14 January Quarterly Economic Report January 2015

Transcription

1 14 January 215 Summary Global monetary policy remains easy with China reducing its overnight cash rate, Europe entering into non-standard monetary policy, Japan stepping up its quantitative easing program and the US currently on hold at extremely low rates. However, the US Fed is beginning to stir with increased discussion regarding the possibility of lifting interest rates some time in 215. The sharp drop in oil prices in recent months of over 5% will have significant implications for the world. It should provide a boost to global economic growth, and increase the purchasing power of households. This quarter s special feature article assesses the outlook for oil. Global bond yields remain low by historical standards and, as yet, there are few signs of emerging inflation. Lower oil prices combined with subdued wage growth is restraining both inflation and consumer spending across the major economies. There remain concerns for the global economy, including Japan re-entering recession and a stalling of growth in Europe. Worries about Greece have also resurfaced, including the possibility of Greece exiting the euro. Meanwhile, the US has continued to diverge from other advanced economies, where the outlook remains relatively more positive. This divergence is being reflected in currency markets, driving the US dollar to multi-year highs against major currencies. Australian economic growth in the September quarter was disappointing, and was below trend. The transition from mining investment to other areas of the economy remains uneven. A lack of income growth, weighed down by the falling terms of trade due to lower commodity prices is a concern. While near-term risks remain, a further lift in residential construction activity, modest growth in consumer spending and a gradual pickup in non-mining investment remain in prospect. We expect the Reserve Bank will leave rates on hold for all of this calendar year. We believe that the economy will not deteriorate significantly enough for the RBA to cut rates again. But the slow pace of recovery is likely to prevent the RBA from raising rates this year. The Australian dollar has depreciated in recent months and hit a five-year low of 8.33 US cents on 8 January. Much of this depreciation is due to US dollar strength, as the possibility of Fed rate hikes this year grows. Speculation among some market participants of a possible rate cut by the RBA this year has also kept the AUD under pressure together with weaker commodity prices and a softer terms of trade. This quarter s feature article is entitled The Outlook for Crude Oil. 1

2 Contents Special Feature Article 3-8 Crude Oil Outlook Australian Economic Data 9-12 Gross Domestic Product Consumer Prices Labour Force Building Approvals Retail Sales Trade Balance Consumer Sentiment Private Sector Credit Housing Finance Private Capital Expenditure Current Account Company Profits Wage Price Index ABS House Prices Business Confidence & Conditions New Motor Vehicle Sales Interest Rate Markets 13 Central Bank Outlook Bond Yields Currency Markets 14 Australian Dollar Global Currencies Commodity & Share Markets 15 Oil Gold & Base Metals Domestic Equities International Equities Major Upcoming Data 16 Forecasts 16 Contact Listing 17 2

3 Special Feature Article The Outlook for Crude Oil One of the major movers in the past few months has been the price of crude oil. The price of West Texas Intermediate (WTI) cushing crude oil has tumbled 57.2% from its 214 peak of $17.62 a barrel recorded on 23 July to a near 6-year low of US$46.7 a barrel on 12 January 215. It has been a similar story for the price of oil according to the Brent quote. 15 World Oil Price (West Texas Intermediate in US$, Weekly) Jan-5 7-Jan-8 7-Jan-11 7-Jan-14 Weaker global demand, an oversupply and the growth in shale-oil production has conspired to drive the price of oil lower. Financial flows are also having an impact; oil prices have a strong negative correlation with the US dollar. The US dollar has been trending higher since the middle of last year, driven by expectations that the US Federal Reserve will start raising rates this year. Demand Table 1: Oil Consumption (million barrels per day, mbpd) Region (f) 216 (f) Americas Europe Pacific OECD CIS China Other Asia Latin America Middle East Africa Non-OECD Europe Total Non-OECD Overall Total Year-on-Year % Change 1.% 1.4%.9% 1.4% 1.6% Source: International Energy Agency (IEA) 3

4 The world currently consumes about 92.6 million barrels per day of liquid fuels, not all of which are made from crude oil. About 17% of the world's total fuel supply comes from natural gas liquids and biofuels. The world economy has been growing below trend, causing oil demand to be less than otherwise would be the case. Oil demand in some key economies, like the European Union, has been particularly sluggish. It reflects the weak economic conditions in the euro zone economy. Many key economies, notably Japan and the European Union (EU), are also facing a structural decline in their oil usage. The EU, for instance, has agreed upon an ambitious emissions-reduction plan, aiming to cut emissions by 4% by 23 from 199 levels. Along with a shrunken regional refining sector, the stringent environmental restrictions will curtail oil use for transport and power generation. Japan's oil consumption will be hit by economic uncertainty as the government's reform policies cause swings in consumption by households and businesses. A cut in demand is also imminent in the medium term as the government begins to bring some nuclear power facilities back on line from 215. Late last year, the International Energy Agency (IEA) cut its forecast for global oil demand for 215. Please refer to table 1. However, the IEA still expects an increase in demand this year compared with last year. Economies like the US and China should see demand grow this year, helping to underpin a lift in demand this calendar year. Supply Table 2: Oil Production (million barrels per day, mbpd) Region or Cartel (f) 216 (f) OPEC OECD Latin America Asia Africa Others Non-OPEC Processing Gains Overall Total Year-on-Year % Change 2.5%.4% 2.2% 2.1% 1.6% Source: International Energy Agency (IEA) and The Economist Intelligence Unit Table 3: Oil Supply and Demand (million barrels per day, mbpd) (f) 216 (f) Production Consumption Balance Stocks 2,663 2,566 2,696 2,847 3,321 Stocks to Consumption Ratio Source: International Energy Agency (IEA) and The Economist Intelligence Unit There is an oversupply of oil on world markets. The oil market was oversupplied by approximately 7, million barrels per day in 214 and the oversupply is estimated to rise to 1.5 million barrels per day this year. The oversupply reflects demand fundamentals, OPEC s reluctance to cut production and greater output from shale-oil investments. 4

5 Shale Oil and Gas Producers Another key contributor to the fall in the price of oil has been the US shale revolution. Over the past four years, the price of oil has averaged above US$9 a barrel. At such a high price for oil, extracting oil from shale formations, via fracking, became a viable strategy. Fracking is where a mixture of water, sand and chemicals is injected into shale formations to release oil. IHS, a research firm, estimates the cost of a typical project has fallen from US$7 to US$57 per barrel produced in 214, as oilmen have learned how to drill wells faster and to extract more oil from each well. US-based fracking has caused a revolution in worldwide energy supplies. Due to the US fracking boom, world oil supply has lifted. North American shale production has accounted for almost all of net global supply growth since 25. Much of the US shale gas boom is credited to the Marcellus shale formation that stretches across West Virginia, Pennsylvania and New York. The Marcellus now supplies 385 million cubic metres of gas per day, more than enough for half the gas currently burnt in US power plants. Three other shale plays supply a substantial portion of the rest: the Barnett in Texas, the Fayetteville in Arkansas and the Haynesville straddling the Louisiana-Texas border. Together they produce two-thirds of current US shale-gas output. The US shale oil and gas industry has grown rapidly. According to The Economist, drilling has seen around 2, new oil wells completed since 21 (ten times the tally in Saudi Arabia) and boosted America s oil production by a third, to nearly 9 million barrels a day. This amount is just 1 million barrels per day shy of Saudi Arabia s output. OPEC versus the Shale Producers The oil price slide quickened after 27 November 214 when OPEC decided to keep its production target unchanged (rather than cut production to try to push up the oil price). At this scheduled meeting, Saudi Arabia, the largest global exporter, made it clear that it would not unilaterally take on the burden of balancing markets, and, with the support of its allies in the Gulf Arab states, faced down calls from Venezuela, Libya and others to bring down the production target. A commonly held belief is that Saudi Arabia is resisting calls to cut production in order to curb the rapid growth of production from US shale oil plays. Fracking is an expensive business. Depending on the structure of the site, companies usually need the world price of oil to be US$6-1 a barrel to break even. The cost of drilling is also going up as deposits become less accessible. With prices now below this range, investments in this sector look vulnerable. The large fracking companies may be able to sustain losses in the short term, but this is not the case for smaller and overstretched (i.e. highly indebted) companies. Saudi Arabia s tactics might also reflect its longer memory. Back in the 197s, a hike in the oil price spurred huge investments in new fields, leading to an oil glut that lasted a decade. This time round Saudi Arabia may well be allowing the price to fall so that high-cost producers are pushed out of business. This strategy, if successful, may eventually reduce supply, causing the price of oil to rise again. Indeed, some analysts believe that an oil shortage could reappear as soon as 216 if oil prices remain under US$6 a barrel for six months this year. 5

6 Saudi Arabia may also be trying to protect its position as the world s biggest supplier of oil. The IEA Chief Economist, in his 213 annual outlook, predicted that by around 22 the US would become the world s largest global oil producer due to the boom in fracking. By allowing the oil price to fall, Saudi Arabia and the rest of OPEC will drive out some of the US shale oil producers. There are anecdotes and signs that some high-cost shale producers are already suffering. Many of these producers are overstretched, carrying huge levels of debt. Moody s Investors Service recently estimated that, should prices remain below US$6 a barrel for a significant period of time, companies in North America will slash capital spending by up to 4%. Most of the lost revenue will hit the exploration and production (E&P) companies' bottom line, which will reduce cash flow available for re-investment. As spending in the E&P sector diminishes, oilfield services companies and midstream operators will begin to feel the stress. Before the Christmas holidays, the number of rigs drilling for oil across the US had already fallen by 7% since early October 214, according to the oilfield services company Baker Hughes. However, Moody's believes that major oil companies are in a stronger position to weather the financial storm caused by lower prices because they have already trimmed their capital expenditure for 215. While the number of shale-oil producers is likely to fall in the short term, the shale industry is still likely to survive and prosper in the long run. The official charter of OPEC states that the organisation s goal is the stabilisation of prices in international oil markets. Recent actions by OPEC suggest its goal has shifted from defending prices to defending market share, leading to a tussle between OPEC and the shale producers. There might be some disagreements inside OPEC over production targets with Libya, Venezuela and Iran on one side and Saudi Arabia and its Gulf allies on the other. However, it is important to note that OPEC members rarely adhere to official OPEC targets. Therefore, we cannot rule out members producing above or below their designated quota. With heavy state subsidies and infrastructure investment programmes underway, even the Gulf oil producers cannot survive low prices indefinitely. Further, Saudi Arabia may have difficulty maintaining production at over 1 million barrels per day for an extended period. Almost all of the world's discretionary spare capacity resides in Saudi Arabia and amounts to an estimated 2 million barrels per day. If we do swing to a supply shortage, Saudi Arabia may find itself in the position of needing to run the taps full out for much of 216. In such an event, the world will see much higher oil prices potentially above US$1 a barrel. Impact on World Economic Growth The lower price of oil provides a boost to world economic growth. The International Monetary Fund s (IMF) Chief Economist, Olivier Blanchard, recently estimated that GDP in 215 could be boosted by.3-.7% above the IMF s baseline world growth forecast of 3.8% (made in October 214). Large importers of oil, notably Japan, India and Europe, will particularly benefit from lower oil import bills. However, Japan and Europe have become more efficient users of oil in recent years. The United States no longer imports as much oil as it once did. Nevertheless, the weaker oil price will also still benefit the US economy. 6

7 Blanchard also acknowledged that there was an increased risk of global financial instability, but viewed these risks as limited because serious currency damage was only likely to be inflicted on a few oil-exporting countries including Nigeria, Venezuela and Russia. Among these oil-exporting countries, a notable loser has been Russia. The Russian economy has also suffered due to sanctions. The Russian rouble has depreciated sharply in response to weaker oil prices. Since early June 214, when the price of oil started tumbling, the RUB has depreciated about 81% against the USD, despite efforts by Russian authorities to halt its decline. Lower oil prices will also put further downward pressure on inflation rates in many major economies. Most major economies already have low rates of annual inflation. Lower inflation, other things being equal, suggests monetary policy may be looser than otherwise would be the case. For example, in Europe, the case is building for the European Central Bank (ECB) to do more on the policy front and adopt a full-blown quantitative easing program that involves the purchase of sovereign bonds. The euro zone annual inflation rate is low and falling and policy makers are concerned about the possibility of deflation. The US Federal Reserve, on the other hand, might be able to wait a little longer before it starts raising its interest rates. For financial markets, there are also some fears that an extended period of prices at current low levels could cause many fracking operators to default on an estimated US$2 billion of borrowings, raised mainly through bonds. Such a default could have adverse ripple effects through financial markets. Forecasts Table 4: Major Oil Price Declines Based on Monthly Closing Prices of WTI Change in Price Between Peak & Trough No. Months Between Peak and Trough in Price Date of Peak in Oil Price Date of Trough in the Oil Price Price at Peak Price at Trough Main Trigger 31-Oct Jul-86 $3.4 $ % 9 Saudi Oversupply 28-Sep-9 28-Feb-91 $39.6 $ % 5 Gulf War 31-Dec-96 3-Nov-98 $25.92 $ % 23 Asian Crisis 3-Nov- 3-Nov-1 $33.82 $ % 12 Recession 3-Jun-8 3-Jan-9 $14. $ % 7 Global Financial Crisis 3-Jun Jan-15 $15.37 $ % 6* Oversupply Average of first 5 episodes: -56.9% 1.3 * As at 13 January 215, but the decline in the oil price might not yet have concluded. Recent data shows that consensus forecasts have reset to much lower levels. Most forecasters have the low in the oil price set in the US$45-55 per barrel range. With the price still falling, it is difficult to predict a floor. Looking at history might provide a guide. Examining the table, the average decline in the previous five episodes of major declines in the price of oil, was 56.9%. The current price decline remains only slightly smaller than this, suggesting there could only be limited further downside in store, if history is a guide. We can also consider the balance of risks. With crude oil prices having more than halved since June 214, the balance of risk has possibly shifted from further falls towards a rise in prices in the future. 7

8 In terms of variability in the oil price, it is possible that the tussle between the traditional oil producers and the shale-oil producers will reduce the variability the oil prices. Lower volatility in the oil price is better news for the world economy. This of course assumes the absence of geopolitical tensions and wars in the Middle East that have historically contributed to volatility. Besa Deda, Chief Economist Ph:

9 Recent Australian Economic Data Gross Domestic Product Consumer Price Index 8 % Gross Domestic Product % 8 6 Consumer Prices (annual % change) Y/Y Headline CPI Underlying CPI Q/Q GDP in real terms expanded by.3% in the September quarter, well below consensus forecasts for growth of.7%. On a year ago, GDP growth was 2.7%, unchanged from the June quarter. Growth was narrowly focussed or lopsided across sectors and regions. It was mostly driven by net exports. Household consumption made a modest contribution. The big drag on growth was business investment. Government spending and inventories also weighed on growth in the quarter. Incomes were weak. GDP in nominal terms is the income measure of economic activity and it fell by.1% in Q3. It was the first decline in just over five years and was driven by falling commodity prices pushing the terms of trade lower. Labour Force RBA 2-3% pa Inflation Target Band 1 Mar-2 Mar-5 Mar-8 Mar-11 Mar-14 Headline inflation rose by.5% in the September quarter. A large rise a year earlier dropped out of the annual calculations, helping the annual rate drop from 3.% in Q2 to 2.3% in Q3. It is the lowest annual headline rate in one year. The underlying rate, which is the focus of policymakers rose by.5% in the September quarter. The annual rate stepped down from 2.7% to 2.55%. It was also the lowest annual rate in one year. The repeal of the carbon price is likely to have had a significant impact on the Q3 inflation figures, chiefly through a direct effect on utility bills. Across different groups, elevated price pressures can be largely attributed to one-off impacts or structural factors, suggesting soft domestic demand is keeping a lid on prices in most areas. Price pressures in housing are the exception. Building Approvals Unemployment Rate (per cent) Jobs grew by 42,7 in November the biggest monthly jobs expansion since March 212. The unemployment rate rose to a 12-year high of 6.3% with a rise in the participation rate preventing a fall in the jobless rate. Most of the jobs were created in the part-time sector, a trend that has been in place in recent months. Morover, the underemployment rate rose to 8.6%, the highest rate since the survey began in Both hint at some excess capacity in the jobs market. The number of residential building approvals surged 7.6% to an all-time in November. In the two months to November, approvals rose 19.9%, the strongest back-to-back rise since September 212. Much of the increase was driven by multidwelling developments such as apartments and townhouses. But approvals for private sector houses are not far from the peak struck in this cycle. The growth in approvals indicates that housing construction will continue to strengthen. 9

10 Retail Sales Trade Balance Retailing grew by.1% in November, following healthy gains in the two months to October. The renewed pessimism among consumers in recent months, according to consumer sentiment surveys, could have moderated household spending in the lead up to Christmas. There remain ongoing risks from low levels of consumer confidence and subdued income growth, which could temper retail spending. Annual growth slipped from 5.7% in October to 5.% in November, the weakest pace in six months. However, the annual pace of growth remains well above the long-run average of 4.3%. Anecdotes suggest that retail sales through most of December were modest but a turnaround came in the week before Christmas. These reports in addition to low interest rates and the upswing in housing suggest that moderate growth in consumer spending is in prospect. Consumer Sentiment Australia s trade deficit widened slightly from $877bn in October to $925bn in November, but due to revisions to past data, Australia s trade deficit now fell below $1bn for two consecutive months. The large revision and better-thanexpected trade position suggests exports have been quite resilient despite falling commodity prices. However, smaller deficits are also partly due to weaker imports, and indicate weakness in domestic demand. Declining mining investment will further weigh on imports. Additionally, the depreciation in the Australian dollar should continue to help prop up exports and limit import demand. However, weakness in commodity prices suggests that a surplus could remain out of reach over the near term. Private Sector Credit 13 Consumer Sentiment Index 3 Private Sector Credit (By Component, Annual % Change) Housing 85 Source: Melb Institute & Westpac 7 Jan- Jan-3 Jan-6 Jan-9 Jan-12 Jan-15 Consumer confidence levels remain a threat to the outlook for spending. The Westpac-Melbourne Institute index fell 5.7% to 91.1 in December the lowest level since August 211. A reading under the 1 level means the pessimists outweigh the optimists. The survey was undertaken over 1-7 December, a period that included the release of the weakerthan-expected GDP result for Q3. Business Other Personal -1 Jan-3 Jan-7 Jan-11 Jan-15 Credit growth in the private sector grew by.5% in November. The annual rate was at 3.% at its trough in the middle of 213 and has now risen to 5.9%, the fastest pace in nearly six years. Despite the pickup, the pace of growth remains well under the long-run average. Growth in housing credit, particularly for investors, continued to be the key source of strength. Investor housing credit grew by.8% in November and lifted to 1.% on a year ago, the strongest annual growth rate in just over 6½ years. 1

11 Housing Finance Capital Expenditure 2 Housing Finance (By value, $ billions) Owner Occupier $bn 2 Capital Expenditure (actual and planned) Estimated for Investor 8 4 Actual 4 Jan-3 Jan-6 Jan-9 Jan-12 Jan-15 Owner-occupier demand lost further ground in November with the number of owner-occupier loans declining.7%. However, if the refinancing of loans is excluded, the number of new owner-occupier loans fell.8%, following a 1.3% decline in October. For the year to November, the number of new owner occupier (i.e. excluding refinancing) loans fell 5.5%, its weakest annual pace in nearly four years. Investor housing loans fell for the first time in six months, during November, possibly in response to rising house and unit prices. The value of investor loans fell 2.2% in the month, but was still up 13.% on a year earlier. The annual pace, while still firm, is well down on the 2% plus growth rates seen during 213 and most of 214. The proportion of investor housing remained high at 4.4%, only marginally down on the record level of 41.% reported in September 214. Current Account 98/99 1/2 4/5 7/8 1/11 13/14 Private business spending rose.2% in the September quarter, following an upwardly revised 1.6% rise in the June quarter. The back-to-back positive growth over the last two quarters is encouraging, given the accelerating decline in mining investment. Mining investment grew at its weakest annual pace in 14 years. We are slowly seeing an improvement in the non-mining sectors of the economy, which is helping to offset the decline in mining investment, and suggests that animal spirits may be building as the RBA hopes. Growth in non-mining has been driven by the other selected industries category like services, which rose 5.5% in Q3, and 12.% in the year. It was the strongest annual growth in six years. Capital spending plans over were upgraded, and imply a less pronounced decline in investment spending than indicated in the previous release. Company Profits $bn 1 Current Account Balance 6 % Company Profits % 6 Goods & Services Current Account Primary Income 3 15 annual % change quarterly % change The current account deficit narrowed to $12.5bn in the September quarter, a $1.4bn improvement on the deficit in the June quarter. The goods and services deficit narrowed for the quarter, but it remains far from the surplus recorded in the March quarter. Falling commodity prices have continued to weigh on export values and have offset stronger export volumes in the quarter Mar-98 Mar-2 Mar-6 Mar-1 Mar-14 Mar-18 Gross company operating profits rose.5% in the September quarter, but fell 3.4% on a year earlier. Given that profits from the mining sector account for almost 3% of the total, the outcome could have been a lot worse. Profits in the nonmining sector rose 2.9% in the quarter and up 2.4% over the same quarter last year. Company profits in the mining sector fell 5.% in the Q3, as better output volumes were swamped by lower prices. 11

12 Wage Price Index Residential Property Prices q/q % y/y % Quarterly % Change (lhs) Wage Price Index Annual % Change (rhs) Wages grew at just.6% in the September quarter. Annual growth remained steady at the lowest on record since the series began in 1997, at 2.6% in the year to the September quarter. The recent rise in the unemployment rate suggests wages growth will remain subdued for some time. Further, the unemployment rate is unlikely to fall substantially in the near-term, and this will continue to keep a lid on wage growth. The subdued pace of wages suggests that domestic inflationary pressures will remain well-contained, and confirms that the RBA can keep official interest rates at their current low levels for some time. Business Confidence & Conditions 1 Growth in dwelling prices has continued to moderate, according to CoreLogic-RP Data. The capital city average rose.9% in December, but annual growth slowed to 7.9%, the weakest in over a year. We expect further moderate growth in the period ahead. A flood of new residential buildings should help keep a lid on house price growth. Additionally, affordability constraints and less attractive rental yields for investment may start to deter some buyers. Nonetheless, low interest rates and firm population growth should continue to support demand. New Motor Vehicle Sales 4 Australian Business Conditions & Confidence, Monthly 1 New Motor Vehicle Sales (monthly seasonally adjusted data, in 's) 2 Confidence Index 9 8 Conditions Index -2 7 Source: NAB -4 Jan-3 Jan-7 Jan-11 Jan-15 Business conditions fell to 5.4 in November, after a spike to 12.6 in October. Despite the drop, the overall trend is still looking much better than months prior and levels of capacity utilisation have continued to improve. Firms uncertainty over the outlook for their industries was reflected in a further erosion of business confidence. Business confidence fell from 4.5 in October to 1.2 in November. Confidence levels vary greatly across industries. Services have been replaced with construction as the most optimistic. Source: ABS 6 Jan-6 Jan-8 Jan-1 Jan-12 Jan-14 Jan-16 Sales of new motor vehicles slipped back for a second month in a row. Sales fell.6% in November following a 1.8% decline in October. Over the year to November, sales of new motor vehicles are down 3.8%. While these have been relatively sluggish outcomes, sales remain relatively elevated following very strong growth in

13 Interest Rate Markets Central Bank Outlook The Federal Reserve brought its quantitative easing program to an end in late October. Investors are now focused on the timing of the first interest rate hike from the Fed. Markets expect the first US rate hike to occur in June 215. June 215 has been our long-held view. The steady improvement in the US economy means this remains a reasonable expectation. The European Central Bank (ECB) left its interest rate structure unchanged during the December quarter but began its nonstandard monetary measures. The ECB began purchasing covered bonds and asset-backed securities. It has yet to move into the realm of purchasing sovereign bonds, but such a move is being widely anticipated and debated. The ECB intends its new asset purchase programme to run for two years. The combination of low, and in some cases negative, interest rates with the asset purchase programme is aimed at unblocking lending in the euro zone. The Reserve Bank of Australia (RBA) kept the official cash rate on hold at a record low of 2.5%. It has been on hold since August 213. Following its December meeting, the RBA once again signalled that the most prudent course is likely to be a period of stability in interest rates. There has been speculation that the RBA may reduce the cash rate in 215. We disagree. The next move in the cash rate is likely to be a hike in Q Official rates have risen in NZ and they seem likely to rise in the UK and the US during 215. China reduced its official interest rates in November 214. Global 2 Year Bond Yields Bond yields across the world mostly fell over the past 3½ months in response to expectations that monetary policy will remain stimulatory for some time. Concerns about the global growth outlook and expectations of low inflation, reinforced by the sharp fall in oil prices, further kept bond yields low. Short-term yields in the US were the exception, as the Federal Reserve set the groundwork for its first rate hike mid this year. Yields on 2-year US treasury notes lifted 1 basis points over the December quarter to.67%, although yields have fallen since the turn of the year. In Australia, further signs of a patchy economy and calls by some market participants for the RBA to cut rates again also pressured yields locally. Yields on 1-year Australian bonds hit a new record low on 13 January of 2.6%. 13

14 Currency Markets Australian Dollar $US 1.2 Index AUD/USD (lhs) TWI (rhs) Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 6 The Australian dollar continued to slide during the December quarter. Prices for iron ore and coal, Australia s major exports, both fell further and, also during the quarter, the US Fed ceased its bond-buying (quantitative easing) program. Adding to the downward pressure on the AUD was growing speculation that the Fed will hike this year and the possibility of cuts to the RBA cash rate. The RBA continued to express its view, and the view of many in the market, that the AUD was still trading well above its fundamantal value based predominantly on commodity prices and the terms of trade. Preventing a more substantial fall in the AUD has been Australia s relative high cash rate by global standards and Australia s AAA credit rating. We expect further AUD weakness in the face of a stronger USD with the expectation that by the end of the year the AUD will stand at US 75 cents. US economic growth is gathering pace with its economy creating jobs and its unemployment rate falling. Members of the US Fed are openly discussing their views on the possibility of lifting the Fed Funds rate. We expect that they will begin to lift rates in June. In the December quarter, the AUD fell 6.5% against the USD. It was down 2.5% against EUR, 3.6% against the GBP, 3.1% against the JPY and fell 6.4% against NZD. Against the NZD, the AUD fell to a record low of on January 7. Our currency forecasts can be found on page 16. Global Currencies $US GBP/USD (lhs) Yen USD/JPY (rhs) EUR/USD (lhs) Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 7 The December quarter and the first half of January has been marked by a further rise in the USD. The USD appreciated as its economy picked up, its quantitative easing program was brought to an end and as the prospect of higher US interest rates in 215 loomed large. At the same time, the ECB began its own non-standard monetary measures by purchasing asset backed bonds, pushing demand down for the EUR. It is widely expected the ECB will also move towards the purchasing of sovereign bonds over time. These moves come as the euro zone struggles to re-establish economic growth. During Q4 214, the USD rose 4.2% against the EUR, 9.2% against the JPY,.4% against the GBP and 4.1% against the CHF. The USD index rose 5.%. 14

15 Commodity Markets Oil Gold & Base Metals WTI oil prices plummeted 41.6% in the December quarter and have fallen further in early 215 to a near six-year low of US$46.7 a barrel on 12 January. Concerns over excess supply and soft demand are factors behind the plunge in prices. The substantial fall in prices will be a boost to household incomes and supportive of global growth. However, the fall in prices will not benefit everyone. Please see this quarter s special article on oil for more information. Share Markets Australia The price of gold slipped 1.7% in the December quarter, but recouped those losses in the new year. While expectations of a rate hike by the Fed and limited inflationary pressures are continuing to keep gold prices under pressure, a flight to safety and the prospect of QE from the ECB is helping to prop up demand. Other commodity prices, including the prices of copper and iron ore have weakened, weighed down by ample global supply, the property downturn in China and a stronger US dollar. International Markets Australian share prices were volatile, but the S&P/ASX2 managed to gain 2.2% in the December quarter, tracking international equity markets. However, the Australian index underperformed stock indices overseas, as falling commodity prices weighed on mining stocks. For 214, the Australian market eked out a 1.1% gain. In early January 215, the Australian share market is slightly lower than where it ended 214. A surprise decision to provide additional monetary stimulus by the Bank of Japan and the possibility of more to come by the ECB continued to be supportive of equity markets around the world. Further evidence of an improving US economy also supported stocks. However, falling oil prices resulted in some unease among investors, particularly for energy stocks around the world. The Nikkei rose 7.9% in the December quarter, the FTSE1 slipped.9% and the S&P5 rose 4.4%. 15

16 Major Upcoming Data and Events Australian Data / Events Underlined January 27 th Aust NAB Business Survey Dec 15 th Aust Labour Force Dec 27 th US Durable Good Orders Dec 15 th US Producer Prices Dec 27 th US New Home Sales Dec 16 th US UoM Consumer Confidence Jan 28 th Aust CPI Q4 19 th China Industrial Production Dec 28 th US FOMC Rate Decision 19 th China GDP Q4 29 th Aust Trade Price Indices Q4 19 th China Retail Sales Dec 3 th Aust Producer Prices Q4 21 st US Housing Starts 3 th Aust Private Sector Credit Dec 22 nd China Flash HSBC Mfg PMI Jan 3th US GDP Q4 Forecasts February 1 st China Mfg PMI Jan 2nd Aust RPData House Prices Jan 2 nd US ISM Mfg Index Dec 2 nd China HSBC Mfg PMI Jan 3rd Aust International Trade Balance Dec 3rd Aust Building Approvals Dec 3rd Aust RBA Cash Rate Decision 3 rd China Non Mfg PMI Jan End Period: Q3 Q4 Q1 (f) Q2 (f) Q3 (f) Q4 (f) Q1 (f) Q2 (f) Interest Rates: RBA Cash Rate, % Day BBSW, % Year Bond, % Year Bond, % USD Exchange Rates: AUD-USD USD-JPY EUR-USD GBP-USD USD-CHF USD-CAD NZD-USD USD-CNY USD-SGD AUD Exchange Rates: AUD-USD AUD-EUR AUD-JPY AUD-GBP AUD-CHF AUD-CAD AUD-NZD AUD-SGD * Note that the AUD cross exchange rates have been rounded (f) 214 (f) 215 (f) 216 (f) GDP, % CPI (Headline), % CPI (Underlying), %

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