Surely not a surplus regardless

That's what the Australian's economics editor Michael Stutchbury asks for in his piece: Tanner needs to sharpen his razor gang to stay in surplus.

At Club Troppo, Fred Argy responds this way:

After reading today’s column by Michael Stutchbury (“Tanner needs to sharpen his razor gang to stay in surplus”), where he urges that the “Government should not fatten the budget’s structural bottom line”, I remain as bemused as ever.

The Government’s fiscal strategy is clearly defined as
- achieving budget surpluses, on average, over the medium term; and
- improving the Government’s net financial worth over the medium term.

This requires the Government to run a deficit in times of extreme market failure – of which there is no better example than the present. All western g

Unfortunately, the Government (notably Mr. Swan) is itself indecisive – stressing at times the risk of running a deficit and at other times the risk of not doing so.

Mr. Stutchbury jumps on the Swan bandwagon and puts forward three arguments against discretionary spending.

The first argument is political. “Voters remain skeptical of deficit budgeting”. Yes, they are skeptical (thanks to the rubbish that Costello was feeding the public for many years). But wouldn’t voters treat the prospect of higher unemployment as a much more serious type of threat? Even Malcolm Turnbull is urging the Government to do more to “save jobs, jobs and jobs”. How else can you do it without active political intervention – including infrastructure spending?

The second reason is economic. It is “one thing to allow the budget surplus to shrink naturally as the automatic stabilisers from a weaker economy”, as they boost spending on unemployment and reduce tax revenue. It’s another thing again “to deliberately blow the surplus”. Where does the fiscal strategy make any distinction between “automatic stabilizers” and “discretionary spending” – especially of the infrastructure kind?

The third reason is political economy. “Once the possibility of a deficit world is entertained, there is no obvious limit to what could be spent”. This is ideology triumphing over sound economics.

Stutchbury's piece is below the fold:

Tanner needs to sharpen his razor gang to stay in surplus

WAYNE Swan did more than tear up Labor's first budget in 13 years this week. He formally buried the financial foundations of the Rudd Government's first term, with the loss of $40 billion from its four-year budget bottom line.

Now the Treasurer must follow through on his warning that the Government is "going to have to cut our cloth to suit the circumstances". Cut is the word, for the alarming deterioration in the budget's bottom line signals that Finance Minister Lindsay Tanner needs to sharpen up his razor gang. And, although he appeared bumbling this week, Swan was right to refuse to concede that the budget might slip into deficit.

The idea that we should now spend the surplus built up in good times to use in today's bad times, so we can soon return to the good times, ignores one critical point.

This is not a normal economic cycle. In structural terms, the budget is probably already in deficit, which will become apparent as commodity export prices fall to more sustainable levels. This year's forecast budget surplus has collapsed from $21.7billion to $5.4 billion even though the terms of trade will still rise a final 10 per cent thanks to BHP and Rio iron ore and coal contracts.

Kevin Rudd was elected a year ago on the assumption that these rivers of gold from the China boom, itself supported by the era of cheap credit, would finance his spending programs. Instead, the China boom has come to an abrupt halt and next year's iron ore and coal contract prices will be negotiated down. The budget suggests that this will drag down the terms of trade by 8.5 per cent next year, further shrinking the surplus to virtually nothing.

Rudd's problem is that the spending programs John Howard and Peter Costello embedded in the budget during the boom are now unsustainable. China will ramp up again, but the commodity price bounty is unlikely to be as blue-sky as before.

"I hate the fact that we have wasted so much money," Access Economics director Chris Richardson says of the profligacy of the late Howard-Costello era. "This was a big cycle and it was great on the way up. But we are now losing a lot of money very fast and that process has not finished yet."

That means Rudd, Swan and Tanner need to cut into this structural budget fat before they pile on any more of their own programs. Swan calls the Government's spending plans "ambitious". Think pensioner rises, tax reform, maternity pay, handouts to the states for health, education and infrastructure for starters.

Swan stonewalled something awful during his Wednesday press conference, refusing to acknowledge that Labor's promise to maintain a surplus over the course of the economic cycle meant the budget could slip into deficit, if it were needed to cushion the economic slump.

It was a fair line of questioning. But the Treasurer refused for three good reasons, despite the "yes we can go into deficit" chorus from the big-government cheer squad.

The first reason is political. The Keynesians may be smarter, but voters remain sceptical of deficit budgeting. Malcolm Turnbull and Opposition treasury spokeswoman Julie Bishop know that completely blowing a $22 billion budget surplus in 12 months or so would be a political black mark against the Government's economic competence.

The second reason is economic. It is one thing to allow the budget surplus to shrink naturally as the "automatic stabilisers" from a weaker economy boost spending on unemployment benefits and reduce tax revenue. It's another thing again to deliberately blow the surplus.

The case against using fiscal policy to try to actively smooth out the economic cycle remains that it is all too easy for politicians to hand out budget goodies to people and all too difficult to then take them back. Think of the political furore over the Rudd Government's minor means-testing of Howard's overly generous subsidies for household solar heating. Over time, this political imbalance ratchets up the size of government for no productive end.

It may well be part of the story, highlighted by Reserve Bank governor Glenn Stevens, of Australia's productivity growth slowdown. Tanner tells the story that Liberal and Nationals ministers spent $451 million on 6141 discretionary grants in 2002. By the 2007 election year, this had exploded to $4.5 billion on 49,060 grants.

At various times, the budget papers have tried to measure the size of the budget's structural bottom line in order to make sense of rules such as maintaining a balance or surplus over the course of the economic cycle. This has gone out of fashion in Australia, in part because it suited politicians to treat the terms-of-trade revenue boost as structural and permanent rather than cyclical and temporary.

Treasury insists that any further attempts at budget pump-priming be timely, temporary and targeted. But this three-T rule already is being breached. Rudd and Swan have made it clear that the $4.8 billion pre-Christmas handout to pensioners contained in the $10.4 billion short-term fiscal stimulus package is not temporary at all, but a downpayment on a permanent pensioner pay rise.

And so the third reason is one of political economy. The budget's relatively optimistic forecast of 2 per cent economic growth this year preserves at least the appearance of preserving a budget surplus. This draws a line that must not be crossed. Once the possibility of a deficit world is entertained, there is no obvious limit to what could be spent on what to boost the economy. (By example, my counterpart at The Age urges fighting the recession threat by spending more taxpayers' money on Melbourne train lines, public housing and unemployment benefits.) This does not mean the Rudd Government should tighten fiscal policy as the economy turns down. But it means the Government should not further fatten the budget's structural bottom line. Otherwise, the budget will remain stubbornly in deficit when the economy picks up -- leaving a "black hole" for someone else to deal with.

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Going down - further

New forecasts from the International Monetary Fund predict a global recession next year with the economies of the US, Europe and Japan shrinking, and Australia's outlook worse than predicted by the Treasurer just four days ago.

"This will be tough, it will be hard, it will be difficult," said Prime Minister Rudd greeting the revised forecasts. "The bottom line is the global economy has suffered a huge whacking as a consequence of the global financial crisis."

The November update to the IMF's World Economic Outlook has the US contracting 0.7%, the UK 1.3%, mainland Europe 0.5% and Japan 0.2%. A month ago the Fund expected all but the UK to grow.

Worldwide economic growth will slow to 2.2%, well below the 3% benchmark the IMF uses to define a global recession.

As the Fund released its update the Bank of England cut its official interest rate by an unprecedented 1.5% to just 3.0% - its lowest level since 1954.

The IMF is forecasting negative inflation in the major developed economies and interest rates close to zero - something that would make economic management much more difficult...

"When you get to zero interest rates, you're done in terms of using interest rates," said the Fund's chief economist Olivier Blanchard. "We're not there yet, but as we get closer, clearly the room is smaller."

Although starting from a strong position, Australia would be hit hard.

"It's a raw material exporter and at the same time it is very much integrated with other advanced economies and expecting a slowdown for the same reasons as the other advanced economies are. Taking the two together we see real growth in Australia slowing appreciably in 2008/09, probably hitting around 1.80%," Dr Blanchard said.

In Tuesday's budget update the Treasurer Wayne Swan forecast growth of 2.0%, climbing to 2.25% the following financial year.

Mr Rudd played down the difference.

"The growth projected by both by the IMF and in the forecast released by the Treasurer are basically about the same. I think there is a difference of about 0.2%. We have to deal with the challenges we face coming off the back of this gloomy prognosis from the IMF and a global recession across the major economies next year."

The Solomon Lew-owned toy and home goods distributor PlayCorp and the Commonwealth Bank both announced plans to shed staff in response to the global slowdown.

Playcorp will sack 20 of its 100 staff working in graphic design, sales and administration in its Melbourne office.

The Commonwealth Bank confirmed that downsize its institutional banking division and corporate communications arm, but could give no numbers.

The Australian Prudential Regulation Authority revealed in its annual report that it has been helping manage small number of financial institutions that it believes are facing difficulty. "Where APRA has had concerns that an institution was not managing its liquidly or funding profile as conservatively as would be expected, supervisors have worked closely with that institution to address the concerns," the report said.

APRA did not identify the institutions.

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Want to get up to speed on Saturday's election?

New Zealand's:


Joshua Williamson of TD Securities is here to help:

Out of the nineteen registered parties in New Zealand, only two have any real ambition to lead the next Government out to 2011. These are the incumbent centre-left Labour Party and centre-right opposition National Party. Led by Prime Minister Helen Clarke, Labour has been in power since 1999 and if successful would start a fourth consecutive term in office. But opinion polls have placed the Labour Party behind the National Party, led by John Key, although the gap has been narrowing in recent months. A composite of opinion polls shows that the National Party still maintains the lead ahead of the Labour Party with the Green Party the most improved of the minor parties...

The better performance of the National Party is directly related to the weakening of the economy that has reflected badly on the incumbent government. This was despite the Government’s announcement of $10.6 billion worth of personal tax cuts that started on October 1. If the distribution of seats goes according to the general polling trend, the National Party would win 56 (currently holding 48 seats) of the 120 seats in the House of Representatives while Labour would pick up 42 seats (currently holding 50 seats).

But the performance of the Nationals would not give it enough seats to govern in its own right. In fact, neither of the major parties has held a majority since 1951, which makes the minor parties important players. Labour currently governs with the support of three other parties to give it a total of 65 seats in the House of Representatives. This time around, one of these parties, United Future has said that it will support the Nationals. All told, the Nationals can probably count on one other minor party for support. Labour, on the other hand, can probably count on support from four minor parties including the Green party. The cumulative impact of the six smaller parties, including the increase in support for the Green party could make the election result much closer than the polling for the two main parties currently suggests.

Despite the political horse-trading that will occur once the voting is tallied, the National Party should be the first past the post. The incumbent Labour Government is proving unpopular and the mood appears similar to that which saw the incumbent Liberal Government removed from power in Australia in November 2007 after voters decided that it had reached the end of its useful lifespan.

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Unemployment to rise 1% or 5% - nothing in between

Scott Haslam at UBS on what's at stake:


"How bad will the growth slowdown be? The debate seems to be centred around the somewhat banal question of whether Australia is going to incur a technical recession over coming quarters or not.

But regardless of whether GDP shows zero, slightly positive or slightly negative growth – none, one or two quarters of negative growth – it’s going to feel weak, consistent with our most significant downturn in about a decade.

The more relevant debate is about whether the unemployment rate is going to rise 1%pt or 5%pts, because history shows very clearly over the past 50 years, that there is nothing, no nothing, in between...

Indeed, in the two most recent periods where the unemployment rate rose 5%pts, 1982/83 & 1990/91, these were not short sharp slowdowns, but involved almost two years of broadly negative growth. While it’s impossible to say the latter more dire outcome won’t emerge, the shorter period of near zero growth seems more likely at this stage.

Sure, it’s true that it’s hard to see a more perfect negative storm for a credit loving commodity rich Australia than one involving a credit crisis and collapsing commodity prices. But it’s also true that if there was ever a period of time that Australia was going to outperform its advanced economy peers – given the fiscal and monetary fire-power on hand (and the insulating force of a falling exchange rate) – this also would be it.

As we’ve noted over recent months, to our advantage, the RBA has been leaning on the interest-sensitive sectors of the economy since Australia’s housing boom back in 2003, to contain inflation risks in the face of an overwhelmingly strong commodity and investment boom. Indeed, over recent years, the Australian consumers have noticeably reduced the pace at which they consume credit and increased their saving.

Deep recessions tend to arrive due to either consumers or businesses sharply curtailing their spending. Policy is working hard to counter the former - the so-called paradox of thrift. By our estimates, the 185bp of cash rate cuts passed on to date will be worth circa 9½% of after-tax income for an individual with an average mortgage, which adds to the over 2% of disposable income from this year’s tax cuts and cash-handouts.

So there’s no doubt consumer’s will have income, particularly if, as this week’s October jobs report shows, employment growth is slowing in a relatively orderly way to date (and remains positive).

But do unhappy consumers spend? We think they do, if they have money (though credit growth will surely be the victim of the Government’s most recent cash hand-out).

Challenging this notion, however, is the negative wealth effects due to the most significant fall in household net worth we have on record. If this week’s level of the Australian equity market holds through to the end of the year (…our equity strategists think we’ll see a double digit rise by then), net worth as a share of income will have fallen from its peak of 7.7 times income to just 5.7 times income. Falling wealth hashistorically aligned with rising saving rates…as people feel less wealthy, they save more out of their current income.

Helpful, in part, is the fact that in contrast to history, very little of the rise in wealth has been spent (which may reflect the most recent period was driven more by equity markets than house prices). Indeed, the rise in the saving rate over recent years is not out of line with the wealth destruction to date, suggesting the saving rate may not rise too much further, though we forecast a further rise toward 4% from 1%.

A sharp drop in business investment (the other driver of recessions) is a more worrying risk, though the much lower level of (economy-wide) corporate gearing and low and falling debt servicing costs provides some hope businesses will cut jobs growth to zero, not move it materially negative, as in 1982/83 and 1990/91."

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How low? According to Westpac...

Australian interest rates are set to move dramatically lower with Westpac predicting the lowest official rate since the Reserve Bank began targeting rates by March.

The new Westpac forecast, beefed up in the wake of this week’s Melbourne Cup Day cut is for an official cash rate of 4.00% in March – lower than at any time since the Reserve Bank began making announcing rate targets during the early 1990s recession.

The previous low - 4.25% - was reached in 2001 amid concern that Australia would follow the US and Europe into recession.

Since September the Reserve has cut rates from 7.25% to 5.25% and is expected to cut by another 0.50 points next month.

The Westpac forecast would require cuts totalling 0.75 points during the Bank’s first two board meetings of the year in February and March.

If fully passed on by banks the cuts would slash the standard variable mortgage rate to around 6.35% from its high of 9.6%...

The total saving on a $300,000 mortgage would amount to $644 per month.

Defending the forecast Westpac’s chief economist Bill Evans said the new low point of 4.00% for cash was “not aggressive in the current circumstances”.

“We expect the Fed in the US to cut 0.50 points and Europe to cut 2.00 points. The risks to this forecast are on the downside,” he said.

The Members Equity Bank, owned by industry super funds, trumped the big banks on Thursday by agreeing to pass on all of Reserve Bank’s Melbourne Cup Day 0.75% cut. Its new standard variable mortgage rate will be 7.24%.

Its spokesman Tony Beck said retail rates would only keep falling for as long as the big banks had competition.

“Competitive pressures will determine the extent to which this and future Reserve Bank rate cuts are passed on. Without competition from small banks, the big banks will dominate once again.”

The mortgage broker AFG said its sales jumped 18% in October as record numbers of borrowers refinanced to take advantage of new lower rates.

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Odd news on employment

A surprise jump in employment in October masked a hollowing out in Victoria and a rapid deterioration in NSW.

The Bureau of Statistics says an extra 34,300 Australians found work in the month, bringing the total gain in employment since June to 62,000 – more than predicted in Wednesday’s budget update.

Australia’s unemployment rate remained steady at 4.3% as it has for six of the last seven months.

Employment Minister Julia Gillard said still expected the rate to worsen to 5% as forecast in the update.

“We have been very clear with the Australian public that we anticipate an increase in unemployment. We expect unemployment to be at 5 per cent by the middle of next year and above that by the middle of the year after,” she said...

The Finance Minister Lindsay Tanner told Fairfax radio said he wasn’t prepared to trust the result.

“Look, monthly figures fluctuate. The monthly figures are very unreliable, so whether they go up or down significantly, people of both sides of politics always express great caution about emphasising monthly figures,” he said.

The figures show that 17,500 people lost their jobs in NSW in the month, one of that state’s worst results on record.

The NSW unemployment rate edged up from 4.8% to 5.2%.

Victoria retained the jobs it had, but employment increased by only 200 workers throughout the month keeping its unemployment rate steady at 4.4%.

But beneath the surface Victoria's labour force is hollowing out. More than 4,000 full-time jobs have been lost in past six months, replaced with 5,500 extra part-time jobs.

The net effect, calculated by The Age using a formula that treats two part-time jobs as equivalent to one full-time job is a mere gain of 700 full-time equivalent jobs – the worst performance of any state apart from NSW which lost 61,600.

The mining states of Queensland and Western Australia did better much than Victoria, gaining the equivalent of 40,400 jobs and 37,500. The smaller states of Tasmania and South Australia also did better, gaining 7,000 and 5,200.

Unemployment in Western Australia and Tasmania, fell to record lows of 2.2% and 3.5%.

“Looking through the data our view is that as private investment is postponed or cancelled amid an increasingly gloomy outlook jobs prospects will dim,” said JP Morgan economist Stephen Walters.

“Officials probably will not take too seriously a job report that indicates that firms rushed to employ tens of thousands of new workers as equity markets collapsed, the world's major economies plunged into recession, and governments in many countries were forced to bail out their respective banking systems.”

Westpac’s Bill Evans said employers might be reluctant to shed skilled labour during the downturn after having had such difficulty finding it during the upswing.

Mr Tanner said the economy remained “very sound”.

“The fundamentals are strong and we have got good business investment, we've got good balance sheets, we've got good banks, and still, a significant budget surplus. So it's not what's happening here that's the problem, it's just these downward pressures internationally. If they get seriously worse, then we're in uncharted territory.”

JOBS: RISING, FLAT AND FALLING

Growth in six months to October

                 Jobs*    Jobless    

Qld       +40,400        -400

WA       +37,500      -8100

Tas          +7000      -1600

SA           +5200     +4700

Vic            +700       -1500

NSW    -24,200   +17,100

Aust  +61,600     +14,200

Source: Bureau of Statistics. * Trend growth in full-time equivalent jobs. National and state trends estimated separately. 

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Shemozzle: Swan's media management

Here's what happened.

Early yesterday journalists were invited to a 10.30 am press conference with the Treasurer in the Parliament House Blue Room “on the Mid-Year Economic and Fiscal Outlook”.

The blue-covered MYEFO document is about 5mm thick (although the main points could be summarised on a couple of pages).

We turned up to the Blue Room to find no copies of the MYEFO document, and then the Treasurer started speaking.

As he spoke his staff handed out an unusually uninformative 1½ page press release – it included no tables and it was missing vital forecasts such as those for real growth and inflation in the out years.

This meant that with the possible exception of the Treasurer’s staff there was literally only one person in the room who would have known what the forecasts actually said – the Treasurer himself. It later transpired that even he wasn't too sure.

So instead of asking questions about the content, the journalists had to first engage in a fishing excercise asking questions designed to establish what the content was...


Such as:

JOURNALIST: You said at the start in your opening comments that nominal GDP might be around 3% in 2009-10. Given inflation projections, doesn’t that suggest the economy will at least not be growing in a couple of years’ time or will not be accruing any actual real growth. Also, what does this slashing of surpluses mean for the Government’s infrastructure and aspiration tax cuts?

TREASURER: All of our forecasts are there for you to digest, Laura.

JOURNALIST: They’re not.

JOURNALIST: Sorry we haven’t got any.

JOURNALIST: We normally get the Statement at this point. Why have we not got the statement?

TREASURER: The statement is coming out and you’re going to get a briefing from Treasury, and I’m happy to make myself available.


And this:

JOURNALIST: Could you clarify for us the real GDP numbers, Treasurer? You’ve given us one for this year, but what are the out years because you’ve only given us nominal figures.

TREASURER: 2009/10: 3 per cent.

JOURNALIST: So, you’re basically forecasting a very shallow…

TREASURER: Sorry, nominal GDP 2008/09: 7¾. 2009/10: 3.

JOURNALIST: Real?

TREASURER: Real GDP: 2. 2009/10: 2¼.


And then this:

JOURNALIST: What is the outlook for inflation… in the out years?

TREASURER: That’s alright, I’ll just pull out the inflation numbers.

A VERY, VERY LONG PAUSE AS THE TREASURER ATTEMPTED TO LOOK THROUGH THE DOCUMENT

TREASURER: My charts, No it’s okay, I’ll pull it out here. The forecasts are…

A FURTHER VERY LONG PAUSE

TREASURER: CPI? Three and a quarter in the Budget, three and a half MYEFO.

JOURNALIST: In the outer years?

TREASURER: I’m just looking for those.

A VERY VERY LONG PAUSE

TREASURER: I’ll come to that in a sec. Go to the next one and I’ll give it to you.


The horror was that none of the 40 or so people in the room knew the answer, apart perhaps from some Treasury officials who weren't about to belittle Mr Swan by publicly helping him out.

Two questions later the Treasurer came up with answer.

And then, after the press conference, as we left the room the Treasurer's press secretaries handed us the copies of MYEFO from boxes. There had been more than enough to go around.

A colleague who had to leave the press conference early saw the boxes outside of the door then, so there was no obvious physical reason why the documents could not have been handed out ahead of the press conference when they were needed.

Tackled as to the reasons for behaving this way the Treasurer’s staff said that that was how it was done under the previous government - no documents were handed out until after the press conference about them was over.

Costello and Howard did act that way sometimes, but that doesn’t make it a good idea. In fact it is an ugly and cynical idea whose motivations can only be guessed at and does not befit a goverment commited to openness.

As it happens, when Costello and Howard unveilled last year’s MYEFO in the lead-up to the election they did hand it out. We used it to ask them questions during the press conference.

And they also made sure that the press release they distributed had all the relevant facts on it and that they knew them.

Here's a different way that Swan and his staff could have handled things:

1. Hand out any document they wish to release ahead of the press conference about it. Ten minutes or 30 minutes would be okay;

2. Summarise the main points of the document (with tables) on a few sheets of paper for the journalists (and for themselves);

3. Then invite questions about the content of the document rather than questions designed to elicit what it is.

Will they do it that way from here on? I reckon. What happened Wednesday was a shemozzle, a farce. It is excruciating to listen back to. Almost no-one in the room was familiar with the document they were talking about.

Australia deserves better. Swan's office can and will do better.

I am sure Wayne Swan himself would like to put Wednesday behind him.

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Swan's shemozzle

I'll fill you in on the reasons later, but Lenore Taylor in the Australian summarises well what happened, and how it felt:

"POLITELY asking Wayne Swan what the inflation forecasts are didn't sound like a question to stop a press conference.

But when the Treasurer took almost 1 1/2 minutes to answer, fumbling through notes and looking around to his staff for assistance, it reduced the room to dumbfounded, foot-shuffling silence.

As his obvious discomfort grew, time seemed to stall in the small room used for important government press conferences. The Treasurer's staff -- probably aware rushing to his aid would only make the situation worse -- started studying their shoes almost as soon as the question was left hanging in the silence.

Eighty long, quiet seconds later even seasoned reporters were looking around for a way to end his agony. Finally someone asked the Treasurer another question and as he answered he managed to find the inflation figures that had eluded him.

At least when then deputy Labor leader Brian Howe walked into a cupboard while trying to get out of a press conference in 1991, the embarrassment was mercifully brief...

It's likely that, in preparing to deliver the bad economic news of the mid-year economic forecasts, the Treasurer had been focusing on other things. After all, once the global economic crisis began in earnest, the Rudd Government's "war against inflation", declared earlier this year, petered out as confidence grew that the inflation genie was going to pop itself back into the bottle.

That, for the record, is pretty much what the new Treasury forecasts did show when Swan finally found them. Inflation is now forecast to be 3 1/2 per cent this year, falling to 3per cent next year and 2 1/2 per cent in the two years thereafter.

That finally puts it back in the Reserve Bank's target zone. But both the bank and the Government are concentrating on far more pressing problems. It just goes to prove that perceptions of both the magnitude of problems and the passage of time are relative.

The race that stopped the nation on Tuesday took more than twice as long as Swan's desperate search for the inflation answer yesterday. Yet, compared with the uncomfortable aftermath to the question that stopped the press conference, the Melbourne Cup seemed to fly by in a wink."

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"There’s no point in trying to sugar coat this" - Swan

Declaring that the global financial crisis had knocked a $40 billion hole in future budget surpluses the Treasurer Wayne Swan signalled that a swathe of government plans including infrastructure spending and grants to the states were up for review while promising to deliver pension reform as promised.

“There are a large number of areas which we are ambitious to proceed in, in which we will have to take tough decisions and make tough choices,” the Treasurer said while launching the mid-year budget update. "But we have implemented all of our election commitments in the context of the last Budget. We have ambitious plans across a range of areas. We are going to have to cut our cloth to suit the circumstances”.

Tax receipts are forecast to collapse $4.9 billion during the current financial year and then by more than $30 billion over the next 3 years as capital gains tax and corporate tax revenues slump.

“All of that all is a consequence of what's going on internationally,” he said. “Of course if international conditions were to deteriorate further, then there could be more to come"...

This year’s budget surplus will drop from the projected $21.7 billion to $5.4 billion as a result of spending on the multi-billion economic stimulus program and waning tax revenues.

Economic growth will slip from 2.75% to 2%. Asked whether it would remain positive in each quarter or briefly slip into negative territory as predicted by forecasters including Westpac the Treasurer replied, “we expect growth to be positive, okay? That is our forecast and we have forecast this as we normally forecast these matters – 2% positive growth. I can’t be any clearer than that.”

The revisions came as the Statistician released building approvals data described by the ANZ as “an absolute shocker”.

Building approvals fell 7% in September and 22% over the year with approvals in NSW slumping to the lowest level on record.

“You’ve got to start taking the prospect of a recession very seriously when you see that kind of fall,” said ICAP Securities economist Adam Carr. “It’s tighter lending standards and the negative outlook for property prices.”

Asked to describe the risks attached to the government’s new forecasts Mr Swan said the risks were on the downside.

“But having said that, coordinated global action is occurring. You’ve seen action in terms of monetary policy and other governments move to stimulate their economies. Both those things, I think, hold out the prospect of stabilising conditions.”

The Opposition Leader Malcolm Turnbull said the forecasts were not as grim as the Treasurer’s language suggested.

“Growth is projected next year to remain positive. Compared to other countries that would be a very good result. I am concerned that the
government does not have a very good handle on these issues of economic management,” he said.

As Mr Swan held open the possibility of cutting the budget surplus further the Shadow Treasurer Julie Bishop said he was yet to deliver one.

“All he has done is forecast a Budget surplus and he has now reduced it to $5 billion. He has cut three quarters off the surplus he inherited. He is yet to deliver a surplus.”

Mr Swan said he was not “forecasting going into deficit in any single year” but that if “international conditions were to further deteriorate, that would have an impact on future surpluses”.

Westpac’s chief economist Bill Evans said it would be entirely appropriate to move the budget modestly into deficit.

“Recall that the fiscal rule is to balance the budget over the cycle. And with no net debt, there will be no concern from a balance sheet point of view,” he said.

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Meanwhile, the Bureau of Statistics turns on the lights

After earlier turning them off

In a welcome development the Bureau of Statistics announced that it would reinstate the full monthly retail trade survey which it downsized as a result of Budget cuts, citing “global developments” and heightened interest in the economy.

"Key macroeconomic statistics users had indicated that more robust monthly retail trade data are their top priority at this time for improved economic statistics."

Thank heavens.

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Economic growth will slow to close to zero

Expect to hear much more about this throught the day.

For now, here's the Mid Year Economic and Financial Review as presented on the Treasury's website:

Global economic conditions have changed dramatically since the Budget was delivered in May.

The global financial crisis has entered a new and dangerous phase. More than 30 financial institutions around the world have failed or been bailed out and, globally, stockmarkets have suffered significant losses.

These difficulties are affecting global growth, with the economic outlook for advanced economies deteriorating rapidly. All members of the G7 group of advanced economies have experienced negative growth at some time during 2008...

Australia is not immune from the effects of the global financial crisis and the global downturn. But Australia is better placed than most other countries to withstand the fallout.

In light of global developments the Government has taken decisive action to strengthen the economy and support Australians, including guarantees of bank deposits and wholesale funding and the $10.4 billion Economic Security Strategy.

Notwithstanding the significant challenges arising from the deterioration in the world economic outlook, the Australian economy is expected to continue to grow in 2008‑09. The Government is also continuing to budget for surpluses in 2008‑09 and across the forward estimates.

An underlying cash surplus of $5.4 billion is forecast for 2008‑09 (0.4 per cent of GDP). In accrual terms, the fiscal balance is expected to record a $5.8 billion surplus in 2008‑09 (0.5 per cent of GDP).

The escalation in the severity of the global financial crisis and associated weaker global economic outlook has, however, seriously impacted on the fiscal outlook, particularly from 2009‑10.

Almost all of the decrease in the surplus beyond 2008‑09 is due to the significant reduction in revenues associated with the global financial crisis. Policy decisions have had relatively little impact on estimated expenses and revenues in these years.

Expected taxation receipts have been revised down by $4.9 billion in 2008‑09, by $12.2 billion in 2009‑10, $12.4 billion in 2010‑11 and $7.9 billion in 2011‑12.

These downward revisions are largely the result of lower forecasts of capital gains tax (CGT) and company tax. Recent dramatic falls in the value of global equity markets, including the S&P ASX 200 index trading around 1500 points lower in late-October than at Budget, has reduced estimated CGT. It is expected that CGT will fall from a peak of almost $20 billion in 2007‑08, to a trough of just under $12 billion in 2009‑10. Company tax estimates have been revised down significantly as profits are expected to be negatively affected by credit market turmoil, weaker global growth and, from 2009‑10, falling terms of trade.

Cash payments in 2008‑09 are estimated to be $10.6 billion higher than at the 2008‑09 Budget. This largely reflects new policy decisions of $11.0 billion including $9.7 billion for the Economic Security Strategy.

Table 1.1 presents the fiscal and underlying cash balances for 2008‑09 and
the forward years.



Further details on the accrual and cash budget estimates are provided in Part 4: Fiscal Strategy and Outlook.

Fiscal strategy

The key elements of the Government's medium‑term fiscal strategy, as set out in the 2008‑09 Budget, are:

. achieving budget surpluses, on average, over the medium term;

. keeping taxation as a share of GDP on average below the level for 2007‑08; and

. improving the Government's net financial worth over the medium term.

The 2008‑09 Budget was delivered at a time when strong countervailing forces were affecting the economic outlook.

The fiscal strategy for the 2008‑09 Budget year was for a budget surplus of at least 1.5 per cent of GDP; to 'bank' rather than spend revisions to tax receipts; and to reorient spending and taxation arrangements so that new spending was fully offset by savings. This was designed to allow the automatic stabilisers to work.

The Government recognised the risks of deterioration in world economic conditions, and acted prudently to deliver a strong surplus — an important buffer against future uncertainties.

A strong surplus was required in the 2008‑09 Budget in order to:

. bear down on the inflationary pressures in the economy by reducing public demand;

. provide funding through current and future budget surpluses for future capital investment in the infrastructure, education, health and hospital needs of the nation; and

. ensure a strong financial position at a time of heightened uncertainty in the international economy.

During September and October it became clear that the flow‑through of global financial market developments to the economy was going to be much more severe than previously anticipated.

Accordingly, the Government has responded to these developments by adapting its fiscal policy settings for the 2008‑09 Budget year by:

. allowing the 'automatic stabilisers' — the tendency for both revenue and spending to vary in line with economic conditions — to support economic stability;

. targeting a discretionary fiscal stimulus of about 1 per cent of GDP at areas of weakness in domestic demand; and

. maintaining a strong fiscal position, including by continuing to budget for a surplus, in order to provide flexibility to adapt the fiscal stance as needed.

The adapted fiscal policy settings for 2008‑09 are consistent with the medium‑term fiscal strategy.

Domestic and international economic outlook

The Australian economy is forecast to grow by 2 per cent in 2008‑09, ¾ of a percentage point lower than expected at Budget. Growth is forecast to remain subdued at 2¼ per cent in 2009‑10. The downward revision reflects the effects of the global financial crisis on the Australian economy. This crisis represents the most significant upheaval in global financial markets since the Great Depression. The global downturn stemming from the crisis is now expected to be deeper and more widespread, and has seen growth forecasts revised down sharply around the world. The G7 economies are expected to be in recession in 2008. Australia is not immune from these effects, but is better placed than most countries to withstand the fallout.

The world economy is expected to grow by 3¾ per cent in 2008, and moderate to 3 per cent in 2009. These forecasts have been revised down since Budget, in particular for 2009, where growth has been revised down by 1 percentage point. Since Budget, there has been a significant deterioration in global financial conditions and confidence. This deterioration intensified in September and October 2008 and is expected to adversely affect global growth. Advanced economies are expected to experience little growth and emerging market economies are forecast to record below trend growth. A gradual recovery in the world economy is expected late in 2009.
Chart 1.1: Forecast economic growth rates for G7, Euro area and Australia in
2008 and 2009



Source: Australian Government Treasury. International data refers to calendar years. Australian data refers to financial years (2008‑09, 2009‑10). Calculations for G7 and Euro area growth rates use GDP weights based on purchasing power parity. The G7 comprises the US, Japan, Germany, France, Italy, the UK and Canada.

The global financial crisis will increasingly affect growth over the forecast horizon. In Australia, as in other countries around the world, there has been a tightening of credit conditions as banks have passed on higher funding costs and taken a more cautious approach to lending. Share markets have fallen sharply, to be down by around forty per cent since the start of 2008.

Global commodity prices have also fallen sharply, as it has become increasingly likely that emerging economies will be more affected by the crisis than previously expected. The outlook for commodity prices has been revised down and the terms of trade are now forecast to fall by 8½ per cent in 2009‑10. As a result, nominal GDP growth in 2009‑10 is forecast to grow by only 3 per cent, compared to growth of around 8 per cent over the last two years.

The Australian dollar has also fallen sharply over the past few months, largely as a result of the easing of monetary policy and the changed outlook for global growth and commodity prices. Falls in the Australian dollar have provided crucial support for the Australian economy on previous occasions of severe global weakness, such as during the Asian financial crisis in 1997‑98, and the previous US recession in the early 2000s. A lower dollar will again play an important role in helping the economy adjust to weaker world economic growth — by cushioning the effects on exporters and supporting Australian firms competing with imports.

The outlook for household consumption has deteriorated significantly since Budget. Consumers have been weighed down by high interest rates, tighter lending conditions and significant falls in household wealth as a result of the declines in global sharemarkets, and this has been reflected in very low levels of consumer confidence. The fiscal stimulus from the Economic Security Strategy will support consumption growth over the forecast period. Dwelling investment has likewise been weighed down by credit conditions, and will remain subdued in the near-term before recovering in 2009‑10, supported by the introduction of the First Home Owners Boost and reductions to official interest rates.

Business investment is expected to remain solid in 2008‑09, supported by the large amount of work already underway. Growth is expected to slow as these projects are completed, with investment intentions downgraded on the back of tighter credit conditions, the increased cost of equity funding and a weaker outlook for commodity prices.

High inflation persists, with headline inflation recently reaching 5 per cent. Inflationary pressures are expected to moderate as global growth slows, flowing through to lower global oil and food prices. Inflation is expected to fall to 3 per cent through the year to the June quarter 2010.

The marked deterioration in the global economic outlook, and the resulting fallout for the Australian economy, is forecast to result in more moderate employment growth than at Budget. As a consequence, the unemployment rate is forecast to rise to 5 per cent by the June quarter 2009 and 5¾ per cent by the June quarter 2010.

The global financial market crisis continues to present serious risks to the world and domestic outlook. Significant uncertainty remains over the extent and duration of the economic downturn stemming from the crisis, and the effect on Australia. While governments and central banks have acted swiftly with a view to restoring confidence in the financial system and bolstering economic growth, it remains to be seen whether these actions will be sufficient to stabilise global financial markets. Further economic weakness in advanced economies, beyond that currently anticipated, remains a distinct possibility should financial markets fail to stabilise and confidence remain brittle. This presents a downside risk to emerging economies through trade and financial market linkages. Should this risk materialise, this would have further adverse effects on Australia's economic outlook, particularly if it resulted in further weakness in growth in China and lower commodity prices than currently anticipated.

Given the current volatility in financial markets and changing global economic conditions, there will be a higher degree of uncertainty in the forecasts than usual.

Table 1.2 presents the major economic parameters used in preparing the Mid‑Year Economic and Fiscal Outlook 2008‑09. The parameters for 2008‑09 and 2009‑10 are forecasts, while those for 2010‑11 and 2011‑12 are projections. The projections of economic growth are based on analysis of underlying trends in employment and productivity. Similar to Budget, the projection years include the assumption that the prices of key non‑rural commodities will fall further from their 2009‑10 forecast levels. The projections of inflation are consistent with the medium‑term target band.

Table 1.2: Major economic parameters(a)



All parameters except the CPI are year average percentage changes. The CPI is through the year growth to the June quarter. As in previous budget documents, projections assume a two-year step down in non‑rural commodity prices.

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In the words of The Economist...

"There is no getting around the fact that Mr Obama’s résumé is thin for the world’s biggest job. But the exceptionally assured way in which he has run his campaign is a considerable comfort. It is not just that he has more than held his own against Mr McCain in the debates. A man who started with no money and few supporters has out-thought, out-organised and out-fought the two mightiest machines in American politics...

"Most of the hoopla about him has been about what he is, rather than what he would do. His identity is not as irrelevant as it sounds. Merely by becoming president, he would dispel many of the myths built up about America: it would be far harder for the spreaders of hate in the Islamic world to denounce the Great Satan if it were led by a black man whose middle name is Hussein; and far harder for autocrats around the world to claim that American democracy is a sham. America’s allies would rally to him. At home he would salve, if not close, the ugly racial wound left by America’s history and lessen the tendency of American blacks to blame all their problems on racism...

"In terms of painting a brighter future for America and the world, Mr Obama has produced the more compelling and detailed portrait. He has campaigned with more style, intelligence and discipline than his opponent. Whether he can fulfil his immense potential remains to be seen. But Mr Obama deserves the presidency."

The Economist, It's time, Oct 30, 2008

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Expect more cuts, and more again

The Reserve Bank is set to cut interest rates by a further 0.50 percentage points within weeks after its most aggressive series of cuts since the 1991 recession.

A surprise cut of 0.75 points – the third in three months – has brought the total cut in the cash rate since September to 2.00 percentage points, undoing almost five years of rate hikes.

If fully passed on the cuts would slash the standard bank variable mortgage rate to 7.6% from 9.6%, taking $400 a month off the cost of servicing a $300,000 loan.

The further cut expected in December would bring the total saving to $500.

Whereas the statement accompanying the Reserve’s October cut of 1.00 points warned that the Bank did not regard it “as establishing a pattern for future decisions”, Tuesday’s announcement included no such caution...

Instead, the Bank invited speculation about further cuts by saying it would “continue to monitor developments and make adjustments as needed to promote sustainable growth”.

Treasurer Wayne Swan said the Bank took the action to protect families and businesses from an “ugly” global financial crisis.

“The statement from the Reserve underscores the extent to which that global crisis is impacting now on this country. We are certainly not immune,” he said.

Mr Swan will this week release the Mid Year Economic and Financial Review, which is expected to show that the crisis will cut corporate tax and capital gains tax revenue by as much as $10 billion a year, destroying much of the budget surplus.

The Treasurer said that the $10.4 billion fiscal stimulus package due to hit wallets from December and the 2.00 point rate cut showed fiscal policy and monetary policy working in tandem in order to prevent a recession.

“I do expect to see positive growth, and when the outlook is published you will see the government’s forecast,” he said.

The Reserve Bank statement painted a picture of an economy in decline saying that spending and activity would be “weaker than earlier expected” as a result of “deteriorating” international conditions.

Growth in Australia’s key market, China was slowing, contributing to further falls in world commodity prices”.

“The thing that struck me the most about the Reserve Bank’s statement was the absence of any moderating commentary,” said ICAP Securities economist Adam Carr. “The Bank is clearly very worried by the global economic backdrop and the impact it will have domestically.”

The Commonwealth Bank – Chamber of Commerce quarterly survey released ahead of the rate decision showed business confidence at its lowest ebb since the survey began in the early 1990s.

The index of current conditions fell to 41.1 from 60.9 a year before.

News of the rate cut boosted the All Ordinaries 200 index 40 points. It was down 46 points before the announcement and closed the day down just 6 points. The Australian dollar dived from US67.2 cents to a low of US66 before steadying at US66.30.

Forecasters from JP Morgan, Citibank, UBS and TD Securities are all expecting a further cut of 0.50 points when the Bank board next meets on December 2.

Most expect a further 0.75 points of cuts beyond that bringing the cash rate down from today’s 5.25% to a historic low of 4.00% next year.

Commonwealth Securities raised concern that the Bank might be easing too quickly suggesting that the residential property market “could quickly build up a head of steam”.

“Not only is population growth the fastest in 20 years but the rental market is super-tight and there’s an under-supply of new homes,” said CommSec economist Craig James.

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The Commonwealth Bank can only cut 0.58 points

So it says

But this story from Dow Jones Newswires suggests otherwise:

THE gap between Australian interbank lending rates and cash rate expectations today narrowed to levels not seen since before the Lehman Brothers collapse and the following global financial markets panic mid-September.

The spread between the benchmark 90-day bank bill swap rate set and the three-month overnight index rate narrowed to 54 basis points early today, in from 64 basis points yesterday and well down from its peak of 144 basis points early October.

The current spread is the lowest it has been since September 14, which just preceded Lehman Brothers' bankruptcy filing.

The thawing in Australian lending rates also follows falls in US dollar LIBOR and its spread to the relevant overnight index swap rate.

"It has been a very gradual decline, but we are seeing signs of relief on the funding front," ICAP senior economist Adam Carr said.

"There are good indications we've seen the worst in terms of the credit freeze."

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0.75 points!

Here's what the Bank said:

"At its meeting today, the Board decided to reduce the cash rate by 75 basis points to 5.25 per cent, effective 5 November 2008.

World financial markets have remained turbulent over the past month. Global equity prices have been volatile and fell further in net terms, and there have been significant exchange rate movements, including a sharp depreciation of the Australian dollar. A number of governments have announced measures to strengthen their financial systems, which should help to stabilise conditions over time.

International economic data have continued to point to significant weakness in the major industrial economies, and there have been further signs that China and other parts of the developing world are slowing as well. These conditions have contributed to further falls in world commodity prices.

In Australia, the overall path of economic activity appears until recently to have been close to what the Board had expected, with a needed moderation in demand occurring after a period of earlier strength. Recent reductions in borrowing rates, the depreciation of the exchange rate and the fiscal stimulus announced in October will work to assist growth in the period ahead, but deteriorating international conditions and falling commodity prices will have a dampening influence. On balance, it appears likely that spending and activity will be weaker than earlier expected.

Consumer price inflation in Australia remained high in the September quarter. As expected, CPI inflation in year‑ended terms picked up to 5 per cent, while underlying measures were just over 4½ per cent. Nonetheless, capacity pressures are now easing and, given the outlook for more moderate growth in demand and activity, it is reasonable to expect that inflation in Australia will soon start to fall. Global disinflationary forces will assist in this regard, though the depreciation of the exchange rate means that the decline of inflation to the target could take longer than would otherwise be the case.

Weighing up these international and domestic developments, the Board judged that a further significant reduction in the cash rate was warranted. The Board will continue to monitor developments and make adjustments as needed to promote sustainable growth consistent with achieving the 2–3 per cent inflation target over time."

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Tuesday in Canberra

Wonderful as always, but quiet.

Melbourne Cup day is a Canberra public holiday. Yes, I know. It shouldn't be.

Outside the Treasury building (where I once worked) I noticed hardly any cars - see photo. The first time in a long time.

Things must be settling down.

At the National Museum with the children I took a look at Phar Lap's heart.

Things get busy for me at 2.30 pm.

Wayne Swan has scheduled a press conference for 2.35 pm. Yes really.

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Grim, just grim

Guest post from Macquarie's Rory Robertson

**The financial and economic damage from the global credit crunch has been accumulating since the "music stopped" in money and credit markets in August 2007. For starters, equity markets in most countries have suffered falls of around 30-40% over 2008 so far, with many commodity prices, and property prices in many places, also having come under severe downward pressure.

**Across the world, economic activity now is either slowing sharply or shrinking. And the global economic backdrop continues to deteriorate. A growing number of indicators have "fallen off a cliff" in October, suggesting that households and firms pretty well everywhere are "hunkering down" in the wake of the dramatic intensification of financial turmoil post-Lehmans' collapse in mid-September. Business investment in Q4 and beyond seems likely to show jaw-dropping slumps in many economies.

**Disturbingly, the famous "paradox of thrift" seems to have taken over for now, with households and businesses across the world suddenly "saving for a rainy day", thus ensuring that the coming economic weather is indeed bleak. As an example, Christmas parties now are being cancelled as "an acknowledgement of the need for restraint in the context of the current economic climate"...

**The US economy - the world's biggest by far - obviously is in a deepening recession, with employment looking set to shrink for another couple of years. Friday's Payrolls report probably will confirm that job losses increased in October, from 159k in September.

**Indeed, each of the big developed (G7) economies - the US, Japan, the UK, Germany, France, Italy and Canada - now is either in a severe recession or well on the way. The BRICs too - the big developing economies of Brazil, Russia, India and China - are slowing significantly. Unemployment is rising or set to rise sharply in most places.

**Accordingly, the outlook for policy rates seems clear: as unemployment rises and inflation subsides, central banks will (continue to) cut aggressively, towards 2% in the UK and the Euro-zone (from 4.5% and 3.75%), and towards 4% in Australia and New Zealand (from 6% and 6.5%). The US and Japanese economies too still need all the help they can get: from 1% and 0.3%, Japan's previous ZIRP - Zero Interest Rate Policy - is a growing prospect.

**Unfortunately, the nature and size of today's global economic and financial problems have become increasingly clear as time has passed. A vicious "feedback loop" is playing out between tighter credit, weaker economies and lower asset prices, and around again.

**Despite unprecedented official efforts, credit availability for households and businesses continues to deteriorate pretty well everywhere. Many lenders - like most everyone else - are hunkering down to survive any worst-case scenario. The obvious problem is that if lenders won't lend, then economies can't grow. Moreover, the availability and price of credit - as we saw in boom times - are big-time drivers of asset prices.

**We've experienced a serious financial panic in recent months, with dramatic falls in global equity prices, commodity prices and (non-US$, non-yen) currencies. It's been a particularly wild and woolly time since Lehmans collapsed in mid-September.

**That event sparked a sudden intensification of "risk aversion", a massive global rush to the safety of cash and other risk-free assets. In a period of about six weeks, many equity- and commodity-price indexes generally dropped by around 30%, and many (non-US$, non-yen) currencies experienced dramatic if smaller drops.

**Why that savage episode of liquidation? Well, since the early-2000s, there had been strong market uptrends in global equities, commodities and many (non-US$, non-yen) currencies. Buying bred buying, increased leverage and higher prices on the way up. Now, "deleveraging" of hedge funds and financial institutions in particular is underway on a massive scale, selling has bred selling, and prices have been forced sharply lower.

**While there's been some welcome stability in recent days, no-one knows how the current extraordinary episode will end. Despite governments across the globe intervening aggressively to support their banks and other intermediaries at the core of their financial systems, and central banks cutting interest rates aggressively, the global credit crunch of the late-2000s rapidly is becoming the most damaging financial event in our lifetimes.

**It's not exaggerating the seriousness of the current situation to say that global financial disaster still is possible. For starters, growing economic weakness - and falling revenues - will turn many loans "bad", and undermine the balance sheets of lenders everywhere.

**Moreover, as noted above, the availability and cost of credit are critical drivers of asset prices. Unfortunately, the ability of capital-constrained financial systems in the G7 economies to sustain recent levels of credit - let alone produce credit growth - is under extreme stress.

**With demand having slumped recently in most economies, equity prices sharply lower and credit conditions tighter, trading conditions for many businesses are extremely difficult, to say the least. Across the globe, large numbers of firms - both big and small, financial and non-financial - will cease operations over coming quarters and years. As the volume of insolvencies surges, assets will continue to be transferred from weak balance sheets to strong balance sheets, at lower prices.

**The good news is that G7 inflation no longer is a problem, the "Third Oil Shock" is dead - buried by the more-than-halving of the US$ oil price since mid-year - and interest rates are being reduced. Earlier widespread worries about excess inflation have been crushed by growing excess capacity and rising unemployment globally, alongside sharp falls (reversals) in oil and other commodity prices.

**Policy rates are falling towards record lows across the G7 and the OECD. In the US, the Fed last week cut its funds rate by a further 50bp to 1%, revisiting 2003-04's rock-bottom rate. The US policy debate now is turning towards "deflation" and the merits of ZIRP.

**As noted here previously, US headline CPI inflation will be less than 1%, perhaps less than zero, by this time next year. The drop from recent 5-6% headline rates will be dominated by the reversal of the earlier surge in petrol prices, but trend wage and price pressures also will subside significantly as US unemployment trends to 8%, maybe higher.

**In Canada - an economy "joined at the hip" to the deepening US recession - the BOC already has halved its policy rate to 2.25% (from a peak of 4.5% last December), probably on the way to 1% as unemployment trends from 6% towards 8%.

**In Japan, there's the prospect of a return to deflation and ZIRP. The BOJ last week surprised pretty well everyone by cutting its policy rate by 0.2pp to 0.3%, rather than by 0.25pp to 0.25%. Why Governor Shirakawa felt strongly enough to hold back 5bp worth of cut is unclear, not that it matters much.

**In the UK and the Euro-zone, meanwhile, the BOE and ECB have looked hopelessly flat-footed in 2008. Embarrassingly, they chose not to cut rates in the six months to September, despite their economies trending towards recession. Indeed, the ECB actually hiked in July (just after GDP shrank in Q2!), and then managed not to cut at its meeting a fortnight after Lehmans' collapse.

**On 8 October, with the Fed reportedly leading the charge, both the BOE and the ECB were dragged by the nose to a co-coordinated 50bp rate cut. Both institutions will need to cut rates by 100bp this Thursday (6 November), if critics are to be convinced that Europe's policymakers have much of a clue about the current dire situation. With local recessions just warming up, the BOE and ECB probably will both find themselves cutting to 2% (from 4.5% and 3.75% at present) over the coming 6-12 months.

On a more positive note...

**Given the savage "hunkering down" now underway in businesses and households across the globe, the Australian economy may not be able to avoid recession. The main worry is that our record-breaking uptrend in business investment may already be in full retreat. In any case, there are at least four factors that give the Australian economy a fighting chance to outperform in a serious global downturn:

(1) The RBA's effective policy framework, and plenty of monetary ammunition. The RBA has cut its cash rate by 1-1/4pp at its past two meetings, and the standard-variable mortgage rate has fallen by a similar amount. The Fed, the ECB and the BOE can only dream of such powerful pass-through. Moreover, the RBA's cash rate still is a relatively high 6%, so there's plenty of room for lower rates as required. I'm guessing the RBA will cut to a "neutral" 5% by Christmas, dragging mortgage and business-borrowing rates significantly lower.

(2) The weak A$ now is Australia's new best friend, given the substantial recent drops in global commodity prices. The A$'s 25-30% decline from mid-year highs is a huge free kick for Australian exporters and import-competers. Yes, global demand is weakening fast but at least our tourism, agricultural, manufacturing, education and other tradeable sectors will sell more with the A$ below 70 US cents than above 90 US cents (or with the TWI in the 50s rather than in the 70s).

(3) Canberra's pristine balance sheet means there is plenty of fiscal ammunition. As now is well known, there's plenty of room for counter-cyclical fiscal-policy efforts, including tax cuts, cash injections, and the further expansion of infrastructure programmes. (Both those already announced, and those that will be announced over the next year or two.) Importantly, with a no-net-debt starting point - and Australia's lenders well regulated and still-very profitable - Canberra's guarantee of financial system deposits and selected (new and existing) debt securities is absolutely credible.

(4) Australia's housing sector is widely seen as having the problem of "under building" rather than "over-building, as in the US. In particular, net immigration rising from 100k towards 200k over the past decade has collided with a flat two-decade trend in new home starts of only 150k per annum. That is, Canberra has overseen the biggest immigration programme in Australia's history, without initiating the construction of extra homes. ("Land release" and "planning" for home-building generally are overseen by State and local governments.) The dismal lack of co-ordination between Canberra and the States on immigration and housing long has been seen as a problem, putting upward pressure on home prices and rents, and reducing "housing affordability". Now, Australia's slow-moving housing-supply response suddenly seems a good thing, limiting somewhat the size of any future home-price falls.

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The strange artifact that makes us think house prices are collapsing

Australian house prices are officially falling faster than at any time since the 1970s, but the collapse may not be all it seems.

The Bureau of Statistics reports that Australian capital city house prices fell 1.8% between the June quarter and the September quarter of this year – the biggest slide since its reports began. Melbourne prices slid 1.9%.

The news would be disturbing were it not for a pattern that has been developing after these “preliminary” figures have been published.

Three months ago the Bureau's preliminary figures suggested that Melbourne house prices slid 0.3% between the May and June quarters.

This week it quietly revised that result up to a jump of 1.0%.

The recent pattern has been for the headline-grabbing preliminary reports to show weak house prices and later less-publicised revisions to show improvements.

The Bureau says this is because it gets its preliminary information from the banks who collect house price data when they approve loans. It later replaces it with the more comprehensive data collected by land titles offices.

Recently the makeup of the banks' loans has changed...

They have acquired new customers who would have once borrowed from non-bank lenders, many of them for lower-value houses. It's making the preliminary estimates of house prices less reliable than they used to be and usually more negative than they should be.

Melbourne house prices may well be sliding as this week's figures suggest, but probably not as fast as those figures suggest, and almost certainly not faster than at any time since the 1970s as the figures suggest.

A new supplier of house price information RP Data believes that that prices are showing signs of recovering. Owned by the shared-equity mortgage provider Rismark International, RP collects detailed information from agents which allows it to compare like sales with like sales - the same number of bedrooms in the same suburb, a method it believes gives a truer picture.

It's indicative figures for the September quarter suggest that prices fell 0.5% nationally, down from 2.0% in the preceding quarter. It says Melbourne prices scarcely moved, falling 0.02%.

Melbourne houses and units sold faster than in any other capital. Melbourne houses were sold in an average of 35 days compared to 39 days in Sydney and 61 in Perth.

RP Data's national research director Tim Lawless said he expected the lower-priced segments of the market to recover first, “with first home buyers leading the charge” to take advantage of dramatically lower interest rates and the doubling of the first home buyers grant.

“Premium priced properties will take significantly longer to recover as these markets are much more heavily influenced by the ongoing pain being inflicted by the share market, lower company profits and lower than than expected bonuses,” Mr Lawless said.

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Expect 0.50 points, perhaps more

We will know here, at 2.30pm AEDT

Australia's Reserve Bank will announce it's third successive interest rate cut minutes before the running of today's Melbourne Cup, with the betting being on whether the cut will be a cut of 0.50 percentage points or more.

A cut of 0.50 points if fully passed on would cut the standard variable mortgage rate to around 8%. A cut of 0.75 points would take it below 8%. It would be the first time mortgage rates had been below 8% since late 2006.

As Bank staff prepared for today's meeting and the 2.30pm announcement they were presented with new figures showing job vacancies dwindling, retail spending sliding and inflation evaporating.

The inflation gauge prepared by the Melbourne Institute and TD Securities collapsed to an annual rate of 3.9% in October from an official rate of 5% in September.

“It shows starkly the speed at which inflation is unwinding, said TD strategist Joshua Williamson. “A further cut in interest rates is entirely appropriate"...

Retail sales fell a seasonally-adjusted 1.1 per cent in September, led down by spending on non-essential goods. Large retailers did better than small retailers.

The Macquarie Bank's Rory Robertson warned that “paradox of thrift” seemed to have taken over, with households and businesses suddenly “saving for a rainy day” and so ensuring that the weather became bleak. He said as an example, Christmas parties were being cancelled as “an acknowledgment of the need for restraint in the context of the current economic climate”

The ANZ count of job advertisements released Monday fell 5.9% in October, with Victorian newspaper job advertisements down 11% in the month and 31% over the year.

“Growth in newspaper job advertisements is at its weakest since 2001,” said ANZ economist Warren Hogan. “The economy avoided recession then but the unemployment rate climbed from to 7%. The only weaker outcomes for newspaper job advertisements were in the recessions of 1991 and 1982.”

The Reserve Bank's commodity price index slid 5.1% in October, its first fall after a year of spectacular gains.

The Treasurer Wayne Swan said the economy was slowing, but that he did not expect a recession.

“The Government will publish in the next week or so our Mid-Year Economic and Fiscal Outlook and all of those figures will be out there for everybody to see. But I would just make this point: the Government does expect to see positive growth. We are not immune from the fallout of the global financial crisis. You can see that in the data today.”

Financial markets are pricing in a 100% chance of a rate cut of 0.50 points today and an 81% chance of a larger cut.

Most of the data before the board builds a case for a larger cut. Building the case for caution is a belief amongst Reserve Bank staff that the retail trade figures are unreliable following cutbacks at the Bureau of Statistics and that the $1,000 bonus payments to be delivered to families, pensioners and carers in December will boost consumer spending in the lead up to Christmas.

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Commodity prices: Now that's a turndown!

Pretty sharp eh? Quite different to how it looked last month.

As the RBA puts it:

Preliminary estimates for October indicate that the Index fell by 5.1 per cent (on a monthly average basis) in SDR terms, following an increase of 0.7 per cent (revised) in September. The largest contributors to the fall in October were decreases in the prices of copper, wheat, nickel and aluminium.

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Another Bishop howler

From a press conference a few moments ago:

"In the May Budget the Government forecast that 134,000 jobs would be lost in the next 12 months."

Er, Julie, in the May budget the Government forecast an increase in the number of jobs.

This is becoming concerning.

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St George has fallen, BankWest is in danger, and the Bendigo bank will be next, so...

Here's the Consumers Association's advertising campaign:




Good, eh?

Here joshua Gans and Rabee Tourky outline what's wrong with Swan's argument that allowing big banks to gobble up small ones makes banks safer.

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Super Super Tuesday

Jessica Irvine in the Sydney Morning Herald:

"It's the odds-on favourite for a Tuesday trifecta: an interest rate cut of half a percentage point at 2.30pm, Mad Rush to win the Melbourne Cup at 3pm and Barack Obama for US President.

But racegoers beware. Of the three bets, picking a Melbourne Cup winner has the longest odds.

"It certainly will be easier making money on interest rates than it will be trying to get a winner home in the Melbourne Cup," a Centrebet spokesman, Neil Evans, told the Herald"...

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An incredible statement

Shadow Treasurer Julie Bishop, today:

JOURNALIST: Does the Opposition have any idea on how to free up those frozen funds?

JULIE BISHOP: If the Government had not put in place an unlimited guarantee in the first place this would never have occurred.

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At last, genuine help instead of diversions

Investors facing hardship have been thrown a lifeline as Prime Minister Kevin Rudd concedes it will be tough to avoid a recession.

The Securities and Investments Commission told mortgage funds late yesterday that, on request, it would amend the rules governing their operation to allow them to give preference to people in genuine hardship when deciding who gets access to limited funds.

At present the funds are required to treat all members equally when deciding whether to allow redemptions.

The change would allow them to give preference to members who are "unable to meet reasonable and immediate family living expenses". Those members would be limited to withdrawing a maximum of $20,000 each, plus half of the balance of their investment. This would mean that a member with $100,000 in a frozen fund would get access to $60,000.

ASIC chairman Tony D'Aloisio defended the cap, saying it would ensure hardship cases continued "to participate in the risks and rewards of the investments along with other members".

The Investment and Financial Services Association welcomed the move as "genuinely good news".

"ASIC needs to be commended for the work they have done and the time they have done it in," association chief executive Richard Gilbert said.

But he could give no guarantee that every one of the 15 or so funds that have frozen redemptions would take advantage of the offer..

"It will depend on the circumstances of each fund and the liquidity of the fund and its cash flow," he said. "We will do our best to expedite the process but I can't put days or weeks on it."

Mr Rudd adjusted his language on the economy, openly countenancing the possibility of a recession.

Avoiding a recession was "the core challenge of the Government," he told Fairfax radio.

Mr Rudd said he agreed with the Reserve Bank deputy governor that Australia probably could avoid a recession but that "the other thing to say in levelling with people is that this will be tough, very tough".

"Most other developed economies around the world are either in recession or heading there right now, and we are part of a global economy," he said.

Reserve Bank data released yesterday showed consumer credit shrinking faster than at any time since the 1991 recession as households paid off debts or decided against new borrowing.

ANZ economists said that underlying consumer debt might be shrinking even faster than the September figures suggested as they would have been artificially boosted by borrowing to cover margins in a month in which the share market fell 10%.

Mr Rudd said he was confident that "a fair whack" of the bonus payments the Government would be sending to pensioners, families and carers in December would be spent but that he could not be certain.

"At the end of the day I can't predict what each individual consumer is going to do with their money," he said, adding that this was "one of those times when the entire nation will try very hard to pull together".

Other data released yesterday showed that home sales fell further in September despite that month's 0.25 percentage point interest rate cut and a further 4.5% slide in job vacancies in October.

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