2012 and 2013. But more evidence is needed to see outright cuts. Key indicators to watch will be the labour market survey for September, out next week, and 3Q CPI, due on 26 October. Confidence surveys out next week are also important. A rise in the unemployment rate from its current 5.3% to 5.5% (or higher) would open the door for a rate cut. Combine it with a reading on the trimmed mean inflation measure that was in, or below, the target band and we could see the RBA willing to pull the trigger. Neither is our central forecast, so we still see the RBA on hold this year. We expect unemployment to be broadly steady and underlying inflation to print above the band. But these data are notoriously hard to forecast and critical indicators for the RBAs next move. Here we set out some views on recent indicators of employment, inflation and confidence.

7 October 2011
Paul Bloxham Economist HSBC Bank Australia Limited +612 435 966 522 paulbloxham@hsbc.com.au View HSBC Global Research at: http://www.research.hsbc.com

Issuer of report:

HSBC Bank Australia Limited

Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

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Are we at a labour market turning point? (Sept data next week)

The unemployment rate ticked up in July and August
% 67

but other labour market indicators are less bearish

% 8

Labour Force
Participation Rate (LHS)

66

Employment has fallen modestly for the past two months and the unemployment rate has also ticked up, from 4.9% in June to 5.3% in August. We expect it to hold steady in September, though this measure is fiendishly hard to forecast. At the same time, there has been an increase in hours worked, suggesting there is plenty of work to be done; businesses just seem uncertain about taking on new workers. This could be the sort of behaviour brought on by significant financial concerns. There were other anomalies in the employment survey: the rise was mostly driven by Queensland, which could reflect the lagged effect of the floods; and, there is some question about the seasonality of the data.

65

64

63 Unemployment Rate (RHS) 62 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: Datastream

Job advertisements held up well in August

% 3.0 2.5 2.0 1.5 1.0 Unemployment rate (inverted, RHS) 0.5 0.0 2003 2005 2007 2009 2011 6.0 6.5 Job Advertisements (% of labour force, LHS)

September reading is due next week

% 3.5 4.0 4.5 5.0 5.5

Job Advertisements

There are a number of timely partial indicators of labour market for Australia which are coincident indicators of conditions. Job advertisements are a fairly reliable and smooth indicator of labour market conditions. Indeed, as the chart to the left shows, they are smoother than the unemployment rate. When job advertisements fall decisively, they provide a strong signal that conditions have weakened. In the past few months, they have levelled out, but not fallen.

Source: Datastream; ANZ Bank

Other indicators are stronger than the unemployment rate

Employment question in business conditions survey
30 20 10 0 -10 -20 -30 1997 2000 2003 2006 2009 30 20 10 0 -10 -20 -30

a very different signal from that in late 2008, so far There are a host of other timely measures of labour market conditions in Australia, including a count of unemployment benefit recipients, the official quarterly measure of vacancy rates and a range of business surveys. Most of these indicators are more positive than the unemployment rate. The NAB monthly business conditions survey has a component on employment (shown left), which was sitting around its average in August and is still well above the levels reached in late 2008. We get the September reading next week. Job vacancies rose in 3Q and unemployment benefits have held broadly steady.

Source: Datastream; National Australia Bank

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Inflation is expected to be elevated (3Q print on 26 October)

Seasonal reanalysis lowered underlying inflation
%ye 5 New* 4 4

but reweighting of index is upside risk for future prints

%ye 5

Underlying inflation

The statistics bureau has taken over the seasonal analysis of the RBAs preferred measures of underlying inflation, and deemed that more of the components are seasonal than previously thought. This has seen revisions to the trimmed mean and weighted median measures of inflation the RBAs favourites. The average of these two measures is now running closer to the middle of the target band than previously (2.55% vs. 2.70%). But, as a part of the regular re-benchmarking of the CPI they have also increased the weight of housing, health and household services all items that have been running ahead of average recently.

3 Old* 2 RBA target band 1

0 2002 2004 2006 2008 2010

*Average of trimmed mean and weighted median

Source: ABS; RBA

We still expect inflation to be elevated

% 6 5 4 3 2 1 0 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 *Trimmed Mean Quarterly Year-ended

which would make the RBA reluctant to cut rates There are a number of supply-side factors that are expected to continue to see inflation rise in 2H. Electricity prices have been increasing solidly due to lack of distributive capacity, which is expected to see persistent inflation. Water prices have also been rising, which is putting upward pressure on inflation. Housing rents have been growing above the middle of the target band, due to relatively low vacancy rates. Rising unit labour costs, due to increasing wages and weak productivity growth, have put upward pressure on services prices (now carrying a higher weight than before). Global inflation has been rising and the recent depreciation of the exchange rate will see further upward pressure.

Inflation*

Source: ABS; RBA; HSBC

View on unemployment impacts the inflation outlook

Lower unemployment drives higher inflation
5 4 3 2 1 0 3 4 5 6 7 8 9 Unemployment rate (%) 10 11 12

if unemployment stays above 5%, it will reduce inflation Estimates of the natural rate of unemployment in Australia vary through time, particularly as the nature of the industrial relations environment changes. Given recent policy changes and weak productivity growth it seems that unemployment below 5% is quite clearly unsustainable. Recent history suggests, however, that when the unemployment rate falls below 5% it tends to put upward pressure on inflation. The recent rise to above 5% will see less upward pressure on inflation from the labour market. The more it rises, the more downward pressure is applied.

Source: ABS

Inflation (%, 4Q advanced)

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Financial woes weaken sentiment (more prints next week)

Consumer sentiment low but buying conditions positive
Consumer Survey Questions
Long run average = 100

RBA have been highlighting a focus on buying conditions Consumer sentiment has weakened over recent months as households have seen large declines in their equity portfolios, and have received a continued battering from negative global financial news. Sentiment bounced back in September, as the negative news was offset by the expectation that the RBA would not be lifting interest rates this year, due to the financial market woes. October reading is due next week. The RBA have focused less on sentiment in recent months and more on the question about buying conditions, which has held up much better than it did in 2008. Households may be unhappy but they are still cashed up and happy to spend. RBA have recently highlighted that household unemployment expectations are a watch point, as they have risen.

150 Consumer sentiment 125

150

125

100

100

75

Good time to buy a household item

75

50 2000 2002 2004 2006 2008 2010

50

Source: Datastream; Westpac-Melbourne Institute

Business conditions average but confidence has fallen

NAB Business Survey
105 90 75 60 45 30 15 0 -15 -30 -45 1997 2000 2003 2006 2009 30 15 0 -15 -30

spectre of 2008 has risen, with local businesses worried Being a small open economy Australia is highly tied into global developments and business surveys have begun to reflect concern about the global financial woes. Business conditions in August were a little below average. Across industries there has been significant divergence, with most industries still positive. Those exposed to mining have been positive, while those that are exchange rate exposed have been less so. Retail has been very weak, reflecting that households are spending more on non-retail items. Confidence has fallen sharply, though remains well above levels reached in late 2008. Confidence is more fickle than conditions and, while generally interpreted as a leading indicator, its lead is weak. September reading next week.

Conditions

Confidence

-45 -60 -75 -90 -105 -120

Source: Datastream; National Australia Bank

Dont forget the mining boom

USD per tonne 200

spot traded commodities have fallen but bulks have not Spot traded commodities have fallen sharply in recent weeks on the back of global financial woes, but as yet, commodities that traded largely on a contract basis are still holding firm. Australias largest exports are iron ore and coal, which are largely traded on contract. Prices in spot markets for these commodities a timely guide to current prices have come down a little in recent weeks, but are still at very high levels. Spot traded commodities can often be unduly influenced by speculative flows and the general global risk environment, rather than supply and demand dynamics for the deliverable commodity. Bulk commodities are less susceptible to these bouts of emotion.

Iron Ore Spot Price

160

120

80

40

0 Dec 2008 Jun 2009 Dec 2009 Jun 2010 Dec 2010 Jun 2011

Source: Bloomberg

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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Paul Bloxham

Important Disclosures
This document has been prepared and is being distributed by the Research Department of HSBC and is intended solely for the clients of HSBC and is not for publication to other persons, whether through the press or by other means. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy the securities or other investment products mentioned in it and/or to participate in any trading strategy. Advice in this document is general and should not be construed as personal advice, given it has been prepared without taking account of the objectives, financial situation or needs of any particular investor. Accordingly, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to their objectives, financial situation and needs. If necessary, seek professional investment and tax advice. Certain investment products mentioned in this document may not be eligible for sale in some states or countries, and they may not be suitable for all types of investors. Investors should consult with their HSBC representative regarding the suitability of the investment products mentioned in this document and take into account their specific investment objectives, financial situation or particular needs before making a commitment to purchase investment products. The value of and the income produced by the investment products mentioned in this document may fluctuate, so that an investor may get back less than originally invested. Certain high-volatility investments can be subject to sudden and large falls in value that could equal or exceed the amount invested. Value and income from investment products may be adversely affected by exchange rates, interest rates, or other factors. Past performance of a particular investment product is not indicative of future results. Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues. For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research. * HSBC Legal Entities are listed in the Disclaimer below.

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