Global Economic Overview. - Global Financial Instability & Outlook - Green shoots or weeds? - Ramifications for Australia

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1 Global Economic Overview - Global Financial Instability & Outlook - Green shoots or weeds? - Ramifications for Australia Alan Oster - Group Chief Economist 1

2 Apr-2 Jan-3 Oct-3 Jul-4 Apr-5 Jan-6 Oct-6 Jul-7 Apr-8 Jan-9 And it can t be over emphasised what a dramatic collapse there was in global confidence, production and activity in late 28. As we move into mid 29 the rate of fall has clearly moderated and nearly stabilised Purchasing managers index (LHS axis) Global Industrial output and PMI Business survey results Industrial output year on year % change (RHS) Industrial output 3mma % change (RHS) Global Industrial production stabilising at around -15% And PMI surveys of manufacturing by July back around 48.5 albeit not yet at the 5 break even line

3 Jun-7 Sep-7 Dec-7 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 If look at what is happening now rather than 12 mths to %, which includes a lot of history then, can see we are getting very close to a bottom. 8 Monthly Change in Industrial Production % US UK JAPAN GERM ANY FRANCE Italy 3

4 Another feature of the data is that business has become much more optimistic about the future than what is happening now Business survey balance statistics - US, UK, Germany and France Expected business conditions Current business conditions Jan- Jan-1 Jan-2 Jan-3 Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 4

5 1/1/9 1/2/9 1/3/9 1/4/9 1/5/9 1/6/9 1/7/9 1/8/9 Jan-9 Jan-9 Feb-9 Mar-9 Apr-9 May-9 Jun-9 Jul-9 Having gone from fear of Armageddon in February to Green shoots fever in July in equity markets Commodity markets are currently reassessing.a touch mixed Global Equity Markets Since 1 January 29 CHINA Japan all India US S&P UK Aust CRB Reuters Indexes of Commodity Prices CRB 4 12 INDUSTRIALS GRAINS LIVESTOCK & MEAT ENERGY PRECIOUS METALS SOFT AGR

6 Clearly financial markets have settled down a lot and equity market volatility has moved back to more normal levels 9 Share prices index of volatility VIX index /1/7 1/7/7 1/1/8 1/7/8 1/1/9 1/7/9 6

7 Feb-85 Feb-86 Feb-87 Feb-88 Feb-89 Feb-9 Feb-91 Feb-92 Feb-93 Feb-94 Feb-95 Feb-96 Feb-97 Feb-98 Feb-99 Feb- Feb-1 Feb-2 Feb-3 Feb-4 Feb-5 Feb-6 Feb-7 Feb-8 Feb-9 Feb-1 As have currency markets Key driver is commodities and hence a proxy for global growth AUD / USD was over sold during fear of global collapse We see currency around 85c rising to around 9c in late Model AUD and Forecasts v Actuals ACTUAL Plus 1 std error Less 1 std error Model driven by: Commodities; USD / EURO as a measure of USD weakness Long run rates; Relative unemployment;.5.4 Stk break for late199s (around 13c). Relative Equity Mkts 7

8 What the market is now doing is recognising that growth isn t here yet and wondering whether it got ahead of itself in 2 key areas.. Key areas of concern are What will happen to profits in the next 6 months. And here we clearly haven t seen the full impact of events late last year and into 28 And the labour market much further to go. And the extent of capacity that has been lost or currently remains idle 8

9 1/1/7 1/4/7 1/7/7 1/1/7 1/1/8 1/4/8 1/7/8 1/1/8 1/1/9 1/4/9 Dec-97 Dec-98 Dec-99 Dec- Dec-1 Dec-2 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 In the US there are signs of a stabilisation in house prices: And in manufacturing surveys suggest some recent return to growth from awful levels, but broader economy wide surveys still falling a touch US House Prices- FFHA Manufacturing and Economy wide Surveys - ISM 2.5 US House Prices - 3 & 12 Mths to % - Seasonally Adjusted Federal Finance Housing Agency 8 8 US Quarterly Growth Annualised and Manufacturing / Total ISM 1.5 Monthly change % LHS 12 Mths to % RHS TREND ANNUALISED GDP MAN ISM TOTAL ISM

10 In the USA while Q2 GDP was as expected history was revised down a lot and consumption weakened in Q2 The recession just got worse US GDP Annual % ch. 6 1 Consumer weakened ppts Contributions to GDP 4 2 Previous estimate Mar-9 Jun-9-4 New estimate -2 Consump Housing Investment Inventories Public Net exports GDP 1

11 What our mini model highlights is that based on what has already happened in markets and policy US GDP should be stabilising. But still small falls till late 29 and then very moderate in 21 (13/4 %) US Quarterly GDP v Nab Mini Model ACTUAL / FORECASTS Interest rate/ Los Model Model based on - real rates - house prices - equity markets - oil prices - currency - credit crunch -2 Jun-92 Dec-92 Jun-93 Dec-93 Jun-94 Dec-94 Jun-95 Dec-95 Jun-96 Dec-96 Jun-97 Dec-97 Jun-98 Dec-98 Jun-99 Dec-99 Jun- Dec- Jun-1 Dec-1 Jun-2 Dec-2 Jun-3 Dec-3 Jun-4 Dec-4 Jun-5 Dec-5 Jun-6 Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Models don t expect+ ve growth till late 29 11

12 Mar- Mar-1 Mar-2 Mar-3 Mar-4 Mar-5 Mar-6 Mar-7 Mar-8 Mar-9 Mar-99 Sep-99 Mar- Sep- Mar-1 Sep-1 Mar-2 Sep-2 Mar-3 Sep-3 Mar-4 Sep-4 Mar-5 Sep-5 Mar-6 Sep-6 Mar-7 Sep-7 Mar-8 Sep-8 Mar-9 In China latest GDP estimates a surprise strong growth in H2 29. Survey s also show growth in local construction, real estate and manufacturing Chinese GDP suggest a kick to growth in early Chinese GDP - Quarterly and 12 mth to % (on SA And business feeling better CHINA Business Climate Index RETAIL / WHOLESALE REAL ESTATE 1.5 Quarterly GDP - LHS 12 Mths to % - RHS 6 11 AGGREGRATE INDEX MANUFACTURING. 8 12

13 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan- Jul- Jan-1 Jul-1 Jan-2 Jul-2 Jan-3 Jul-3 Jan-4 Jul-4 Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Apr-98 Jan-99 Oct-99 Jul- Apr-1 Jan-2 Oct-2 Jul-3 Apr-4 Jan-5 Oct-5 Jul-6 Apr-7 Jan-8 Oct-8 Jul-9 But very much locally driven. Exports still terrible. Policy very much driving growth fiscal and credit Chinese Exports still very weak Credit expansion massive Chinese Exports FOB - 12 Mths to % Financial Insitutions : Loan Growth 12 Mths to %

14 On China: We are expecting growth of only 8% in 29 but only on the back of large fiscal and credit packages. Policy has worked so far And back to around 9% in 21. But ok only if world recovers. Results very much driven by the large government stimulus (16% of GDP) Much lower GDP growth could cause social disruption already 2m left the cities in late 29 due to unemployment We are now forecasting growth in 29 of 8% and 9% in 21 But stimulus ramping up near term growth, then fades a touch CHINESE GDP GROWTH - AND FORECASTS TO 21 Annual Average 12 Mth % FORECASTS Dec-99 Dec-2 Dec-5 Dec-8

15 But on green shoots.. For most really more that the rate of slowing may be moderating China more promising and possibly Australia However overall even a slowing is indicative that we may be nearing a turning point baring any further financial problems Don t under-estimate the stimulus both in terms of the fiscal packages and monetary policy (and expansion of central bank balance sheets especially in USA, UK and a lesser extent Europe) 15

16 Globally we see GDP falling 1 ½ % in 29. Largely history but... China is helping Asia but Europe still terrible IMF ANNUAL GROWTH TOTALS WEIGHTS GDP US GDP JAPAN EURO GDP UK GDP nonjap asia latin america china canada India Africa CIS E Europe Middle East Other advanced GLOBAL TOTAL

17 Key reasons why global recovery will be moderate.. In the near term unemployment will keep rising until trend growth returns (late 21 ) Anglo Saxons will be more wary of gearing and de-leverage Bank will also put great emphasis on risk ( maintaining capital strength more important than market share) Monetary authorities will want to get settings back to more normal levels (starting in late 21) Fiscal repair needs to start probably a 2111 story 17

18 18 AUSTRALIA

19 Dec-84 Dec-85 Dec-86 Dec-87 Dec-88 Dec-89 Dec-9 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec- Dec-1 Dec-2 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Latest accounts (surprisingly) showed moderate growth in March quarter. Need to be careful as three real drivers : Consumers helped by cash drops: Massive drop in imports (reflecting falling investment) and some growth in exports 2.5% Real Output/Expenditure (GDP) - Quarterly Quarterly GDP 4 per. Mov. Avg. (Quarterly GDP) 2.% 1.5% 1.%.5%.% -.5% -1.% 19

20 Dec-84 Jun-86 Dec-87 Jun-89 Dec-9 Jun-92 Dec-93 Jun-95 Dec-96 Jun-98 Dec-99 Jun-1 Dec-2 Jun-4 Dec-5 Jun-7 Dec-8 Very sceptical about Q1 estimates Domestic demand fell quite sharply. And the various measures of GDP are more different than any time since Domestic demand v GDP (Quarterly %) Gap between measures of GDP 3.% 2.5% 2.% Quarterly GDP Domestic Demand 3.% 2.5% 2.% 1.5% 1.5% 1.% 1.%.5%.5%.%.% -.5% -.5% -1.% -1.% -1.5% -1.5% -2.% -2.% 2

21 Business confidence fell to levels lower than the bottom of the 199 recession in early 29. Now improving significantly and in July was back to cyclical average levels (& best since mid 27) Business Confidence 3 Index Monthly Index Trend (SA) 1 1 Average recession level Seasonally adjusted* Jun-99 Dec-99 Jun- Dec- Jun-1 Dec-1 Jun-2 Dec-2 Jun-3 Dec-3 Jun-4 Dec-4 Jun-5 Dec-5 Jun-6 Dec-6 Jun-7 Dec 7 Jun 8 Dec-8 Jun 9 * Seasonally adjusted by NAB 21

22 Business activity held up better than confidence during the crisis. But kept slowing till May Big jump in activity in June that was broadly maintained in July Index 3 Business Conditions Monthly Index Average -1 Trend (SA) -1-2 Seasonally adjusted* s Recession level -3-4 Jun-99 Dec-99 Jun- Dec- Jun-1 Dec-1 Jun-2 Dec-2 Jun-3 Dec-3 Jun-4 Dec-4 Jun-5 Dec-5 Jun-6 Dec-6 Jun-7 Dec 7 Jun 8 Dec-8 Jun 9 * Seasonally adjusted by NAB 22

23 Dec-89 Dec-9 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec- Dec-1 Dec-2 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Encouragingly forward orders also improved. And overall survey points to actual underlying growth in Q2 (around ½%. Q3 started even stronger. If maintained implies growth near 1% Index 15 New Forward Orders Monthly Index 15 Forward Orders (Change & Level) As an Indicator of Domestic Demand - 6 Mthly Annualised % in Demand 1 5 Trend Average Seasonally adjusted* DEMAND 6Mthly Annualised Forward Orders Jun- Jun-1 Jun-2 Jun-3 Jun-4 Jun-5 Jun-6 * Seasonally adjusted by NAB Jun-7 Jun 8 Jun 9 23

24 While encouraging there were some specials in the results in June and signs of a switch in growth drivers Overall suggests that the momentum won t be sustained. Key drivers in June Govt cash drops in May The investment allowance on car retailing First home owners on construction Very encouraging but. In July retail / wholesale down and transport flat Manufacturing & construction up Infrastructure & schools etc Index July-6 Oct-6 Jan-7 Apr-7 Jul-7 Oct 7 Mfg Construction Business Conditions by Industry Monthly, Seasonally Adjusted 3 month Moving Average* Jan 8 Apr 8 Jul 8 Oct 8 Retail Wholesale Jan-9 Apr- 9 Jul 9 Jul-6 Oct-6 Jan-7 Apr-7 Jul-7 Oct 7 Trans & Util Mining Jan 8 Apr 8 Jul 8 Oct 8 Jan-9 Fin Bus & Prop Rec&Pers Index Apr-9 Jul

25 25 Who do bankers like

26 26 And don t

27 Capacity utilisation stabilising but still a lot of demand is being met by stocks Utilisation rate % 85 Capacity Utilisation Seasonally adjusted & trend Index 2 Stocks Monthly Index Trend 1 5 Average Seasonally adjusted* -5-1 Trend (SA) Seasonally adjusted* Jun-99 Jun- Jun Recession Jun-2 Jun-3 Jun-4 Jun-5 Jun-6 * Seasonally adjusted by NAB Jun-7 Jun 8 Jun Jul-99 Jan- Jul- Jan-1 Jul-1 Jan-2 Jul-2 Jan-3 Jul-3 Jan-4 Jul-4 Jan-5 Jul-5 Jan-6 * Seasonally adjusted by NAB Jul-6 Jan-7 Jul7 Jan 8 Jul 8 Jan-9 Jul

28 Business investment off lows.. And longer term intentions better but still at very low levels (i.e. around early 199 levels). Index 5 Capital Expenditure: Monthly, Quarterly & Annual Original Index 5 4 Annual Expe ctations - RHS Jun '7 to Jul ' Monthly Trend - LHS 2 1 Qtrly Acutal - LHS 1-1 Qtrly Expectations - LHS Monthly - LHS Dec-9 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec- Dec-1 Dec-2 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Jul-7 Nov-7 Mar-8 Jul-8 Nov-8 Mar-9 Jul-9 28

29 % of firms Credit demand is slowing. Overall 35% of business don t want credit. Availability of credit not much changed and good compared to offshore. Demand for credit not supply the main issue. 6 5 Availability of Finance Constraint December January February March April May June July NET DIFFICULTY Significantly more difficult Slightly more difficult No Change Slightly easier Significantly easier No Borrowings reqd 29

30 On the labour market we see much reduced shedding of labour in our surveys. And a big move to reduce hours and lower full time /part time shift. Good for unemployment but still involves less income. Index 2 Employment Monthly Index 2 Hours Worked - By Industry Trend (SA) Average Seasonally adjusted* 199s Recession level -2-3 Jul-99 Jan- Average hours per week Mining Construction Mfg Transport, Storage & Utilities Australia Wholesale Finance, Business & Property Retail Rec & Pers Services Jul- Jan-1 Jul-1 Jan-2 Jul-2 Jan-3 Jul-3 Jan-4 Jul-4 Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul7 Jan 8 Jul 8 Jan- 9 Jul 9 38 Dec-6 Mar-7 Jun-7 Sep-7 Dec-7 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 38 * Seasonally adjusted by NAB 3

31 31 And so far hours worked has taken a bigger hit than employees compared to past cycles. Good but. That still hurts incomes

32 Consumption Outlook Key drivers of model: incomes (employment /wages) wealth effects (houses and equity). Model says wealth destruction dwarfs income effects Going forward wealth has improved but incomes set to fall Dec-88 Dec-89 Dec-9 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec- Dec-1 Dec-2 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 6. Real Consumption - Annual Growth Forecasts 6% Assume equity markets broadly unchanged in 29 H2 then up around 8% per annum % 2% House prices overall to fall between 5-7% over the next months Model lhs Actual plus f Model % -2% -4% Rates at 3 % till early 21 then up The impact of the cash splashes in late 28 and 29 evident in gap re model and outcomes. 32

33 % oya Key drivers of housing not just debt. Going forward the critical driver will be unemployment. Key drivers of housing are Population Interest Rates Incomes The state of the dwelling cycle Unemployment But not uniform across States Income distribution - Already first home owner scheme has seen demand and prices rise at bottom end of the market Sep- 87 Sep- 88 Sep- 89 Sep- 9 Sep- 91 Sep- 92 Australian House Prices - 12 Mth % Sep- 93 Sep- 94 Sep- 95 Sep- 96 Sep- 97 Sep- 98 Sep- 99 Actual Model Sep- Sep- 1 Sep- 2 Sep- 3 Sep- 4 Sep- 5 Sep- 6 Sep- 7 Sep- 8 Sep- Sep % 45% 4% 35% 3% 25% 2% 15% 1% 5% % -5% -1% -15% 33 We expect house prices to fall by around 5-7 per cent over the next year in response to rising unemployment

34 Our own data tends to show that house price moves have been larger at the bottom than the top. With the FHOB more important than rates. Think this also true for construction activity NAB Monthly Housing Approval Data - Mvt in property values by decile Jul-9 Jan-9 Jul-8 Jan-8 Percentile 12 mth mvt 12 mth mvt 1% 215, +7.5% 25, +3.7% 2, 197,78 2% 275, +5.8% 265, +6.% 26, 25, 3% 32, +3.2% 31, +3.3% 31, 3, 4% 36, +2.9% 35, +2.9% 35, 34, 5% 4, +.% 397, +4.5% 4, 38, 6% 45, +.% 45, +5.2% 45, 427,824 7% 52, -1.% 5, +1.6% 525, 492,329 8% 62, -3.9% 65, +2.5% 645, 59, 9% 84, -3.2% 8, +.% 868, 8, No. approvals 2,585 13,741 15,791 18,968 34

35 Jun-9 Jun-91 Jun-92 Jun-93 Jun-94 Jun-95 Jun-96 Jun-97 Jun-98 Jun-99 Jun- Jun-1 Jun-2 Jun-3 Jun-4 Jun-5 Jun-6 Jun-7 Jun-8 Jun-9 Jun-1 oya And as noted earlier nothing suggests business investment will do other than go backwards by around 2%. Certainly past behaviour dictates this type of response 35 Underlying Business Investment - Actual v Model Forecasts 35% 3 3% Model Actual plus f 25% 2% 15% 1% 5% % -5% -1% -15% -2% -3-25% 35

36 Sep-96 Sep-97 Sep-98 Sep-99 Sep- Sep-1 Sep-2 Sep-3 Sep-4 Sep-5 Sep-6 Sep-7 Sep-8 Sep-9 Sep-1 Mar-89 Mar-91 Mar-93 Mar-95 Mar-97 Mar-99 Mar-1 Mar-3 Mar-5 Mar-7 Mar-9 Index of Export to Import Prices Certainly terms of trade falls will hurt income flows and wealth destruction in households is important. Australia's Terms of Trade Annual Change in Household Wealth Y/Y % Average to Terms of trade will hurt but still not disaster re levels Source: ABS, &, NAB Economics 36

37 Mar-87 Dec-87 Sep-88 Jun-89 Mar-9 Dec-9 Sep-91 Jun-92 Mar-93 Dec-93 Sep-94 Jun-95 Mar-96 Dec-96 Sep-97 Jun-98 Mar-99 Dec-99 Sep- Jun-1 Mar-2 Dec-2 Sep-3 Jun-4 Mar-5 Dec-5 Sep-6 Jun-7 Mar-8 Dec-8 Sep-9 Jun-1 To date exports have held up better than past relationships would have suggested. Element may be Chinese stocking but we still see a slowing from here 25% Export Volumes - Actual v Model Year ended % Change 25 Real exports Al model 2% 2 15% 15 1% 1 5% 5 % -5% -5-1% -1 37

38 Dec-86 Dec-87 Dec-88 Dec-89 Dec-9 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec- Dec-1 Dec-2 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Annual % change Important to differential the private and public sector outlook Overall we expect private activity to continue to fall especially in H2 29 7% 4% Domestic Demand - Private & Public 7% 4% The offset will be public demand which is expected to accelerate to around 5 ½% 2% -1% -4% -6% Underlying Public Demand Private Demand 2% -1% -4% -6% 38

39 199/ / / / / / / / / / 2/1 21/2 22/3 23/4 24/5 25/6 26/7 27/8 28/9 29/1 21/11 211/12 Change (% of GDP) Level 2/1 =1 Looking at the Budget from the policy viewpoint (Structural Surplus deficit) Structural Deficit / Surplus - Annual Movement % of GDP and Implied Balance Change - LHS Deficit Level of Structural Surplus / Deficit Surplus Biggest policy response in recent history And sharp movement into deficit But nothing after 21/11. 39

40 Balance sheet of Govt still very strong relatively But would have preferred not to put policy on auto pilot in medium term % of GDP Government Net Financial Liabilities Japan Govt s Balance sheet not the problem Note: OECD/IMF estimates/forecasts for General Government Sectors. Govt forecasts for Australia. Australia United States UK Germany But Govt really not doing more than relying on a strong economy to eventually gets back to surplus in 215/16!! Could well need a stronger policy reaction later down the line 4

41 Dec-84 Dec-85 Dec-86 Dec-87 Dec-88 Dec-89 Dec-9 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec- Dec-1 Dec-2 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 For 29 we now see GDP flat in 29 with a weaker second half. 9. And up 1.2% in 21. That is a U shaped recovery not a V. 2.5% 2.% 1.5% 1.%.5%.% Real Output/Expenditure (GDP) - Quarterly Quarterly GDP 4 per. Mov. Avg. (Quarterly GDP) GDP marginally negative out to late 29 No return to reasonable growth till 21 And not really trend growth till % -1.% GDP (fiscal years) + 1% in 28/9 zero % in 29/1 41

42 Dec-85 Sep-86 Jun-87 Mar-88 Dec-88 Sep-89 Jun-9 Mar-91 Dec-91 Sep-92 Jun-93 Mar-94 Dec-94 Sep-95 Jun-96 Mar-97 Dec-97 Sep-98 Jun-99 Mar- Dec- Sep-1 Jun-2 Mar-3 Dec-3 Sep-4 Jun-5 Mar-6 Dec-6 Sep-7 Jun-8 Mar-9 Dec-9 Sep-1 % change - 12 months to % - rate And that means employment growth will deteriorate further We now expect unemployment to peak at around 7 ¼ % Australian Labour Market 5% 4% 3% 2% 1% % -1% -2% EMPLOYMENT - LHS UNEMPLOYMENT RATE - RHS -3%

43 Clear that inflation will be moving down significantly in out period Already wages and purchase cost are slowing sharply. Retail prices less so. But end of next year will see inflation at bottom or below targets Nab Survey data on wage/ prices Annual -% 8 7 Costs & Prices 12 Months ended, original data Annual -% Purchase costs Inflation outlook RBA & Nab Inflation (CPI) - Nab's Headline & Core v RBA Forecast & Target Through the year percentage change Labour costs RBA Target 3 Economy-wide prices Jun- Dec- Jun-1 Dec-1 Jun-2 Dec-2 Jun-3 Dec-3 Jun-4 Dec-4 Jun-5 Dec-5 Retail prices Jun-6 Dec-6 Jun-7 Dec 7 Jun 8 Dec-8 Jun Jun- 2 Dec- 2 Jun- 3 Dec- 3 Jun- 4 Dec- 4 Jun- 5 Core CPI Core CPI RBA Headline CPI Dec- 5 Jun- 6 Dec- 6 Jun- 7 Dec- 7 Jun- 8 Dec- 8 Jun- 9 Dec- 9 Jun- 1 Dec- 1 43

44 On short term interest rates dynamics RBA thinks it has finished with rate cuts and is relatively relaxed. The focus now is when to start rising rates Key driver is their view that they want to get back to normal over the cycle Critical to the timing is the growth and unemployment outcomes in H2 29. Based on their forecasts we would expect them to start in Feb 29 Do 5 points in early 21, then follow up with another 5 in mid year and another 25 near year end That get them to 4 ¼% by late 21 And a similar process in 211 gets them to neutral by late 211 Forecasts that are weaker (we are around ½% lower on growth and ¼% lower on inflation) would see them starting later say mid 21 44

45 Sep-85 Sep-86 Sep-87 Sep-88 Sep-89 Sep-9 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep- Sep-1 Sep-2 Sep-3 Sep-4 Sep-5 Sep-6 Sep-7 Sep-8 Sep-9 Sep-1 % Interest rates dynamics But a continuation of the current growth momentum (and worse than expected inflation and higher house prices) would bring the process forward Possibly as early as November Market expectations of 5 points by Xmas and a peak rate of 6 ½% however look well overdone It would in our view produce significant undershooting of growth and inflation expectation A Taylors Rule Perspective On rates Australian Cash Rate Cash - Taylor's rule dd Cash - actual + forecasts Cash - Taylor's rule gdp A Taylors rule perspective (which combines expected growth and inflation outcomes) suggests that the RBA will be attempting to move a touch ahead of the game

> Macro Investment Outlook

> Macro Investment Outlook Dr Shane Oliver Head of Investment Strategy and Chief Economist October 214 The challenge for investors how to find better yield and returns as bank deposit rates stay low 9