Sunday, January 20, 2008

The year ahead as seen by Glenn Stevens... London.

The head of the Reserve Bank has warned of a “common shock” in the form of internationally coordinated credit crunches as worldwide share markets suffered another day of losses.

The Australian index slid for the tenth consecutive day – the longest run of losses in its 15-year history.

Only 14 of its 200 stocks rose in price as the index slid a further 2.1 per cent to close down 17 per cent from its November high.

Addressing a business function in London overnight, his first overseas speech since becoming Governor, Glenn Stevens said he didn’t know how the year would pan out but he was attempting to cope with an economy “operating at full stretch” amid “financial turmoil”...

The biggest risk facing Australia and the rest of world was not a
“spillover” from slow demand in the US, but a “commonality” of financial
crises throughout the globe.

“If, for example, it were the case that a credit crunch occurred
simultaneously in many countries, there would be a contractionary impact
around the world even before any spillover effects via trade got going,” he

There had already been signs of a “common shock” in several of the world’s
leading economies in the form of “a rise in the market cost of finance and,
in some cases, perhaps, the possibility of a wider withdrawal of credit.”

“Even though it was American borrowers who could not repay, lenders much
further afield were affected.”

The Governor said that “to date” it appeared that the credit crunches would
not spread further. Asian banks appeared to have little exposure to US
sub-prime loans. But there was “no guarantee of plain sailing”.

China was just as important to the Australian economy as the US.

Indeed, for Australians “it will be just as important over the years ahead
to keep an eye out for imbalances in the Chinese economy as to watch the
problems of the US economy”

The Governor’s “guess” was that China would cope with a slowdown in the
United States because its own consumers were boosting their spending
rapidly. There was a widespread expectation that that contract prices for
some of Australia’s key commodities would rise further during 2008 pushing
Australia’s terms of trade higher still.

The resulting threat to inflation meant that the
Bank would need to act “delicately” in the years ahead, wanting to both
restrain inflation and keep the financial system in tact.

So far Australia had weathered the international financial storm well with
little disruption to its real economy.

“Firms whose business models relied on short-term debt funding have been
tested; a couple have, for practical purposes, left the scene,” the Governor

But “all that could change if the credit tightening abroad takes a serious
turn further for the worse”.

Mr Stevens described Australia’s inflation outlook as “uncomfortably high”.
He said price increases were being synchronised “in a fashion eerily
reminiscent of the early 1970s” and that not to take action against them
could itself trigger a crisis of financial confidence.

The Reserve Bank will meet to decide to decide the immediate future of
interest rates on February 5.

After meeting the Governor on Tuesday the Treasurer Wayne Swan said that
Australia faced an extended period of elevated inflation that would put
upward pressure on interest rates.

The inflation figures for the December quarter will be released on