Economics, interest rates and currencies chart pack

Transcription

1 Economics, interest rates and currencies chart pack Charts prepared for ANZ Senior Management th March Saul Eslake Chief Economist

2 Summary of economic forecasts 7e f 9f World economy Oil prices (US$ per barrel) 7 US GDP growth (%).9. 1¼ ¼ Europe GDP growth (%). 1. 1½ Japan GDP growth (%)..1 ½ 1 China GDP growth (%) ¾ 9 World GDP growth (%).7. ½ ½ Australian economy Real GDP growth (%).. ½ ¾ Unemployment rate (year-end, %).. ¼ Underlying inflation (year-end, %).. ½ Current account deficit (% of GDP) ½ - Credit growth (%) ½ New Zealand economy Real GDP growth (%) 1.. 1½ ½ Unemployment rate (year-end, %).. ¼ Underlying inflation (year-end, %).. ¾ Current account deficit (% of GDP) ½ -¾ Credit growth (%) ¾

3 Summary of financial market forecasts Mar Jun Dec Jun 9 Dec 9 International markets US Fed funds rate (% pa)..... US 1-year T-note yield (% pa) ECB refi rate (% pa) US$ US$ - Yuan US$ Australian markets RBA cash rate (% pa) day bill yield (% pa) year bond yield (% pa) A$-US$ New Zealand markets RBNZ cash rate (% pa) year bond yield (% pa)..... NZ$-US$ AS-NZ$

4 Australia s economy is at the intersection of two very powerful global forces The crisis in global credit markets resulting from the bursting of the credit market bubble which built up during the middle years of this decade triggered by, but no longer confined to, the US sub-prime mortgage market resulting in substantial declines in the value of a wide range of securities and derivatives threatening to lead to a global credit crunch and possibly to a recession in the US and other large industrialized economies The on-going rapid growth and industrialization of China and other emerging economies putting continued upward pressure on a wide range of commodity prices as well as heightening concerns about climate change Australia is exposed to both of these forces financing the world s fourth largest current account deficit predominantly through borrowing means Australia is exposed to the risk of a global credit crunch but the commodities boom is also adding directly and indirectly to inflationary pressures within Australia, and putting upward pressure on the A$ Australia s short- to medium-term macroeconomic prospects will largely depend on the relative strength of these two forces

5 The current global financial crisis stems from the bursting of a credit market bubble From this To this. Cheap and easy money Reduced appetite for risk Distrust of new forms of finance Increased appetite for risk New forms of financial engineering Reduced capacity for leverage Increased capacity for leverage Falling asset prices Rising asset prices Slowing economy

6 The credit market crisis was triggered by the bursting of the US housing bubble beginning in mid- US housing market US house prices % change from year earlier (Case-Shiller index) Mns (annual rate) US housing starts Actual Trend Months' supply US unsold homes Actual US mortgage delinquencies % 'seriously delinquent' Trend Sources: S&P; US Commerce Department; US National Association of Realtors; US Mortgage Bankers Association.

7 Dramatic declines in the value of mortgage-backed securities have led to substantial losses incurred by big global banks 7 ABX index of prices of US mortgage-backed securities Losses announced by major banks since mid Dec- Mar- 7 Jun- 7 Sep- 7 Dec- 7 AAA rated AA rated Mar- Jun- Bank Merrill Lynch Citigroup UBS HSBC Morgan Stanley Bank of America Washington Mutual Credit Agricole Total (US$ bn) Dec- Mar- 7 Jun- 7 A Sep- 7 Dec- 7 BBB- (sub-prime) Mar- Jun- Wachovia JPMorgan Chase Canadian Imperial (CIBC) Barclays Bear Sterns Royal Bank of Scotland Deutsche Bank Wells Fargo TOTAL* Source: Bloomberg. * incl. smaller banks not shown separately.

8 These losses (and fears of more to come) have made banks reluctant to lend to one another Inter-bank borrowing rates and overnight index swap (OIS) rates United States. % pa. -mth Libor... Fed funds rate... OIS. Dec- Jun-7 Dec-7 Jun % pa ECB refi rate Euro area -mth Libor OIS. Dec- Jun-7 Dec-7 Jun- United Kingdom 7. % pa. -mth Libor... BoE repo rate OIS. Dec- Jun-7 Dec-7 Jun- Australia. % pa. -mth Libor 7. OIS 7.. RBA cash rate.. Dec- Jun-7 Dec-7 Jun- * The OIS is an indicator of market expectations of future movements in cash rates. Sources: Thomson Financial; Bloomberg.

9 Banks short-term funding spreads are widening again (for the third time since mid-7) 9 Spreads between short-term (9-day) inter-bank borrowing rates and expected official cash rates 1 1 Basis points (-day moving average) UK Euro area US Australia Dec- Mar-7 Jun-7 Sep-7 Dec-7 Mar- Jun- Note: expected official cash rates proxied by overnight index swaps (OIS). Sources: Thomson Financial; Bloomberg.

10 Worsening stresses in credit markets also apparent from widening CDS spreads 1 Credit default swap (CDS) spreads US & European banks Basis points 17 Wachovia 1 1 Citigroup 1 7 HSBC Dec- Jun-7 Dec-7 Jun Basis points US brokers Merrill Lynch Goldman Sachs Dec- Jun-7 Dec-7 Jun Basis points US corporates IBM AT&T Home Depot Dec- Jun-7 Dec-7 Jun- Australian banks 1 Basis points 1 1 itraxx index for major 7 banks Dec- Jun-7 Dec-7 Jun- Sources: Thomson Financial; Bloomberg.

11 Sharply diminished investor appetite for securities has forced banks to take large volumes of assets onto their balance sheets US banks securities holdings US$trn Other securities Government securities 1. Dec- Jun-7 Dec-7 Jun US$trn US banks commercial & industrial loans 1.1 Dec- Jun-7 Dec-7 Jun- US banks business lending % change from year earlier US bank capital adequacy * 1 % * Ratio of banks assets to difference between assets and liabilities for domestically chartered US banks (at best a rough proxy for capital, and no allowance for risk weights). Sources: US Federal Reserve.

12 Banks in the US and the euro area are tightening credit standards 1 US banks Euro area banks Commercial & industrial loans Loans to enterprises - - Net balance tightening standards (%) Small Large Net balance tightening standards (%) Mortgage and consumer loans Mortgage and consumer loans - Net balance tightening standards (%) Mortgage* Consumer Net balance tightening standards (%) Consumer House purchase * Weighted average of prime & sub-prime after June 7 Sources: US Federal Reserve and European Central Bank surveys of loan officers.

13 The tightening in lending standards will lead to slower growth in bank lending and to slower economic growth 1 Bank credit standards and growth in C&I * lending Bank lending and economic growth 1 1 % change from year earlier Net balance tightening (%) Lending standards for large - C&I loans Banks' C&I 1 mths lending forward (left scale) (inverted; -1 right scale) % change from year earlier Banks' C&I lending (left scale) Real GDP (right scale) % change from year earlier * Commercial and industrial. Sources: US Federal Reserve; US Bureau of Economic Analysis.

14 January s panic selling has ceased, but equity markets remain vulnerable to earnings downgrades and other shocks 1 1 US S&P Equity markets 7 UK FTSE Dec- Jun-7 Dec-7 Jun- Japan - Nikkei Dec- Jun-7 Dec-7 Jun- Dec- Jun-7 Dec-7 Jun- Australia ASX All Ords 7 Dec- Jun-7 Dec-7 Jun- Source: Thomson Financial.

15 A number of high-profile composite indicators suggest the US economy may be in, or heading for, a recession 1 Composite indicators of US economic activity Purchasing managers indices 7 Net balance (%, trend) 9 9 Conference Board leading indicators Chicago Fed activity index % deviation from trend Philadelphia Fed activity index % ch from year earlier (trend) Note: Shaded areas denote recessions as defined by the National Bureau of Economic Research. Sources: Institute of Supply Management (ISM); The Conference Board; Federal Reserve Banks of Chicago and Philadelphia. - Net balance (%, trend)

16 The US housing market looks worse, on most indicators, than it did prior to the last two recessions 1 US housing market indicators in three cycles Prior market peak = 1 From Jun Housing prices 1 1 Housing starts From Mar From Dec 199 Months from market peak Established home sales Prior market peak = 1 (trend) From Jun Unsold homes From Mar From Dec 199 Months from market peak Prior market peak = 1 (trend) From Jun From Mar From Dec 199 Months from market peak Months' sales (trend) From Mar From Jun From Dec 199 Months from market peak 1 1 Sources: S&P; US Commerce Department; US National Association of Realtors; ANZ.

17 So far, however, the US labour market is not deteriorating as quickly as it did prior to the last two recessions 17 US labour market indicators in three cycles Non-farm payroll employment Initial claims for unemployment benefits Prior market peak = 1 From Dec 199 From Jun From Mar Months from market peak 1 1 ' per week (-wk moving average) From Mar From Dec 199 From Jun Weeks from market peak Layoff announcements Unemployment rate 1 's per mth (-mth moving average) From Mar. 7.. % From Dec 199 From Mar 1 From Jun Months from market peak From Jun Months from market peak 1 1 Sources: US Bureau of Labor Statistics; Challenger; ANZ.

18 The US non-financial sector is in a strong financial position, and isn t retrenching in the way it has done in past recessions 1 US business finances and activity in three cycles After-tax corporate profits Non-defence capital goods orders * % of GDP From Jun From Mar From Dec Prior market peak = 1 From Jun From Dec 199 From Mar. Months from market peak Months from market peak 1 1 Debt-equity ratio Manufacturing inventories % From Jun From Dec 199 From Mar Months from market peak 1 1 Non-financial corporations * Excluding aircraft. Sources: US Bureau of Economic Analysis; Federal Reserve; Commerce Department; ANZ Prior market peak = 1 From Jun From Dec 199 From Mar Months from market peak 1 1

19 Household finances are likely to play a larger role in shaping the current cycle than in previous recessions 19 US household finances and spending in three cycles Real personal disposable income Real consumer spending Prior market peak = 1 From Mar From Jun From Dec 199 Months from market peak Prior market peak = 1 From Jun From Mar From Dec 199 Months from market peak 1 1 Personal net worth Personal saving ratio % of annual disposable income From Jun From Dec 199 From Mar Months from market peak % of disposable income (trend) From Dec 199 From Jun From Mar Months from market peak 1 1 Sources: US Bureau of Economic Analysis; Federal Reserve; ANZ.

20 Rising exports, aided by a weaker US$, have more than offset the impact on GDP growth of falling housing construction US dollar, exports and housing Trade-weighted value of US$ Prior market peak = 1 From Mar From Dec 199 From Jun Months from market peak 1 1 Real exports of goods and services 1 1 Exports and housing Cumulative change since Q (US$bn at annual rate) Exports of goods & services Prior market peak = 1 From Jun From Dec 199 From Mar Months from market peak Residential construction - Jun- Dec- Jun-7 Dec-7 Jun- Sources: Thomson Financial; US Bureau of Economic Analysis; ANZ.

21 The US may not experience outright recession, but growth there and in other advanced economies will slow sharply in 1 Major advanced economies real GDP growth United States Euro zone 1 % change from year earlier 1 % change from year earlier Japan United Kingdom 1-1 % change from year earlier 1 % change from year earlier Sources: national statistical agencies; ANZ.

22 The Fed and BoE have been willing to downplay inflation risks; other central banks haven t Consumer price inflation United States * United Kingdom 1 % change from year earlier 'Headline' Excl. food & energy 1 % change from year earlier 'Headline' Excl. food & energy Euro area Australia % change from year earlier 'Headline' % change from year earlier 'Underlying' # 1 Excl. food & energy 'Headline' 1 7 * Personal consumption expenditure deflator. excludes GST impact in 1. # Average of RBA s two preferred measures. Sources: US Bureau of Economic Analysis; Eurostat; UK Office of National Statistics; ABS; RBA.

23 So far the US Federal Reserve has cut rates the most; the ECB hasn t cut at all; and Australia has lifted rates three times Monetary policy interest rates % pa US federal funds rate European Central Bank refi rate % pa Bank of England repo rate Reserve Bank of Australia cash rate. % pa. % pa Sources: Federal Reserve; Bank of Japan; European Central bank; Bank of England; ANZ.

24 If US interest rates bottom at % by July, the US dollar will likely reach a trough around then as well US dollar vs euro and yen US dollar vs euro US dollar vs yen. US$ per (inverted) 1 per US$ Sources: Federal Reserve; Bank of Japan; European Central bank; Bank of England; ANZ.

25 Major developing countries should continue to experience relatively strong growth, albeit a little slower than in -7 Major developing economies real GDP growth China Other East Asia South Africa 1 1 % change from year earlier % change from year earlier % change from year earlier India Brazil Russia 1 1 % change from year earlier % change from year earlier 1 % change from year earlier Sources: national statistical agencies; ANZ.

26 Most developing countries are more worried about rising inflation than slowing growth Major developing economies consumer prices China Other East Asia South Africa - % change from year earlier 1 % change from year earlier % change from year earlier India Brazil Russia 7 1 % change from year earlier 1 1 % change from year earlier 1 1 % change from year earlier Sources: national statistical agencies; ANZ.

27 China s and India s growth has been predominantly driven by domestic demand, not by net exports 7 Contributions to China s real GDP growth Contributions to India s real GDP growth 1 % pts 1 % pts Domestic demand Net exports Domestic demand Net exports Source: China National Bureau of Statistics, CEIC.

28 Australia s economy is at the intersection of two very powerful global forces The crisis in global credit markets resulting from the bursting of the credit market bubble which built up during the middle years of this decade triggered by, but no longer confined to, the US sub-prime mortgage market resulting in substantial declines in the value of a wide range of securities and derivatives threatening to lead to a global credit crunch and possibly to a recession in the US and other large industrialized economies The on-going rapid growth and industrialization of China and other emerging economies putting continued upward pressure on a wide range of commodity prices as well as heightening concerns about climate change Australia is exposed to both of these forces financing the world s fourth largest current account deficit predominantly through borrowing means Australia is exposed to the risk of a global credit crunch but the commodities boom is also adding directly and indirectly to inflationary pressures within Australia, and putting upward pressure on the A$ Australia s short- to medium-term macroeconomic prospects will largely depend on the relative strength of these two forces

29 Australian debt markets have seen similar increases in spreads as in the US 9 Swap spreads Corporate bond yield spreads United States United States Monthly average (basis points) years years Monthly average (basis points) A-rated AAA-rated 1 7 Australia Australia Monthly average (basis points) years years Monthly average (basis points) A-rated AAA-rated Note: spreads are to government bond yields of comparable maturities. Sources: Thomson Financial; Bloomberg; Reserve Bank of Australia.

30 In Australia, as in the US, the debt securities markets have almost completely closed to non-bank borrowers Securitizers loan assets Short-term debt securities issued in Australia 1 1 $ bn All loans Mortgages $ bn Banks & other financial corporations Other 1 7 Australian non-government debt securities issued offshore Long-term debt securities issued in Australia 1 1 $ bn Banks & other financial corporations Other 1 1 $ bn Other Banks & other financial corporations Note: excludes government debt securities. Source: Reserve Bank of Australia

31 With debt securities markets largely closed, credit demand is returning to the banking system straining banks capital 1 Australian financial intermediaries business lending Australian banks capital adequacy ratios % change from year earlier 1 % of 'risk weighted' assets 1 Total capital base ratio 1 'Narrow credit (excl. securitizations) Total (incl. securitizations) 1 Minimum prudential capital ratio* 1 'Tier 1' capital ratio * Under APRA regulations, banks must maintain total base capital in excess of % of their risk-weighted assets, half of which must be in the form of Tier 1 capital (paid-up capital, disclosed reserves and retained earnings). Sources: Reserve Bank of Australia; Australian Prudential Regulation Authority.

32 Reliance on banks overseas borrowings to finance the deficit leaves Australia exposed to abrupt shifts in global markets 1 Financing Australia s current account deficit A$ bn - -qtr moving total Current account deficit 1 Net foreign debt, by borrower % of total Private sector financial corporations Private sector non-financial corporations Public sector Maturity structure of net foreign debt Methods of financing Net equity Banks' net borrowing Other net borrowing Other (incl. reserves) 1 1 % of total < days 1 7 Sources: Australian Bureau of Statistics; ANZ.

33 Australian and US economic cycles have not been closely correlated this decade, and are diverging further now Australian and US economic indicators Real GDP growth Terms of trade % change from year earlier Australia 1 1 Ratio of export to import prices ( = 1) Australia US 1 1 US Unemployment House prices 7 % US Australia % change from year earlier Australia US 1 7 Sources: Australian Bureau of Statistics; US Bureau of Economic Analysis; US Bureau of Labor Statistics; S&P.

34 Australia is much less directly dependent on the US and other OECD export markets than it used to be Australia s major export markets Advanced economies Developing economies % of total (1-mth moving average) % of total (1-mth moving average) Japan Other North-East Asia (Korea, Taiwan, HK) China 1 1 EU 1 ASEAN 1 NZ US India GCC Sources: Australian Bureau of Statistics.

35 Expected rises in coal and iron ore export prices will deliver a further leg upwards in the commodity price cycle in -9 Australian export commodity prices Australia s terms of trade 1- = 1 (US$ terms) 1 - = 1 7 All items 1 All items Note: terms of trade is the ratio of average export to average import prices. Sources: Reserve Bank of Australia; ABS; ANZ.

36 This will boost Australia s income by another % in -9, on top of 11% from terms of trade gains already so far this decade Australia s real gross domestic income and output 7 Real % change from year earlier Real gross domestic income (GDI = GDP adj. for changes in terms of trade) Expected rise in coal & iron ore prices will add % to Australia s income in -9 1 Real GDP (output) Sources: Australian Bureau of Statistics; ANZ.

37 Income will continue to be re-cycled from the business sector to households through the Budget, boosting total spending 7 Australian income tax collections Net saving by sectors of the Australian economy 1. % of GDP % of GDP. % of GDP (-qtr moving average) 1. Companies (right scale). Business Government. 11. Individuals (left scale) Households Sources: Australian Bureau of Statistics; ANZ.

38 Business investment is expected to keep rising strongly, despite global uncertainties and deteriorating financial conditions Actual and projected capital expenditure % change (current prices) Mining % change (current prices) Other industries Manufacturing Total excl. farm and finance % change (current prices) Note: Data are for financial years ended June. Projections for 7- and -9 are based on expected levels of capital expenditure reported to the ABS in its January-February survey, adjusted for the extent to which expectations in this survey have been realized over the five years to -7. Sources: ABS; ANZ % change (current prices) 1 7 9

39 The Australian housing market is likely to remain characterized by excess demand a stark contrast to the US housing market 9 Australian housing market fundamentals Housing supply and demand Capital city house prices 1 's (annual rate) Underlying demand % change from year earlier Completions Rental vacancy rates Capital city dwelling rents % 1 % change from year earlier 1 Average for all capitals Sources: Australian Bureau of Statistics; Real Estate Institute of Australia; ANZ.

40 After more than 1 years of continuous economic growth, Australia s economy has run into serious capacity constraints Indicators of spare capacity in the Australian economy Unemployed persons per job vacancy No unemployed per job vacancy Businesses reporting labour shortages 1 1 % of businesses nominating 'suitable labour' as a constraint on output 9 9 Capacity utilization rate % Office vacancy rates % Sources: Australian Bureau of Statistics; nabcapital; Property Council of Australia.

41 Businesses in many sectors have been able to increase profit margins in these circumstances despite rising costs 1 Profit margins * in selected industries Retailing Wholesaling % % Manufacturing Transport and storage 1 % 1 % * Defined as gross operating profits as a % of sales and shown as a -quarter moving average. Sources: Australian Bureau of Statistics; ANZ.

42 Underlying inflation is at its highest level since 1991 and the RBA is particularly concerned at rising inflation expectations Consumer prices Measures of labour costs % change from year earlier 'Underlying' (weighted median) 'Headline 7 1 % change from year earlier Compensation per employee Wage cost index Household inflation expectations Reserve Bank target band % pa Trend. Actual Sources: Australian Bureau of Statistics; Reserve Bank of Australia; Westpac-Melbourne Institute; ANZ.

43 In a fully employed economy if some sectors are to grow rapidly then others have to shrink After more than 1 years of continuous growth Australia s economy is running out of spare capacity As a result, increases in aggregate demand in excess of the growth rate of the economy s supply potential will inevitably lead to higher inflation, a larger current account deficit, or both If, in this situation, some sectors (eg mining) are to grow rapidly in order to meet global demand, other sectors have to grow more slowly (or shrink) if these consequences are to be avoided Similarly if some regions (eg WA and Qld) are being pushed towards faster growth then other regions must of necessity grow at a slower rate In practice, the room required by faster growth in particular sectors or regions is being created by a combination of rising interest rates a stronger exchange rate and rising costs Inevitably, these will disproportionately impact households with a mortgage, and sectors such as manufacturing and tourism Over the medium-to-longer term the only way to avoid this situation is through policies which expand the economy s supply potential

44 Resources boom benefits north and west more than the southeast, but the gap between the two is now narrowing a bit Resource-rich vs other States and Territories Employment Retail sales 1 % change from year earlier (trend) Qld, WA & NT Rest of Australia % change from year earlier (trend) Qld, WA & NT Rest of Australia Business investment House prices Real % change from year earlier (trend) Qld, WA & NT Rest of Australia 1-1 Real % change from year earlier (trend) Brisbane, Perth & Darwin Other capitals Sources: Australian Bureau of Statistics; ANZ.

45 Reserve Bank will hike rates at least twice more to slow demand and bring inflation back within the target range % pa Short-term interest rates 9-day bank bill yield RBA official cash rate Sources: Thomson Financial; ANZ. 1 interest rate increases since mid- have had little lasting impact in restraining growth in domestic demand largely because they ve been offset by commodity-related income gains, repeated rounds of tax cuts etc. The RBA now says that a significant slowing in domestic demand is likely to be necessary to reduce inflation over time and that unless something else happens to produce such a slowdown (for example, sharply weaker global growth, tighter credit conditions, changes in fiscal policy etc. ).. monetary policy is likely to need to be tighter in the period ahead (ie, rates will rise some more) In other words there will be a significant slowing in demand, what is not clear is how high rates will have to go in order to procure it

46 Commodity prices and interest rate spreads likely to continue supporting the A$ into the second half of this year A$ and commodity prices A$ and interest rate spreads 1. US 1- = 1 1. US 1- = A$ vs US$ (left scale) A$ vs US$ (left scale) RBA index of commodity prices in US$ (right scale) Spread between Australian & US 9-day interest rates (right scale) Sources: Thomson Financial; Reserve Bank of Australia; ANZ.

47 Two alternative scenarios for interest rates 7 Scenario 1 Scenario An inter-related combination of falling share prices, declining business and consumer confidence, and significantly tighter conditions in domestic credit markets could lead to an earlier and more marked slowdown in domestic spending than in our base case forecast In those circumstances the Reserve Bank would reverse course abruptly, cutting rates once it was clear that domestic demand was slowing and unemployment was rising The A$ would likely fall sharply in such a scenario Domestic demand could continue to be surprisingly resilient to further interest rate hikes, and tightening domestic credit conditions (because of rising commodity incomes, tax cuts etc) In those circumstances the Reserve Bank could continue raising interest rates (beyond our base case of 7½%) until domestic demand began slowing abruptly Once clear signs that the business cycle had turned decisively became apparent, the RBA would start cutting rates (but from a higher level than in our base case The A$ would initially rise further than in our base case, but subsequently fall more sharply

48 Credit growth is expected to slow over the next two years reflecting both demand and supply influences Credit growth Housing Business % change from year earlier % change from year earlier Other personal Total % change from year earlier % change from year earlier Sources: RBA; ANZ.

49 Higher interest rates will eventually squeeze domestic spending although it may take a while yet 9 Spending and output Employment and unemployment 7 Real % change from year earlier Domestic final demand.... % change from year earlier Employment (left scale) % GDP (output) Unemployment (right scale) Sources: Australian Bureau of Statistics; ANZ.

50 NZ economy has shown remarkable resilience in the face of high interest rates and a persistently strong NZ dollar Key indicators of New Zealand economy Real GDP growth Capacity utilization Real % change from year earlier 9 % Unemployment Inflation. % of the labour force % change from year earlier Headline Underlying RBNZ target range Sources: Statistics NZ; NZIER; RBNZ

51 The impact of rising cash rates on households has been delayed by the spread of fixed-rate mortgages 1 Mortgage rates Cash vs mortgage rates % pa Floating -year Fixed 9... % pa Effective mortgage rate (+17bp since Feb ) Floating vs fixed rate mortgages % pa Fixed Official cash rate (+bp since Feb ). Floating Source: Reserve Bank of New Zealand

52 However some of the key factors supporting growth in the NZ economy appear to be weakening House prices Net immigration 1 $NZ' ' (1-mth moving total) House sales Export commodity prices 1 's July = 1 1 Trend Sources: REINZ; Statistics NZ; ANZ National Bank.

53 Business confidence has declined once again at the beginning of Headline confidence net % Employment Own activity Net % Investment Net % Net % Sources: ANZ National

54 Indicators for suggest momentum is slowing Financial conditions tight Business confidence falling 9 Annual % OCR introduced GDP (LHS) Index Financial conditions (adv 9-mths, RHS) Annual % NBBO own activity (adv mths, RHS) Net % GDP (LHS) Index Equity market bearish NZX Jan-7 Mar-7 Jun-7 Sep-7 Dec-7 Sources: ANZ National, Statistics NZ, REINZ, NIWA Drought conditions likely to weigh on agricultural production 1 1 Drought weeks Serious (relative to median) East Coast Hawke's Bay Wairarapa Nelson Marlborough Canterbury Otago Bay of Plenty Severe (relative to median) Very severe (relative to median) Waikato Taranaki Manawatu Southland

55 Credit is surpassing inflation as the biggest issue facing the economy at present Cheap funding allowed aggressive pricing previously basis points (-mth avg) 1 1 Average Average -present 1 Spread between -yr carded mortgage and -yr swap rate Index Funding is no longer cheap Australian itraxx average four "big banks" Jun- Oct- Feb-7 Jun-7 Oct-7 Feb basis points Corporate spreads are increasing Spread between NZ corporate (A rated) and relative swap rate 1-yr -yr -yr -yr -yr 7-yr 1-yr Higher funding costs are being passed on % Mortgage rate curve Dec-7 1 Dec 7 Feb Sep 7 Current Floating mths 1-yr -yr - yr -yr - yr Sources: ANZ National, Bloomberg,

56 Although inflation pressures remain elevated and persistent 1 RBNZ s inflation projections exceed % for most of next year Annual % Top of the target band Dec MPS Sep MPS Inflation expectations remain elevated Annual % CPI inflation RBNZ -yr ahead inflation expectations Resource pressures remain tight Food prices heading skywards 1 Annual % Non-tradable inflation (LHS) Capacity utilisation (adv qtrs, RHS) % Annual % ANZ NZD commodity prices (adv 9 mths, RHS) Food prices (LHS) Annual % Sources: ANZ National, RBNZ, NZIER, Statistics NZ

57 The economy is very dependent on late-cycle support from the labour market and fiscal policy Unemployment rate at record lows % of labour force Employment intentions remain robust Annual % Employment growth (LHS) QSBO employment intentions (past mths, RHS) Net % Wage growth at record highs Annual % Fiscal policy set to become more expansionary % of GDP LCI private sector ordinary time wage and salaries Expansionary Contractionary Half year fiscal update Sources: ANZ National, Statistics NZ, NZIER, Treasury

58 RBNZ won t react to slowing growth until inflation has peaked, but NZ$ will anticipate rate cuts and easing commodity prices Short-term interest rates New Zealand dollar 9... % pa 9-day bank bill yield...7 US$ per NZ$ NZ$ per A$ (inverted scale) RBNZ's cash rate.... NZ$/US$ (left scale) A$/NZ$ (right scale; inverted) Sources: Thomson Financial; ANZ.

59 New Zealand credit growth is expected to slow over the next 1 months 9 Housing credit Business credit - agriculture Annual % Annual % Business credit - other Total credit 1 Annual % 1 Annual % Sources: ANZ National, RBNZ