Download QIC Monthly Economic Brief - January 2014.docx

January 2014
Key Points
•
Global equity markets retrace on emerging market fears
•
Solid growth in the global economy in late 2013, but mixed signs emerge in early 2014
•
Ongoing signs of improvement in Australian non-mining private demand
•
RBA leaves the cash rate at 2.50 per cent and signals that rates will remain on-hold in coming months
International economies
Global equity markets retrace on emerging market fears
Equity markets started the year on a soft note, with the MSCI World Index (local currency) dropping 3.3 per cent in
January, the worst monthly result for developed markets since May 2012. Markets came under pressure as investors
once again began to withdraw capital from vulnerable emerging markets (EM). EM equities fell 4.6 per cent in January,
following on from their sizeable underperformance during 2013. The turmoil in EM was exacerbated by the decision
from the US Federal Reserve (Fed) to taper the pace of their asset purchases by a further US$10 billion in January, from
US$75 billion to US$65 billion per month. Increased risk aversion saw US 10-year government bond yields drop 38 basis
points (bps) over the month to their lowest level since early November, the VIX spike 34 per cent and the Japanese yen
and US dollar outperform.
The EM rout was most pronounced in Argentina, Turkey, South Africa and Russia where the prospects of less liquidity
injections by the Fed, higher global interest rates, a slowing Chinese economy and softer commodity prices have
exposed economic and political fragilities. Argentinian woes sparked the turmoil following an almost 20 per cent fall in
the peso in January after the central bank was forced to scale back their exchange rate interventions due to a sharp drop
in international reserves. Turkish assets, which have been under pressure since December due to increasing political risk
following a deepening corruption probe, also performed poorly with the lira dropping another 5 per cent in the month
to a record low and the equity market falling 8.8 per cent. The Russian ruble fell 6.5 per cent and the South African rand
fell 5.6 per cent in January to be near the lows seen during the financial crisis.
Faced with depreciating currencies and already elevated inflation readings, central banks in a number of EM countries
raised rates in January. Turkey hiked its one-week repo rate from 4.5 per cent to 10 per cent, South Africa raised rates
50 bps, while India and Brazil lifted rates 25 bps. While tighter monetary policy is prudent in these economies given the
impact of their falling currency, further reforms are required to ensure fragile EM economies can cope with the
reduction in global liquidity as the Fed moves to end its asset purchase program later this year.
Solid growth in the global economy in late 2013, but mixed signs emerge in early 2014
Although developments over recent weeks will clearly weigh on the domestic demand outlook in Argentina and Turkey
in 2014, in our view they are not sufficient to derail the global recovery given the extent of improvement underway in
the advanced economies, particularly the US. This is highlighted by incoming Q4 national accounts data, which revealed
another solid 3.2 per cent annualised gain in US real GDP in the December quarter, capping off the best half-year since
2003. Similarly, real GDP growth rose 2.8 per cent annualised in the UK in the December quarter and to a 6-year high of
2.8 per cent over the year.
Incoming business surveys suggest ongoing solid global growth in early 2014. The JP Morgan all-industry PMI rose to
53.9 in January, modestly above the average level seen in the December quarter, although the surveys were largely
conducted prior to the latest EM turmoil. Softer readings were evident in manufacturing surveys in US and China,
pointing towards a modest loss of momentum in the world’s two largest economies in early 2014. Nonetheless, we
expect growth in the US and China to rebound in coming months towards the rates seen in late 2013, with growth
expected to average 3 per cent in the US and 7¾ per cent in China during 2014.
Interest rate forecast (%)
Level at
7-Feb-14
Mar-14
QIC Forecast
Jun-14
Dec-14
2.50
2.50
2.50
2.50
0.00 - 0.25
0.00 - 0.25
0.00 - 0.25
0.00 - 0.25
Canada
1.00
1.00
1.00
1.00
Europe
0.25
0.25
0.25
0.25
UK
0.50
0.50
0.50
0.50
0.00 - 0.10
0.00 - 0.10
0.00 - 0.10
0.00 - 0.10
Aus tral ia
US
Japan
Australian economy
Ongoing signs of improvement in Australian non-mining private demand
The Australian economy remains in the midst of a significant structural adjustment as the construction phase of the
mining investment boom draws to an end and ongoing fiscal restraint weighs on public sector activity. Given these
significant headwinds to growth, the Reserve Bank of Australia (RBA) cut interest rates to record low levels in 2013 to
encourage a pick-up in non-mining private sector activity. Evidence that the low interest rates are gaining traction within
the economy is beginning to build, with retail sales improving, house prices continuing to increase and dwelling
approvals near historic highs. Furthermore, survey indicators of business conditions and confidence have shown signs of
improvement in recent months, rising to around long-run average levels after a period of weakness for most of the past
three years. Furthermore, the economy is also benefitting from an increase in resource exports and a lower Australian
dollar, with the trade balance returning to surplus in late 2013. We continue to expect growth in the Australian economy
to improve from a lacklustre 2.3 per cent in 2013 to a still below-trend 2.7 per cent in 2014.
RBA leaves the cash rate at 2.50 per cent and signals that rates will remain on-hold in coming months
Inflation in the December quarter surprised to the upside, with underlying inflation rising 0.9 per cent over the quarter,
the strongest quarterly gain in 2½ years. The recent fall in the Australian dollar placed upward pressure on tradeable
goods prices, while non-tradeable inflation remained elevated despite signs of softer wage growth. The strong gain in
prices during the quarter saw the year-ended underlying inflation rate rise from 2.3 per cent to 2.6 per cent, reaching
the upper half of the RBA’s target band for the first time in two years.
The higher-than-expected inflation print, combined with signs of improvement in non-mining private demand, saw the
Reserve Bank of Australia keep rates on-hold at 2.50 per cent in February and shift towards a neutral bias after holding
an easing bias throughout the second half of last year. Despite changing tracks, the RBA does not expect to move
towards tighter policy settings anytime soon, concluding that “the most prudent course is likely to be a period of stability
in interest rates.” The move by the RBA is in accordance with our long-held view that the cash rate will remain at 2.50
per cent throughout 2014. Below-trend growth and subdued labour market conditions, with the unemployment rate
reaching 5.8 per cent in December and likely to edge-up to 6.0 per cent in early 2014, should contain underlying
inflationary pressures. However, the RBA’s recent forecasts also imply that the next move in rates is more likely to be up
than down. In particular, the RBA expects the underlying inflation rate to be between 2¼ to 3¼ per in December 2014
and June 2015, supporting our view for the RBA to commence tightening policy in early 2015.
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