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Monday, October 18, 2010

Is Australia Immune?

Western world may struggle, but not Australia it appears

Since mid-2009, the world economy has recovered from what is considered the worst economic and financial crisis since the 1930s. After shrinking almost 2% in 2009 – the first contraction since World War II – global real GDP is expected to grow by 3.5% in 2010, the United Nations Council for Trade and Development (UNCTAD) said in a report out in September.

In line with the upturn, world trade has picked up again since mid-2009. Higher commodity prices are boosting national incomes and fiscal revenues. Emerging-market economies, especially in Asia and Latin America, are roaring. UNCTAD expects Asia´s GDP to jump by almost 8% this year, while Latin America´s is forecast to grow by 5%.

But the UN body is worried the global recovery may be derailed in 2011 by the poor performance of Western economies. Fiscal austerity in Europe and the US is pushing the global economy closer to a “deflationary spiral” that will choke off economic recovery, it said. “Ending stimulus measures too soon in an effort to restore the confidence of financial markets could be counterproductive.”

European countries such as Germany, the UK and France implemented austerity programs to appease bond markets after the Eurozone debt crisis erupted this year. The US Government is struggling politically to pass any more fiscal stimulus, especially with elections coming up in November for the House of Representatives and one-third of the Senate. The US Federal Reserve, which has already reduced interest rates to close to zero, is in effect contemplating printing another US$1 trillion, in an attempt to reignite US economic growth.

Australia is a Western economy with the opposite problem. The biggest mining boom in more than a century is powering the economy – the Reserve Bank forecasts it to grow between 3.75% and 4% p.a. in 2011 and 2012. The jobless rate has fallen to what is considered full employment at around 5%.

Rather than deflation, the danger is that inflation rises beyond the Reserve Bank’s target range of 2% to 3% a year. Consumer prices rose 3.1% in the 12 months ended June 30, though the more-watched core inflation – which removes volatile items from the consumer price gauge – stood at 2.7% over that time.

“The task ahead is likely to be one of managing a fairly robust upswing,” Reserve Bank Governor Glenn Stevens said in a speech in September.

Still, the Reserve Bank left the cash rate unchanged at 4.5% for a fifth consecutive month in October. But don’t be surprised if the central bank soon adds to the six quarter-percentage-point rate increases it undertook from October last year to May, which lifted the cash rate from 3%.

1 United Nations Conference on Trade and Development. “Trade and Development Report, 2010. Employment, globalization and development.“ 14 September 2010.

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This article has been produced by FIL Investment Management (Australia) Limited ABN 34 006 773 575, AFSL No. 237 865 (“Fidelity Australia”).
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