Australia Business Forecast Report Q4 2008

Entering A Period Of Economic Weakness

The outlook for Australias economy has deteriorated in recent months, with the onset of the anticipated slowdown manifesting itself in the second quarter national accounts. Q208 GDP performance was the weakest in more than three years, with growth registering 0.3% quarter-on-quarter (q-o-q) (2.7% year-on-year [y-o-y]), following a revised 0.7% q-o-q (3.7% y-o-y) expansion in the first quarter. The slowdown is being led by a downturn in private consumption, with consumers feeling the pinch from record high inflation and interest rates. Household consumption fell 0.1% q-o-q in April-June, its first contraction since 1993. While the external sector has performed well in the first half of this year, bolstered by soaring commodity prices, growing external headwinds present a key risk going forward. BMI expects Australias real GDP growth to register 2.9% in 2008 and 2.0% in 2009, representing a significant deceleration from 4.1% in 2007.

Recent state elections have sounded a warning to Prime Minister Kevin Rudds Labor Party, which has come close to losing its monopoly on holding power in every Australian state and territory. A huge swing against incumbent Labor in the Northern Territories election, held on August 9, reflected growing disappointment over the governments performance. Furthermore, the potential for a hung parliament in West Australia, after neither Labor nor the main opposition, the Liberal Party, managed to secure enough votes to control the Legislative Assembly, would deal another blow to the Labor camp. While nationally, Labor and Rudd remain the most popular choice in public opinion polls, with the nations economic outlook having deteriorated, the government has a tough few years ahead to retain its position through to the 2010 federal elections.

Softening domestic demand has prompted Australias central bank to deliver its first interest rate cut since 2001, lowering the key cash rate from a 12-year high of 7.25% to 7.0% on September 2, 2008. This likely marks the onset of a moderate monetary easing cycle, given Australias deteriorating economic outlook and expectations that inflation will moderate from record highs. Growth in the core consumer price index remains well above the Reserve Bank of Australias 2.0-3.0% target range, accelerating to 4.5% y-o-y in Q208 from 4.2% in Q108. However, the bank expects softening demand and lower oil prices to bring about a substantial reduction in price pressures over time. Underlying inflation is projected to peak at 5.0% at the end of 2008, before easing over the next two years, dropping to within the banks target range by 2010.

We expect the Rudd government to continue implementing reforms aimed at further strengthening Australias business environment, which already scores highly (71.8, with a global ranking of 16th out of 167 states) in our ratings. Rudd is likely to pursue labour market reform and increase spending on education and training to ease Australias skills shortages, and also improve the countrys congested infrastructure. In addition, the government is planning to cut red tape for small- and medium-sized enterprises (SMEs), and improve the countrys technological base.