in

Embargoed until: 11.30am Tuesday 12 July 2011

Global & Australian Forecasts

July 2011

World slows from tsunami disruptions and tighter policy. Domestic sector struggling to gain traction as confidence slumps. Carbon tax softens growth & increases CPI .
Global growth is slowing from the exceptionally strong pace seen last year and, while we have slightly revised our forecasts, the impact on global growth is minimal. This slowing is not surprising economic policy is being tightened in many countries, the Japanese disasters have disrupted global supply chains, oil prices are higher and household real incomes are coming under pressure in several countries as inflation outstrips wage gains. Despite this, global growth is expected to remain a touch above its 4% trend through 2011 and 2012, mainly due to solid outcomes in China, India, Latin America and the Asian Tiger economies. Developed economy growth is nearer 2% while emerging economy growth is 6 to 7%. Australian forecasts weaker in Q2 & Q3 reflecting continuing softness in discretionary spending, and delays in recovery of coal export volumes. Severe weakness in retail in latest survey, along with continuing softness in wholesale, parts of transport, manufacturing and construction points to ongoing softness. Strong export prices, mining investment and Queensland rebuilding expected to lift GDP growth in Q4 with more solid growth in 2012. In 2012/13 the forecasts include some tentative impacts from the carbon package (-0.2% off GDP). Inflation is % higher, assuming no wages impact. Overall, we now expect GDP growth of 1.7% in 2011 and 4.6% in 2012. Next 25 bp rise in cash rate deferred until December, when growth momentum and labour market tightness will be more apparent. Final 25 bp rise put back to May 2012.

Key global GDP forecasts (calendar years)

Country/region IMF weight 2008 2009 2010 % change United States Euro-zone Japan China Other Asia Global total Australia 21 15 6 13 4 100 2 0.0 0.2 -1.2 9.6 3.2 3.0 2.6 -2.6 -4.1 -6.3 9.2 0.2 -0.6 1.3 2.9 1.7 4.0 10.3 7.8 5.1 2.7 2011 2012

2.7 2.3 -0.5 9.3 5.3 4.3 1.7

3.3 2.1 3.9 8.2 4.9 4.3 4.6

Key Australian forecasts (fiscal years)

GDP components 09/10 10/11 % change Priv.consumption Domestic demand GDP 2.1 2.1 2.3 11/12 Other indicators 09/10 10/11 % through-year 11/12

3.0 3.3 1.7

2.5 4.1 3.9

Underlying CPI

2.7

2.5
% end of year

2.7

Unemploy. rate

5.1

4.9

4.5

For more information contact: Alan Oster, Chief Economist (03) 8634 2927 0414 444 652

Rob Brooker, Head of Australian Economics & Commodities (03) 8634 1663 0457 509 164

Tom Taylor, Head of International Economics (03) 8634 1883

Embargoed until 11.30am Tuesday, 12 July 2011

Global outlook
Global equity markets have been affected by a number of negative influences month whether through there the be past over an uncertainty would

high unemployment. The outcome is a squeeze in real household incomes that curbs consumer spending and demand growth.

imminent default by Greece, the ending of the Feds second round of quantitative easing with little sign that a third one is about to be started in the near future and growing signs that the pace of global growth is slowing. As a result, equity markets have generally trended downward and volatility has picked up. Neither price declines nor volatility, however, are comparable to the experience of 2008/09. A slowing in the pace of growth is only to be expected in the current environment. High oil and other commodity prices have eroded real incomes in the big developed spending adjusted In the economies only tends in to upward short-term, and be the history As to

commodity exporters after a lag. suggests that big increases in oil prices slow global growth. demand commodity gradually prices start slackens,

weaken and there is evidence that this is happening. While higher oil and food prices are feeding into increased the big wage inflation developed across The monthly data on trade and industrial output shows the pace of global growth has clearly slowed. The CPB measure of world trade volumes shows growth slipping from 15% in 2010 to around 5% in early 2011 while the growth in industrial output has eased from almost 10% last year to near 2%. This slowing is particularly

economies,

inflation is being held back by

evident

in

the

big

developed

economies where output is still running well below its pre-crisis level. The data detailed confirm monthly that a industrial significant

slowing in growth has occurred but they also indicate that part of it reflects the impact of the disasters in Japan on supply chains. Headline growth in world industrial output has eased from around 7% in February to around 3% in April and May but excluding Japan takes the slowdown from 7% to just over 5%. The purchasing managers business surveys also confirm that a slowing is under way but they are still consistent with moderate growth in developed economies. The information in the purchasing managers supplemented long-running surveys by a national can number be of

business

surveys that ask firms what they think is happening to their current business environment and what they expect for the future. These surveys show a sudden and quite marked downturn across in growth the big expectations

industrial economies.

The global economic upturn has been very reliant on big emerging market economies. China, India and Brazil represent around one fifth of global output but almost half of world economic growth. The monthly industrial output data provides the earliest insights into the pace of economic growth in the emerging markets and it is clearly slowing as policy is tightened and the bounce-back from recession levels of output is completed. Business emerging surveys market in the big

expected to be important drivers of US economic growth through the next few years as the economy shifts away from its previous consumer led growth model and they have stayed firm.

economies

indicate that the slowdown is set to continue. Measures of new orders tend to be among the best leading indicators of future trends and they are still pointing to an easing in the pace of growth in new demand coming into Chinese and Indian industry. Business surveys in Brazil for early 2011 show firms expecting less buoyant conditions. The Fed has revised down its

growth outlook for the year in the wake of weaker than expected data. The economy was growing at a sub-trend annualised rate of just under 2% in the first quarter and some of the recent monthly indicators have been disappointing. The Philly Fed has a long running business survey which tends to track cyclical conditions well and it has recently turned down sharply. The US labour market is clearly taking longer to respond to growth than expected and and consumer Business are spending is still soft. investment

exports

The

Japanese

economy

is

growth and we are expecting growth to slow to 8% in 2012. Elsewhere across emerging Asia, the industrial output data also shows a slowdown (affected by supply disruptions from Japan) but export growth still remains surprisingly solid.

gradually recovering from the tsunami and nuclear disasters with export industrial volumes output making and up

some of their losses. However, both remained well below their pre-disaster levels in May and business through Weak usually survey to June results show subdued. is of heel

conditions are still consumer the Achilles

spending

Japanese economic upturns as weak income growth depresses household Consumer stabilising. the year spending spending power. softened

after the disasters but is now We expect growth as reconstruction to resume in the second half of starts but the outlook through the next few years is still soft. Although is looking economic less growth uniformly

remains solid in China, the data strong. Growth in industrial

output is slowing and the latest business surveys were weaker than expected. has The not Chinese made Government

much progress in shifting the balance of growth away from investment consumption expansion volumes slowing has in and the retail actually while toward pace of sales been fixed

recently

investment

growth

remains

rapid. Rounds of tightening in monetary policy are having an effect on money and credit

Economic

conditions

vary

2% - which is above the long term average for the region. The partial economic data for the second quarter has been more mixed with some of the business surveys showing a modest softening in conditions, although they remain very buoyant by historical standards. New orders, which rose strongly between mid-2009 and late 2010 have stabilised since then, industrial output growth has slowed, employment outside Germany is stable rather than rising, exports are not rising at the rate they were but the latest retail trade numbers were better after a long flat period.

greatly across the Euro-zone with deep recessions in the peripheral countries while the core economies a centred on Germany experiencing strong upturn. have Initially been reasonably this

upturn was based on industrial exports from Germany - which spilled Belgium inputs. include over and into economies Austria the like that this in neighbouring

supply German industry with Subsequently domestic demand recovery has broadened out to Germany where, unlike most countries, the labour market is tight and by historical are standards wage being some sizeable

settlements

negotiated. Euro-zone GDP was up by around 0.8% the March quarter and year on year growth was running at around

The following table provides more detail on our global growth forecasts. GLOBAL ECONOMIC FORECASTS
IMF WEIGHTS
GDP US

ANNUAL GROWTH TOTALS 2006 2.7 2.0 3.2 2.9 5.7 5.3 12.7 2.9 9.9 6.1 8.2 6.7 5.7 4.5 5.6 2007 2.0 2.3 2.8 2.7 6.0 5.6 14.2 2.5 9.3 6.3 8.6 5.7 5.9 4.7 5.6 2008 0.0 -1.2 0.2 0.0 3.2 4.3 9.6 0.4 7.3 5.5 5.5 3.0 5.1 1.7 3.0 2009 -2.6 -6.3 -4.1 -4.9 0.2 -2.1 9.2 -2.5 6.8 2.8 -6.4 -3.6 1.8 -1.2 -0.6 2010 2.9 4.0 1.7 1.3 7.8 7.2 10.3 3.1 8.6 5.1 4.6 4.5 3.8 5.8 5.1 2011 2.7 -0.5 2.3 1.3 5.3 5.0 9.3 2.8 8.1 5.5 5.1 5.3 4.4 4.0 4.3 2012 3.3 3.9 2.1 1.8 4.9 4.4 8.2 2.6 7.4 5.9 4.7 3.2 4.2 3.8 4.3 2013 3.3 2.1 2.0 2.3 4.6 4.3 8.0 2.8 7.2 5.9 4.2 3.2 4.4 3.7 4.2

GDP JAPAN EURO GDP UK GDP Asian Tigers latin american 4 china canada India Africa CIS E Europe Middle East Other advanced GLOBAL TOTAL

0.2 0.058 0.146 0.029 0.049 0.086 0.133 0.018 0.054 0.024 0.043 0.035 0.05 0.073 0.998

Embargoed until 11.30am Tuesday, 12 July 2011

Australian outlook
Key Points
The AUD, The domestic economy continues and to the with

of zero, while forward orders fell deeper into negative territory. Although ABS job vacancies declined in the June quarter particularly in the private sector and skilled vacancies declined again in June, ANZ job ads recovered some lost ground. On the export front, the demand for commodities softened in June. Reduced vehicle and steel production and increasing supply continued to act as a moderating influence on bulk commodity prices in June. At the same time, coal production recovering, levels. have also in Queensland, below although pre-flood prices board, remains eased

struggle under the weight of the high consumer mining reticence lingering impacts of the January floods. sector, together transport, utilities and large parts of the services sector, continue to do well in broad terms. However, trade-exposed sectors outside of the mining industry including the majority of manufacturing, consumer-dependent retail and wholesale and construction are still struggling with very poor conditions. While we expect to see a boost to GDP growth in the June quarter, as the economy recovers from the flood-induced downturn in the March quarter, some weakness appears to have persisted well into the June quarter. The uptick in retail trade growth in April was countered by a disappointing outcome in May, with trends in retail trade growth remaining subdued. Employment growth in May also disappointed. Household saving rates are high and asset prices have been soft during the first half of 2011, suggesting that the softness in consumer spending behaviour will persist into the future. While business credit barely rose in May, housing credit continued to grow at a modest pace. Forward indicators outside the resources sector remain at best uneven. In June the NAB business conditions index lifted only modestly, reflecting improved sales and employment, but remained below its long-term average. Business confidence deteriorated and is now at a net balance

Agricultural

commodity across the

reflecting weaker global demand and nervousness about sovereign debt issues. The outlook is for further moderation in both mining and farm commodity prices over the next twelve months. Nevertheless, overall commodity export prices will still be sufficiently strong to keep the terms of trade close to historically high levels. The NAB survey measures of forward orders and business conditions imply that domestic demand and GDP are yet to demonstrate June quarter, that the expected forward pick-up orders associated with the mining boom. For the NAB suggest 6-monthly annualised

demand growth is a touch over 3% - with the June monthly momentum somewhat lower again. NAB business conditions indicate that 6-monthly annualised GDP growth may be around 3%. However, this is likely to be an overstatement because the survey does not fully capture the impact of weak coal mining exports.

Forward orders (change & level) as an indicator of domestic demand (6-monthly annualised) 10 8 6 4 2 0 -2 -4 02 03 04 05 06 07 08 09 10 11

3.9% in 2011/12 and 3.5% in 2012/13.

Headline inflation is expected to begin to ease in the December quarter as fruit and vegetable prices ease in response to an improving supply situation and by mid-2012 the annual headline rate could be as low tax as 1.6%. Commonwealth an increase in Treasury modelling of the impacts of the carbon indicates overall consumer prices of 0.7%. While this would be sufficient to raise the annual headline rate to a peak of 3.6% the initial impacts will be ignored for monetary policy purposes. Although the initial impact of the carbon tax will be excluded from measures of underlying inflation, it can be expected to progressively flow into core inflation. We

Domestic demand

Prediction from orders

Business conditions (change & level) as an indicator of GDP (6-monthly annualised) 8

assume this takes about a year. In explaining its decision not to raise
02 03 04 GDP 05 06 07 08 09 10 11

-2

rates at its July meeting, the Reserve Bank struck a more dovish note than in other recent pronouncements. It pointed to the slowing as global economy through and the suggested that activity may not grow as quickly expected remainder of 2011. While the RBA central scenario continues to involve (at least) trend global growth over the next couple of years and the realisation that incomes in Australia have grown strongly, there are indications that it is cognisant of the wide variations in conditions across industries. We do not expect the June quarter CPI outcome, released prior to the August Board meeting, to provide the RBA with sufficient evidence of emerging inflationary pressure given the recent run of weaker than expected data releases. As such, we have pushed back our next

Prediction from bus conds

Sources: ABS; NAB modelling Our outlook has been adjusted from last month to include the ongoing softness in the domestic economy as well as some tentative impacts from the carbon tax announcement. GDP growth in 2011 is expected to be 1.7%, rising to 4.6% in 2012, reflecting a robust recovery in the second half of 2011. The income boost from the terms of trade, the expected strong growth and task in resources the are sector to investment reconstruction Queensland expected

support this recovery. In financial year terms, our GDP growth forecasts are: 1.7% in 2010/11

rate

rise

expectation

to

December

rose a little in the month, after trending down in the first few months of this year. ANZ job ads also recovered a little in June, driven by a 4.2% rise in internet job ads, while newspaper job ads fell for a fourth consecutive month. The NAB employment index also strengthened in June. While labour conditions were relatively soft in the June quarter, we expect employment growth to strengthen in the second half of 2011 as the domestic economy strengthens and growth momentum picks up.

(previously August). That would allow sufficient time for the strength of activity to be realised and unemployment to fall significantly (to around 4.5% in our forecasts). We expect an additional rate rise will be necessary in May 2012, as the mining industry continues to strengthen and capacity constraints tighten, taking the cash rate to 5%. The RBA may also be concerned that higher carbon associated prices do not feed into price expectations and hence wages

GDP
% change 6 5 4 3 2

Participation rate
Per cent of labour force 66.0 65.9 65.8 65.7

65.6
0

65.5
-1 -2 Dec-2008
% change Source: ABS and NAB forecasts

65.4
Dec-2010
% change on year earlier

Dec-2012

65.3 65.2 65.1 Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun 2008 2009 2010
Source: ABS

As a result our forecasts suggest cash rates on the tight side of neutral when compared Inflation below). with and a Taylors rule (see

Average weekly hours worked

39.7 39.6 39.5 39.4 16.2 16.1 16.0 15.9 15.8 15.7 Jun 16.4 16.3

Interest

Rates

Section

Labour market conditions

While labour market conditions

39.3 39.2 39.1 39.0 38.9 38.8 Sep 2009 Dec Mar Jun Sep 2010 Dec Mar

strengthened a little in June, overall conditions were relatively soft in the June quarter reflecting the softness in activity in the domestic sector. Consistent with a rise in average weekly hours worked, employment rose solidly in June, with a rise in full-time employment more than offsetting a decline in part-time employment. The participation rate also

Full time
Source: ABS Labour Force Survey

Part time

Employment
.6 30
1.5

Retail turnover (current prices)

monthly trend, % change

.4

20
1.0

.2

10

0.5 0.0

.0

0
-0.5 -1.0 -1.5 Nov 2009 May 2010 Food Household goods Clothing, footwear & accessories
Source: ABS

-.2

-10

-.4

-20

Nov

May

-.6 99 00 01 02 03 04 05 06 07 08 09 10 11

-30

ABS % p.m. trend (LHS)

NAB trend net bal. (RHS)

Sources: ABS; NAB

Retail turnover (current prices) Australian labour market
4 3 2 1 0 -1 Dec 2006 Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2011 6.5 6.0 5.5 5.0 -1.0 4.5 4.0 Dec 2012 -1.5 Aug 2009 Nov Feb May Aug 2010 Nov Feb May 1.5 1.0 0.5 0.0 -0.5 monthly trend, % change

Employment (12-months-to, LHS) Unemployment rate (%, RHS)

Sources: ABS, NAB forecasts

Department stores Cafes, restaurants & takeaway food Other

Source: ABS

Although

saving

rates

are

high

and

Consumer demand and housing

Retail trade data confirmed that retailers are finding current conditions quite difficult. Monthly retail trade data (at current prices) fell by a modest 0.6%, partly unwinding a solid rise in May. In trend terms, retail trade increased moderately in the month, and has been gaining some momentum over recent months. Consistent with weak retail trade data, the NAB monthly business survey suggests that activity in the retail sector remains very weak, with retail business conditions deteriorating sharply in June, consolidating a weak outcome in May.

consumers appear cautious, consumption is expected to grow modestly in response to rising household incomes during the remainder of 2011. The carbon tax package is intended to over-compensate lower income earners and to under-compensate higher income earners for the consumer price increases associated with the tax. However, we expect expected September expenditure income entrenched. that consumers prices as become will reduce the with post-tax more expenditure overall in response to higher utilities from quarter recovering 2012,

adjustments

10

House

prices

continue

to

soften.

Private and public investment

The total value of building approvals fell by 7.9% in May, after declining the soft fall in April. The fall was entirely driven by a decline in non-residential approvals, while residential approvals picked up slightly in the month. The weakness in approvals in the month is likely to reflect the negative impact of relatively high interest rates (as well as the expectation for further rate rises), tight credit conditions and supply-side obstacles. By state, dwelling units approved fell sharply in Victoria and in NSW, while approvals were a little higher in Queensland after rebounding sharply in April.

According to RP Data-Rismark, capital city dwelling values fell 1.2% in the 3 months ended May. Among the major capitals the declines ranged from -4.2% in Perth to -0.1% in Sydney. The most recent NAB residential property survey indicated that house prices are likely to grow by only 0.5% over the next year, although the outlook for rents is much stronger. The strongest house price increases are expected in WA (up 1.1%) while the market is expected to be much weaker in SA/NT (a decline of 0.1% is expected) and Queensland (an increase of 0.1%). A structural shortage of dwellings

The

value

of

public-sector

building

remains nationally, although the recent decline in rates of overseas migration can be expected to prevent the situation worsening significantly. Nevertheless, this is likely to maintain a floor under dwelling prices in the longer term.

approvals continues to trend down albeit at a slower pace as Government spending initiatives continue to diminish. While building construction remains fairly subdued (particularly non-residential), continued to engineering public construction

strengthen in the June quarter, with sector construction particularly strong in the quarter.

Building approvals
$ billion per month s.a. 6

0 Aug 2008 Nov Feb May Aug 2009 Residential

Source: ABS

Nov

Feb

May Aug 2010

Nov

Feb

May

Non-residential

11

In
Public sector investment
% of GDP (quarterly, s.a.) 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 Dec 2005 Dec 2006 Dec 2007 Dec 2008 Dec 2009 Dec 2010
25 20 15 10 5

the

March

quarter,

engineering

construction work done declined because of the effects of the Queensland floods on the construction and mining sectors but was nevertheless 17.4% higher than a year earlier.

Engineering construction work done

$ billion per quarter

Building constn Engineering constn Other investment

Source: ABS Sum is total public GFCF

Construction work done

$ bilion per quarter (chain volume, s.a.) 25
0 Mar 2006 Minerals Mar 2007 Mar 2008 Mar 2009 Utilities Mar 2010 Mar 2011

Transport

All other

20

Source: ABS

Transport inc. pipelines; utilities inc. telecommunications

15

Engineering construction work yet to be done

$ billion

10

100 80

5 Mar 2006 Mar 2007 Mar 2008 Mar 2009 Mar 2010 Mar 2011

60

Residential bldg Non-residential bldg Engineering constn

Source: ABS 2007/08 prices except engineering (2008/09 prices)

40 20

Using average 5-year realisation ratios, mining capex is expected to rise by over 40% in 2010-11 and then to more than double from this high base in 2011-12. These projections imply that mining capex would have increased by almost ten-fold since 2004-05. Even using the 5-year minimum realisation ratio, mining capex is projected to more than double over the next two years. Most of this reflects the huge LNG, iron ore and other resource projects under way or committed in Western Australia. There will also be a need for engineering construction work in the rebuilding task in flood-affected areas of Queensland and elsewhere.

0 Mar 2006 Minerals

Source: ABS

Mar 2007

Mar 2008

Mar 2009 Utilities

Mar 2010

Mar 2011

Transport

All other

Transport inc. pipelines; Utilities inc. telecommunications

The

carbon

tax

announcement

is

tentatively assumed to reduce private business investment marginally during 2011-12 because of its expected impacts on relative prices and the cost of capital equipment. assumed some to offset These occur from in adjustments ahead higher of are the public

implementation of the tax. There will be investment energy-switching

technologies from 2012-13 and beyond.

12

Net exports
Most non rural commodity prices eased through May with price growth subdued in June. Commodity markets in the past month have been focused on the possible implications for global demand of a Greek government likelihood of default, such an though event the remains

the same level at this time last year. Repeating the experience of April, the softs were again the biggest movers in the month, with cotton and sugar down 24.7 and 15.3 per cent, respectively. Livestock prices also pulled back through the month with beef and lamb down 5.6 and 4.9 per cent. Dairy (down 2.5 per cent), wheat (down 1.8 per cent), wool (down 0.5 per cent) and barley (down 0.3 per cent) recorded more modest falls. Looking ahead, further weakness should be expected in the near term. The current risk-off attitude that persists in global financial markets, plus the supply response to high prices should see prices ease back further in the coming months. However, a rapid correction appears unlikely given the weather-related risk that persists in a number of commodity markets. As such, farm prices should still remain relatively high by year-end.

uncertain. On top of this, economic data over the past few months have depicted some weakness as developed economies continue to struggle against substantial headwinds tightening to in recovery developing and policy has nations

started to weigh on activity. Movements in currency markets have had little impact on commodity prices over the past few months, with the US Dollar Index (a trade weighted index of six foreign currencies against the US currency) broadly stable since April. Over the rest of 2011, we expect non rural commodity prices to remain at high levels, though some moderation in bulk commodity prices is foreshadowed as supply constraints ease.
NAB Non-Rural Commodities Price Index
Sep 1996=100
Index (f) 500 Index

Growth in demand & exports & net exports

% and % points contribution to GDP

18 15 12 9 6 3 0 -3 -6 -9 Dec 2008 Dec 2009 Dec 2010 Dec 2011

6 5 4 3 2 1 0 -1 -2 -3 Dec 2012

500

400

400

300 AUD terms 200 USD terms 100

300

Domestic final demand (12 mths to) Exports (12 months to) Net exports contribution (qtly, RHS)
Source: ABS

200

100

In

volume

terms,

net

exports

are

0 1997 1999 2001 2003 2005 2007 2009 2011 Source: ABS, ABARE, Bloomberg, Thomson Datastream, NAB

expected to contribute to growth in GDP over the remainder of 2011 as coal export volumes recover.

Costs and prices

Rural commodity prices fell during May in both USD and AUD terms. Despite the fall, prices generally remain well above There are signs of an increase in retail prices in the latest NAB business survey,

13

although retail inflation remains at very low levels. Producer price inflation generally appears to be declining in the survey.
Costs & prices (3-mth ave, annualised %)

Core CPI and NAB retail prices (% per qtr)

1.2 1.0 0.8 0.6 0.4 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 02 03 04 05 06 07 08 09 10 11

0.2
6

0.0 -0.2 -0.4

Current (LHS)
0

Underlying CPI (RHS)

Sources: ABS; NAB

-2

-4 II III 2008 Labour IV I II III IV I II III IV I II 2011 Retail price 2009 Product price 2010

Source: NAB Business Survey

14

Inflation and interest rates

Inflation
We expect core inflation to be 0.75% in the June quarter, only marginally lower than the surprisingly strong March quarter. Given the more dovish tone evident in the RBA post July it
Inflation (CPI) - Nab's Headline & Core v RBA Forecast & Target Through the year percentage change 5.0 4.5 4.0 3.5 3.0

low as 1.6%. Commonwealth Treasury modelling of the impacts of the carbon tax indicates an increase in overall consumer prices of 0.7%. While this would be sufficient to raise the annual headline rate to a peak of 3.6% the initial impacts will be ignored for monetary policy purposes. Although the initial impact of the carbon tax will be excluded from measures of underlying inflation, it can be expected to progressively flow into core inflation. We assume this takes about a year.

meeting

statement,

seems unlikely that this would be sufficient on its own to cause a rate increase at the August meeting. Given expected policy

2.5 2.0
Core CPI

RBA Target

settings (see below) we expect core inflation to continue at around or just below this quarterly rate would over see the the next This annual

1.5 1.0 Jun-02

Core CPI RBA Headline CPI

Jun-04

Jun-06

Jun-08

Jun-10

Jun-12

Australian Cash Rate & Taylors Rule 10

Cash - Taylor's rule dd Cash - actual + forecasts Cash - Taylor's rule gdp

eighteen

months.

8
Cash to Loans Spread widens to 125 points from Nov 2010

rate rise from 2.2% in March quarter to 3.0% by the end of 2011
4
Based on 100 point widening of the spread from cash to loan rates - effective from early 2008 and is maintained

before drifting back into the upper end of the target range. Headline expected quarter response improving situation 2012 and the by inflation to as begin fruit to is to and an supply midannual

2 Dec-04

Dec-06

Dec-08

Dec-10

Dec-12

By early 2012, our forecasts would see the Taylors rule moving relatively close to our interest rate projections.

ease in the December vegetable prices ease in

headline rate could be as

15

Embargoed until 11.30am Tuesday, 12 July 2011

Interest rates
The RBA left the cash rate unchanged at 4.75% at its July meeting. While the Reserve Bank indicated that growth through 2011 is unlikely to be as strong as previously forecast due to a slower than anticipated recover from the floods, it still sees overall growth at trend or above over the remainder of the forecast horizon. As such, an August rate rise appears unlikely given recent softness in the labour market and a volatile international situation. The Board noted that it will continue to assess carefully the evolving outlook for growth and inflation, which suggests that policy may not be tightened until later this year. In our judgment, December is the most likely option given that by then the strength of GDP should be well established (we expect GDP growth 1.5% and 1.7% in Q3 and Q4 2011) meaning that by late 2011 the unemployment rate should be starting to decline significantly (to 4.5% by end year). This will no doubt fuel concerns about cost and wage pressures. We have pencilled in a further (final) rise in May 2011 (bringing our end point target cash rate to 5.25%). Will we expect the impact of the carbon package will marginally slow medium term growth, the RBA will be keen, in a strong growth and rising inflation environment, to ensure that price expectations are kept under control and that higher cost of living pressures do not flow into higher wage demands.

16

Embargoed until 11.30am Tuesday, 12 July 2011

Australian Economic and Financial Forecasts

Fiscal Year 2010-11 F 2011-12 F 3.0 2.5 3.3 4.5 11.9 12.0 2011 - F 2.7 7.4 9.1 Calendar Year 2012- F 2.8 12.2 14.9 2013-F 2.7 2.2 13.4

Private Consumption Dwelling Investment Underlying Business Fixed Investment Underlying Public Final Demand Domestic Demand Stocks (a) GNE Exports Imports GDP Non-Farm GDP Farm GDP Federal Budget Deficit: ($b) Current Account Deficit ( $b) ( %) of GDP Employment Terms of Trade Average Earnings (Nat. Accts. basis) End of Period Total CPI Underlying CPI Unemployment Rate RBA Cash Rate 10 Year Govt. Bonds $A/US cents : $A - Trade Weighted Index

4.7 3.3 0.0 3.4 -0.1 9.4 1.7 1.3 21.0 -50.0

1.6 4.1 0.0 4.1 9.2 8.5 3.9 4.1 -2.2 -25.0

2.4 3.5 0.0 3.5 -0.4 7.9 1.7 1.7 3.0 NA

0.1 4.3 0.0 4.3 11.0 8.7 4.6 4.6 2.9 NA

0.3 3.6 -0.1 3.6 4.9 6.8 3.1 3.2 -2.4 NA

30.0 1.4 3.0 20.9 4.5

22.0 2.2 1.9 2.3 5.3

24.0 0.9 2.1 13.1 5.3

37.0 3.2 2.1 -5.6 4.9

53.0 3.2 1.8 -2.8 4.6

3.8 2.5 4.9 4.75 5.2 1.02 76.2

1.6 2.7 4.5 5.25 5.6 1 71.9

3.2 3.0 4.5 5 5.6 1.05 74.9

3.3 2.8 4.4 5.25 5.6 0.98 70.3

3.4 3.3 5.0 5.25 5.6 0.93 67.4

(a) contribution to GDP grow th

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Macroeconomic, Industry & Markets Research

Australia Alan Oster Jacqui Brand Rob Brooker Alexandra Knight Ben Westmore Michael Creed Dean Pearson Gerard Burg Robert De Iure Brien McDonald Tom Taylor John Sharma Tony Kelly James Glenn Group Chief Economist Personal Assistant Head of Australian Economics & Commodities Economist Australia Economist Australia & Commodities Economist Agribusiness Head of Industry Analysis Economist Industry Analysis Economist Property Economist Industry Analysis & Risk Metrics Head of International Economics Economist Country Risk Economist International Economist Asia +(61 3) 8634 2927 +(61 3) 8634 2181 +(61 3) 8634 1663 +(61 3) 9208 8035 +(61 3) 8634 8602 +(61 3) 8634 3470 +(61 3) 8634 2331 +(61 3) 8634 2788 +(61 3) 8634 4611 +(61 3) 8634 3837 +(61 3) 8634 1883 +(61 3) 8634 4514 +(61 3) 9208 5049 +(61 3) 9208 8129

Global Markets Research - Wholesale Banking Peter Jolly Head of Markets Research Robert Henderson Chief Economist Markets - Australia Spiros Papadopoulos Senior Economist Markets David de Garis Senior Economist Markets New Zealand Tony Alexander Stephen Toplis Craig Ebert Doug Steel London Tom Vosa David Tinsley Chief Economist BNZ Head of Research, NZ Senior Economist, NZ Markets Economist, NZ Head of Market Economics - Europe Market Economist Europe Foreign Exchange +800 9295 1100 +800 842 3301 +800 64 642 222 +800 747 4615 +1 800 125 602 +(65) 338 0019

+(61 2) 9237 1406 +(61 2) 9237 1836 +(61 3) 8641 0978 +(61 3) 8641 3045 +(64 4)474 6744 +(64 4) 474 6905 +(64 4) 474 6799 +(64 4) 474 6923 +(44 20) 7710 1573 +(44 20) 7710 2910 Fixed Interest/Derivatives +(61 2) 9295 1166 +(61 3) 9277 3321 +800 64 644 464 +(44 20) 7796 4761 +1877 377 5480 +(65) 338 1789

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