Nab June 09

Embargoed until 11.30am Tuesday 14 July, 2009

NAB’s Monthly Business Survey & Economic Outlook – June 2009 „ „

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Business confidence improves further while business conditions jump sharply. Trading and profitability back to levels not seen since the collapse in global activity in late 2008 while labour shedding significantly slower. Key drivers of the jump in activity include better performances in manufacturing, construction, wholesaling and finance. Suggesting government stimulus continues to temporarily boost growth. Forward orders jump very sharply (retail & cars). But capacity utilisation unchanged as stocks fall. Survey suggests domestic demand returned to growth in mid 2009. Global forecasts for 2009 unchanged at -1¾% – but signs of stabilisation in the rate of fall in global activity continue to emerge. While growth still some way off, the worst appears to have passed. We have maintained our domestic GDP forecasts for 2009 at -½ per cent and 1% in 2010. We see some of the current strength as temporary with activity to continue to decline in H2 and unemployment to rise significantly (to around 8% next year). Wage pressures ease further but retail prices only just starting to slow. Core CPI could disappoint. RBA now on hold - less inclined to cut rates further, but we would not rule out late cycle cuts as unemployment rises (albeit this is no longer our base case). Rate rises not likely till H2 2010.

June Survey – Key Results • Business conditions jumped sharply – with the overall index up from -14 to -2 index points. This returns the index to the levels of September 2008 just prior to the collapse of Lehman Brothers. All components of the index improved significantly. Trading and profitability improved 10 and 7 points respectively (to index readings of +3 and -2 respectively) – in both cases bringing the indexes back to around the levels of December 2008 when the Government’s first cash payments impacted. • The improvement in employment was even sharper – albeit still implying moderate labour shedding. Overall the employment index jumped 18 points to -7 index points – the biggest monthly improvement in the history of the Monthly Survey – to around levels last seen in October 2008. • Forward orders also jumped sharply - again a record monthly improvement – with the index increasing 14 points to an overall index of zero points. That surge in orders was however driven by very strong retail orders – especially car retailing given the investment allowance. Against that, capacity utilisation edged only marginally higher to a still low 79.3 per cent (79.2 per cent last month). • Confidence again increased – up 6 points to +4 index points – the first positive reading since December 2007. That improvement reflected improved confidence in manufacturing and finance. However, taking on board recent improvements all sectors are now trending higher on confidence. Capital spending also improved to +6 points (-10 last month), with exports also up. • Labour costs were flat in June with wage rises offset by lower employment. As a result labour cost increases have slowed to 1.8% over the last year (2.1% last month). Economy wide prices fell by 0.3% in June, reflecting flat purchase costs and the strong AUD. As a result annual inflation fell from 2.7% to 2.2%. Retail prices were also subdued – up 0.3 per cent – but have only just started to slow. Hence the core CPI in Q2 2009 could surprise on the upside (above 0.7%). • Credit availability eased somewhat – with 15% of respondents reporting tougher credit availability (22% in May). Those reporting no demand for credit increased to a record 43% (33% in May) pointing to continued reluctance to borrow in the current environment. In d e x

35

35

Q u a rte rly

30

M o n th ly

25

30 25

C o n d i ti o n s

20

20

15

15

10

10

5

5

0

0

-5

-5

-10

-10

-15

-15

-20

-20

-25

-25

-30

-30

C o n fi d e n c e Jun-09

Feb-09

Jun 08

Oct 08

Oct 07

Feb 08

Sep-07

Sep-08

Sep-06

Sep-05

Sep-03

Sep-04

Sep-01

Sep-02

Sep-99

Sep-00

Sep-97

Sep-98

Sep-96

Sep-95

Sep-93

Sep-94

-40 Sep-91

-35

-40 Sep-92

-35 Sep-89

• There are signs that global economic activity is starting to stabilise in a range of national business surveys, trade and industrial production data. While equity and commodity markets have eased back a touch recently that probably reflected markets getting somewhat ahead of still poor fundamentals. At this stage we see no reason to revise our global 2009 forecast of -1¾% in 2009 and a moderate 2¼% in 2010. Recovery will be held back by an on-going reluctance to borrow and a gradual tightening in both monetary policy (from late 2010) and fiscal policy (in 2011). Also weakness in global labour markets will limit private sector consumption and especially business investment.

B u s i n e s s C o n fi d e n c e & C o n d i ti o n s In d e x

Sep-90

Economic & Financial Forecasts – Key Points Global

* Se a s o n a l l y a d ju s te d b y N a ti o n a l

Australia • While the Survey points to some upside to current levels of activity we have not changed our Australian GDP forecast for 2009 of – ½%. That in part reflects some scepticism as to the recorded strength in Q1 national accounts (especially in the expenditure estimates) but, more fundamentally, given the extent of recent wealth destruction we still expect very low growth in consumption especially after the cash bonuses wash out and unemployment increases. Also private investment is expected to continue to deteriorate significantly given reduced spending and lower incomes through the terms of trade. Notwithstanding very strong public spending we see final demand falling by 1½% in 2009. For 2010 we have also maintained our forecast of +1%. As a result we still see unemployment reaching 7% by end 2009 and 8% by late 2010.

• At the margin, the stronger current business results have changed the RBA’s balance of risks. With an economy holding up better than expected we now see the RBA on hold, watching for longer. While the deteriorating labour market might well see further moderate rate cuts in late 2009, we now marginally see the RBA more likely to try to tough it out – notwithstanding rising unemployment and sub target inflation. Rate increases are clearly a story for the second half of 2010 – with a target of around 3¾% by year end.

Embargoed until 11.30am Tuesday 14 July, 2009 Key Monthly Business Statistics - 3 Months to June, 2009 Apr 2009

May 2009

Jun 2009

-14 -10 -3 -10 -18 -4

-2 -14 -7 -9 -25 -27

4 -2 3 -2 -7 -11

Business Confidence Business Conditions Trading Profitability Employment Export Sales

Forward Orders Stocks Labour Costs (% q/q) Purchase Costs (% q/q) Final Products prices(% q/q) Capacity Utilisation Rate (%)

Apr 2009

May 2009

Jun 2009

-11 -16 -0.6 -0.1 -0.1 79.7

-14 -15 -0.4 0.0 0.2 79.2

0 -10 0.1 0.2 -0.3 79.3

*All data is seasonally adjusted, except purchase costs and export sales. Cost and prices data are percentage changes expressed at a quarterly rate. All other data are net balance indexes, except capacity utilisation, which is an average rate, expressed as a percentage. See Quarterly Business Survey for more details on technical data specifications. Time series data are available by subscription. Fieldwork for this Survey was conducted from June 24 to June 30 and covered over 400 firms across the non-farm business sector.

MORE DETAILED COMMENTARY Business Conditions & Confidence Undoubtedly the key message – and surprise – in the June Survey is the strength in current activity. For a number of months we have seen business confidence improve and that has continued – led in June by improving sentiment in manufacturing and finance. Much of that, however, could be put down to the prospect that “Armageddon” had been avoided. Thus, until this Survey, actual outcomes have been much less buoyant – and indeed had continued to fall. The June Survey however suggests that improved confidence has now been reflected in better business outcomes. Indeed, business conditions appear to have rebounded to a level roughly similar to that reported prior to the collapse of Lehman Brothers in September 2008 and the near global meltdown in activity that ensued. Bus ine s s Confide nce 30

Business Conditions Monthly

Index

Monthly

Inde x

Index

20

Index

30

30

30

20

20

20

10

10

Trend (SA) 10

10 Average

Ave rage

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0

0

-10

-10

-20

-20

-20

-30

-30

-30

-10

0

Trend (SA)

-10

Seasonally adjusted*

-20

Jun 09

Jun 08

Dec-08

Jun-07

Dec 07

Jun-06

Dec-06

Jun-05

Dec-05

Jun-04

Dec-04

Jun-03

Dec-03

Jun-02

Dec-02

Jun-01

Dec-01

Jun-00

Dec-00

Jun-99

-30

Dec-99

Jun 09

Jun 08

Dec-08

Jun-07

Dec 07

Jun-06

Dec-06

Jun-05

Dec-05

Jun-04

Dec-04

Jun-03

Dec-03

Jun-02

Dec-02

Jun-01

Dec-01

Jun-00

Dec-00

Jun-99

Dec-99

Se as onally adjus te d*

* Seasonally adjusted by NAB

* Se asonally adjus te d by NAB

All components of the business conditions index improved significantly (see chart below left hand panel). Trading and profits (up 10 and 7 points respectively) are now around levels last seen in December 2008 – at the time of the first government cash handout. That is not insignificant, as there is little doubt that the second round of cash handouts together with the extension of the first home owners grant and the investment allowance, has impacted significantly on the June readings. That is also suggested by the sharp improvements in manufacturing, construction and wholesaling in June – together with ongoing out performance in retail. Easing in global financial markets at the same time has helped the finance sector. That said perhaps the most surprising aspect of the Survey was the much improved labour market outcomes. The monthly increase of 18 points in June is the largest monthly movement in the Survey’s history. In brief, the Survey suggests that the better trading and profits has seen business significantly slow the rate of labour shedding. Overall, based on the average of recently Monthly Survey results for both business conditions and forward orders, the Survey suggests domestic demand growth of around ½% or nearly 2% at an annualised rate (see chart below right hand panel). While the Survey results for the March quarter were less negative than the Statistician’s actual estimates for demand, a relatively flat outcome in the first half of 2009 would be an extremely credible performance. While the Survey clearly points to much better than expected outcomes, the real question is whether this improvement can be sustained into the second half of 2009 as the impact of cash handouts and the first home owners grants start to fade. Here we are less certain – albeit increased infrastructure spending will clearly boost public sector demand. Overall we are still very much in the camp that, however welcome the current strength might be, it will not be able to be sustained. Clearly much depends on that judgment and future Survey results will need to be closely watched.

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Embargoed until 11.30am Tuesday 14 July, 2009 Trading , Profits & Em ploym e nt

Forward Orders (Change & Level) As an Indicator of Domestic Demand - 6 Mthly Annualised % in Demand

Monthly, s e as onally adjus te d 3 m onth m oving ave rag e *

Inde x

Inde x

30

30

Trading

25

10

10

8

8

6

6

4

4

2

2

0

0

25

20

20

15

15

Profits

10

10

5

5

0

0

-5

-5

-10

-10

-15

-15

-20

-20

-2

-2 DEMAND 6Mthly Annualised

Employment

-4

-6

-6 Dec-08

Dec-07

Dec-06

Dec-05

Dec-04

Dec-03

Dec-02

Dec-01

Dec-00

Dec-99

Dec-98

Dec-97

Dec-96

Dec-95

Dec-94

Dec-93

Dec-92

Dec-91

Dec-89

Jun 09

Jan-09

Aug-08

Oct 07

Mar 08

May-07

Jul-06

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Feb-06

Apr-05

Sep-05

Nov-04

Jan-04

Jun-04

Aug-03

Oct-02

Mar-03

May-02

Jul-01

Dec-01

Feb-01

Apr-00

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Nov-99

Jan-99

-30 Jun-99

-30 Aug-98

-4

-25 Dec-90

-25

Forward Orders

* Se as onally adjus te d by National us ing TRAMO SEATS

In terms of some of the more forward looking indicators in the Survey, the very sharp jump in forward orders is encouraging - see chart below (left hand panel). While retail forward orders are clearly the strongest (helped by the Government’s cash hand outs) and motor vehicle retailing orders surged on the back of the investment allowance (contributing by itself 3 of the 14 point increase) the bottom line is orders in other cyclical sectors have also moved off their previously extreme lows. That said, and allowing for one off elements, the trend level of orders has again returned to levels around that of September 2008. Also it appears that higher general confidence levels have helped temporarily increase investment spending (albeit again the investment allowance has had an impact) – see chart below right hand panel. Whether that translates into an upward revision to longer term investment intentions is more doubtful – with information on that issue to be released in the full Quarterly Business Survey in a few weeks time. New Forward Orde rs Inde x

Monthly

Inde x

10

Original

50

15

15

Capital Expenditure: Monthly, Quarterly & Annual

Index

10

40

Ave rag e

5

30

0

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20

50 Jun '07 to Jun '09

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Annual Expectations - LHS

Tre nd 5

Index

30 20 Monthly Trend

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10 Qtrly Acutal - LHS

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-10 Se as onally adjus te d*

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Monthly

-30

-30 Dec-90 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Jun-07 Oct-07 Feb-08 Jun-08 Oct-08 Feb-09 Jun-09

Jun 09

Jun 08

Jun-07

Jun-06

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Jun-04

Jun-03

-30 Jun-02

-30 Jun-01

-25

Jun-00

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-10

Qtrly Expectations - LHS

* Se as onally adjus te d by NAB

Exports Inde x

Inde x

Monthly

15

15 Orig inal

10

10

Tre nd

5

Elsewhere in the Survey there was evidence of improved export orders – with the index moving up 16 points to an overall reading of -11points. As shown in the chart (right hand side) this data is quite spiky but looking through that volatility does suggest some trend improvement in recent months.

5

0

0 Ave rag e

-40

-45

-45

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Jun 09

-35

-40 Jun 08

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-35

Jun-07

-25

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Jun-05

-15

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Jun-04

-10

-15

Jun-03

-5

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Jun-02

-5

Embargoed until 11.30am Tuesday 14 July, 2009 Against all the positives, it was notable that the level of capacity utilisation in the economy overall did not really improve much – with the aggregate level of capacity in June at 79.3% compared with 79.2% last month (see chart below left hand panel). In broad terms there was little change across industry – albeit with some evidence of a bottoming at very low levels in (especially) manufacturing and construction. Retail and wholesale capacity utilisation rates have not really changed much in recent months. It appears – as evidenced by the aggregate stock index see chart below right hand column – that recent improved trading has been very much driven by further de-stocking (with the aggregate index still around -10 points). Indeed the de-stocking indices are especially large in manufacturing (24), construction (-32) retail (-17) and wholesale (-15). Stocks

Capacity Utilisation Utilisation rate % 86

Monthly

Index

Seasonally adjusted & trend

85 84

Index

20

20

15

15

10

10

Trend

Average

83

5

82

0

81

-5

80

-10

5 0

Trend (SA)

* Seasonally adjusted by NAB

Jun 09

Jun 08

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Jun-06

Dec-06

Jun-05

Dec-05

Jun-04

Dec-04

Jun-03

Dec-03

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Dec-01

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-20 Dec-00

-15

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Jun 08

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Jun-06

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Jun-02

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78

-10

-15

Jun-99

Seasonally adjusted*

Seasonally adjusted*

Dec-99

79

-5

* Seasonally adjusted by NAB

Since late 2008 we have included a question asking how businesses view the availability of credit. As shown by the chart below there has been a slight decrease in difficulty in accessing credit – with 15% of respondents reporting tougher credit availability (22% last month). Further, those not requiring credit rose to 43% in May (33% last month). As such, the key driver of slowing growth in credit in Australia (unlike overseas) still remains slower demand for credit – rather than credit rationing. Availability of Finance Constraint 60 November March

December April

January May

February June

NET DIFFICULT Y

50

%of firms

40

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0 Significantly more difficult

Slightly more difficult

No Change

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Significantly No easier Borrowings reqd

Trends by Sector and State In trend terms, as can be seen from the charts below, the improvement in business confidence has been broad-based. Clearly, retail confidence has been particularly helped by the Government cash payments, while mining confidence has recovered somewhat due to an improving sentiment in commodity markets.

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Embargoed until 11.30am Tuesday 14 July, 2009

B u s in e s s C o n fid e n c e M o n th ly , S e a s o n a lly

A d ju s te d

b y

3 m o n th

I n d u s try

M o v in g

A v e ra g e * I n d e x

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Retail Wholesale

Trans & Util Mining

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Mfg Construction

Jun-07

-40 Jun 09

-40 Mar-09

-30

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Fin Bus & Prop Rec&Pers

The trend improvement in business conditions is also broad based – with the exception of recreational services. Retail continues to lead the way on the back of cash handouts while mining has also strengthened noticeably on the back of a less bleak global outlook. Most sectors appear to have bottomed – with manufacturing still at very depressed levels. B u s i n e s s C o n d itio n s b y I n d u s try M o n th l y , S e a s o n a ll y A d ju s te d 3 m o n th M o v i n g

A v e ra g e *

I n d e x

In d e x

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Mfg Construction

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Trans & Util Mining

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Jun 09

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Dec 07

-40 Sep-07

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-40 Jun-07

-20

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Fin Bus & Prop Rec&Pers

Across states the trend improvement in confidence has also been broad based and consistent – in keeping with economy wide influences – such as fiscal initiatives and lower interest rates. There is hence little difference in confidence across the states. Turning to business conditions, it is notable the previous power states of Western Australia and Queensland are reporting the weakest conditions – albeit the differences are not large. Most states are however sharing in the recent improvement in conditions. That said NSW and South Australia continue to report the least negative outcomes - albeit business conditions in all states remain poor. Business Confidence by State

30

20

20 Index, sa 3mma

10 0 -10 -20

SA

NSW

Queensland

WA

Australia

Victoria

10 0

-10 -20

-30

WA

Queensland

Australia

NSW

Victoria

SA

-5-

Jun-09

Apr-09

Feb-09

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Aug-08

Jun-08

Apr-08

Feb-08

Dec-07

Oct-07

Aug-07

Jun-09

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Oct-08

Aug-08

Jun-08

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Feb-08

Dec-07

Oct-07

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-30

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Index, sa 3mma

Business Conditions

40

30

Embargoed until 11.30am Tuesday 14 July, 2009 Cost and Price Trends NAB’s Survey suggests that the still softening labour market is being reflected in further slowing in labour costs (a wage bill measure). Indeed, as shown in the charts below, employers are continuing to reduce labour costs with the year on year growth rate of labour costs falling sharply in all sectors. In June, total labour costs were unchanged and the annual growth in labour costs slowed to only1.8% (2.1% last month). oya %

Wage growth

Wage growth

oya %

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Mining

Rec etc

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Wholesaling

Retail

Construction

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FBP

ALL

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Trans

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Purchase costs are also continuing to ease – with no growth in June. As a result the 12-months-to rate of increase decelerated to 4.7% – down from a 5.5% increase in May and from a peak of 7.2% increase as recently as January 2009. Economy-wide price pressures are also easing – with a decline of -0.3% in June, bringing the annual rate down significantly to 2.2% (2.7% last month). Retail prices have however been somewhat stickier. In June retail prices increased by 0.3% on a 3 month seasonally adjusted rate. While well down from 0.7% in May and 1.2% in April, these readings still point to the probability of an underlying CPI result in the June quarter of 0.7% or above. As a result the 12-months-to retail inflation rate remained surprisingly high at 4.1% (4.3% last month). This is not to say that core retail inflation will not fall going forward, but the lags may cause some consternation in the near term. C o s ts & P ric e s 1 2 M o n th s e n d e d , o rig in a l d a ta A n n u a l -%

A n n u a l -% 8

8

P u rc h a s e c o s ts

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L a b o u r c o s ts

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E c o n o m y -w id e p ric e s

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R e ta il p r ic e s

Jun 09

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1

NAB’s Economic and Financial Forecasts: Global Forecasts After recording a strong recovery from their exceptionally low levels in March, global financial, freight and commodity markets have lost some of those gains through the last few weeks. Some of the lift across these markets reflected a “relief rally” as traders priced in a much lower likelihood of extreme financial and economic weakness and sentiment shifted toward the expectation of a severe recession with still functioning financial systems rather than something worse. At the same time, economic data from many parts of the world have shown clear evidence of an easing in the pace of output declines and the markets have been looking forward to a resumption in economic growth through the middle of the year. Despite those fundamental underpinnings for market recovery, it does appear as if the “green shoots” advocates got a little ahead of the economic reality. Outside China, there is not much evidence yet of sustained economic growth and the process of recovery is still fragile and in its early days.

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Embargoed until 11.30am Tuesday 14 July, 2009

The most timely indicators of global economic activity suggest that conditions could finally be stabilizing after the most severe downturn of the postwar period. The pace of decline in global industrial output has settled at around 15% yoy through the first four months of the year which suggests that the level of production could have stabilized at a very low level. The CPB measure of world export volumes shows a similar picture with the drop in volumes settling at almost 20% yoy through March and April and the pace of decline tapering off quite sharply in the recent monthly numbers. Our forecast for the global economy involves a slowing in the rate of decline and then stabilisation in activity by the end of the September quarter, followed by the commencement of modest economic growth toward the end of the year. So far, that looks on track and we have not changed our global forecasts. The various national purchasing managers’ surveys bottomed out around the turn of the year and have become steadily less negative since then. Most survey results still fall short of the 50 mark that signifies expansion but the rate of decline is steadily slowing and a few of the June results even show that modest expansion has resumed in a few industries and markets. An alternative set of business surveys (the US Philadelphia Fed, the UK CBI, the French INSEE and the German IFO) show current activity declining less rapidly, consistent with industry nearing the bottom of the cycle. On the other hand, business expectations for 6 months or so into the future have become much more optimistic in the last few months and business thinks that activity will be growing by the end of the year.

Sustained recovery, however, requires ongoing growth in final demand, particularly private demand. Our forecasts are for a rather weak recovery from the current deep recession. Several deep recessions in the postwar period have been followed by rapid recoveries, producing V-shaped profiles for economic activity. For instance, global growth reached almost 5½% in 1976, after the mid-1970s recession, and 4½% in 1984, after the early 1980s downturn. The milder recessions seen in the early 1990s and at the start of this decade were followed by more moderate upswings in global economic activity. We expect global output to fall by almost 1¾% this year, the first decline of the postwar period and easily the worst outcome since the Great Depression. However, we are only expecting a fairly subdued recovery with growth of 2¼ % next year and it is only in 2011 that growth gets back to the 3½% trend seen in the last 40 years. This rather muted upturn is the outcome of opposing forces. Large amounts of stimulus are coming from economic policies around the world with near zero interest rates in several key economies and budget balances shifting heavily -7-

Embargoed until 11.30am Tuesday 14 July, 2009 into deficit, even after allowing for the impact of the downturn on the fiscal bottom line. Normally, such powerful policy stimulus would lead to a very strong upturn in economic activity. However, there are structural factors that should limit the impact of these policies. Household balance sheets became over-extended during the previous boom and there is likely to be a prolonged period of increased savings and lower borrowing as consumers seek to cut their debt/income ratios and restore their asset/liability positions in the wake of big reductions in wealth. Large parts of the international banking system are likely to take a more cautious approach to lending and that should limit credit growth and allow the pricing of risk to be more appropriate than it was before 2007. Finally, the legacy of the downturn will be much higher unemployment and large amounts of idle capacity and that should limit incentives and ability to spend among households and business. Taken overall, the powerful policy stimulus puts a floor under global economic activity and gets the recovery started but private sector imbalances and fragilities limit the extent of the upturn. The synchronised nature of the global downturn means that no region has emerged unscathed but there are big differences between them in the extent to which output has suffered. Initially it appeared as if the spending, borrowing and importing economies like the US and UK would suffer the most in the recession as the imbalances and vulnerabilities appeared most obvious there. In the event, however, it is the exporting and saving driven economies like Japan and Germany that have suffered the sharpest downturns as activity levels in their export-oriented manufacturing sectors fell sharply. Recently Japanese output has started rising again but it is still well below yearearlier levels. The charts below show how industrial output declined sharply in virtually all areas of the world after the collapse of Lehmann Brothers last September. The main exception is China where output probably fell through late last year but year on year growth was maintained. Even big closed economies like India and Brazil, where there had been some expectation that they might not see too much impact from a US/UK focused recession, found themselves caught up when the downturn became deeper and world-wide. The pace of decline in industrial output has been slowing across East Asia and Latin America but there is no sign yet of an upturn in production.

Just as the downturn was synchronised with all regions being affected, the upturn should be synchronised too. There will, however, still be significant differences between economies in the timing and extent of recovery. The US and China should be among the first to emerge from the downturn, largely reflecting the extent of stimulus to domestic demand in both economies. Chinese economic growth has slipped from a peak of 14% yoy in mid-2007 to just over 6% yoy by early 2009 as exports and real estate turned down. The Chinese economy should bottom-out in the first half of 2009 with growth accelerating through 7% by the end of this year and reaching almost 8% by the end of 2010. The US economy should continue to shrink, but at a declining rate, until September quarter with growth resuming in the final months of the year. Year-average growth should swing from almost -3% in 2009 to nearly 1½% next year.

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GDP US

GDP JAPAN EURO GDP UK GDP nonjap asia latin america china canada India Africa CIS E Europe Middle East Other advanced GLOBA L TOTAL

Embargoed until 11.30am Tuesday 14 July, 2009 IMF ANNUAL GROWTH TOTALS WEIGH TS 2006 2007 2008 2009 0.213 2.8 2.0 1.1 -2.9 0.066 2.0 2.3 -0.7 -8.0 0.161 3.0 2.6 0.6 -4.6 0.033 2.9 2.6 0.8 -4.1 0.046 5.4 5.6 2.2 -4.9 0.083 5.3 5.4 4.2 -1.3 0.108 11.0 11.8 9.5 6.6 0.02 3.1 2.7 0.8 -3.0 0.046 9.9 9.3 7.5 5.4 0.03 6.1 6.3 5.2 3.4 0.045 8.2 8.6 6.0 -5.0 0.04 6.7 5.7 3.2 -3.5 0.038 5.7 5.9 6.4 3.9 0.07 4.5 4.7 1.9 -3.0 5.0 4.9 3.1 -1.8 0.999

2010 1.3 0.8 0.4 0.8 2.4 1.6 7.7 1.0 5.3 4.0 2.0 2.2 2.0 2.2 2.3

2011 2.5 2.5 1.8 2.5 4.5 3.8 8.5 2.5 6.0 5.0 3.0 2.8 4.0 2.5 3.5

The weakness in economic activity and commodity prices has flowed into producer and consumer price inflation, facilitating the reduction of central bank policy interest rates to historically low levels. The sharp decline in industrial output has been paralleled by a steep decline in capacity utilisation rates and the percentage of capacity lying idle across the US, Japan, Canada and big Eurozone economies has risen from around 15% in late 2007 to almost 35% in mid-2009. Unemployment is also rising rapidly with the jobless rate across that same group of big economies increasing from around 5½% in late 2007 to almost 9% by mid-2009 and rates of over 10% seem likely by the end of the year. This is clearly a very difficult environment to seek wage and price rises and all the main measures show sharp declines in inflation or even the onset of deflation. The collapse in headline inflation is shown in the chart below of G7 price changes with the rate of increase of the headline CPI dropping from a peak of almost 4½% yoy in mid-2007 to a tiny fall in prices by April 2009 and at least temporary deflation is expected in some economies for parts of the year. Stripping out the volatile energy and food components on consumer prices, however, shows a more modest reduction in price pressures with the G7 core CPI inflation rate dipping from a peak of around 2½% yoy in mid-2007 to just under 1¾% yoy in April 2009. There is now a great deal of debate and uncertainty over the inflation outlook with opinion split between those who see the massive increase in central bank balance sheets and the return of the “printing of money” as a harbinger of higher inflation to come and those who focus on widespread unemployment and idle capacity as factors keeping prices down. Our view of ongoing modest inflationary pressures depends critically on both monetary and fiscal authorities withdrawing their current emergency policy stance. That process will however be gradual with consumers less willing to take on debt and banks generally more risk adverse. Globally interest rates will remain quite low through the next few years.

Australian Outlook -9-

Embargoed until 11.30am Tuesday 14 July, 2009 While the Survey (and other data) points to an improved growth momentum domestically we have not fundamentally changed our view of the economic outlook over the next 18 months or so. That reflects a number of factors relevant here: •

The first relates to some skepticism as the reported growth in GDP in the first quarter of 2009 – and in particular the very strong GDP(E) measures driven by net exports. Indeed the gap between the average measure of GDP and GDP(P) - which many including ourselves see as probably the more reliable measure – is the largest since September 1982. Gap Between GDP(A) and GDP(P) 2

1.5

1

0.5

0

-0.5

-1

-1.5

Jun-06

Jun-02

Jun-98

Jun-94

Jun-90

Jun-86

Jun-82

-2

•

While the Survey itself suggests acceleration in demand recently the actual demand estimates in the national accounts were even weaker than implied by the survey. If we combine both quarters we suspect the bottom line is an economy that has at least stalled if not gone backwards in the first half of 2009.

•

Beyond that we see elements of pull forward in the recent data – e.g. via the investment allowance and first home buyers scheme – or stimuli that will not be there in the second half of 2009 – e.g. cash hand outs to consumers and continuing strength in net exports.

•

That suggests that the second half of 2009 will see negative growth with the turning point either in late 2009 or early 2010.

This means, that while the pattern of growth between quarters may change, the bottom line in key aggregates does not – at least in calendar year terms •

Thus in calendar 2009 we still expect GDP to fall by around ½% and then grow by around 1% in 2010.

•

For the financial year however the forecasts have been raised to ¾% in 2008/09 and -1/2% (unchanged) in 2009/10.

Looking forward it is hard to see the pace of consumption being maintained in the face of less cash handouts, rising unemployment and the damage done to household balance sheets. Indeed the chart below (left hand panel) shows how robust consumption has been relative to what might have been expected without Government special measures. Equally, while interest rates have no doubt helped, we see the current improvement in construction as very much more tied to the boost to the first home owner’s scheme which is due to be phased out over the next 6 months. Nor are we convinced that business investment – post some bring forward from investment allowances – will do anything other than continue to fall significantly. Currently the forecasts imply falls of around 20% during 2009.

- 10 -

Embargoed until 11.30am Tuesday 14 July, 2009 Underlying Business Investment - Actual v Model Forecasts

Real Consumption - Annual Growth Forecasts

6.0

6%

4.0

4%

35

35%

30

30%

25

25%

20

20%

15

15%

10 2%

10%

5

oya

2.0

5%

0

0%

-5 0.0

0%

-5%

-10

-10%

-15 -2%

-20% Jun-10

Jun-09

Jun-08

Jun-07

Jun-06

Jun-05

Jun-04

Jun-03

Jun-02

Jun-01

Jun-00

Jun-98

Jun-97

Jun-96

Jun-95

Jun-94

Jun-93

Jun-92

-25% Jun-90

Dec-10

Dec-09

Dec-08

Dec-07

Dec-06

Dec-05

Dec-04

Dec-03

Dec-02

Dec-01

Dec-00

Dec-99

Dec-98

Dec-97

Dec-96

Dec-95

Dec-94

Dec-93

Dec-92

Dec-91

Actual plus f

-30

-4% Dec-90

-4.0 Dec-89

Model

-25 Model

Dec-88

-15%

-20

Jun-99

Model lhs Actual plus f

Jun-91

-2.0

In a fundamental sense we still expect exports to fall around 5% over the next year and the terms of trade to decline by another 12%. Of course public demand will be very strong – likely on current estimates to increase by around 3% in 2009 rising to around 5% in 2010. Against that private sector demand is likely to fall by more than 2% in 2009. Domestic Demand - Private & Public

Australia's Terms of Trade 1.3

7%

7%

4%

4%

2%

2%

-1%

-1%

Underlying Public Demand

-4%

0.9 0.8 Average - 1985 to 2000

Sep-10

Sep-09

Sep-08

Sep-07

Sep-06

Sep-05

Sep-04

Sep-03

Sep-02

Sep-01

Sep-00

Sep-99

Sep-98

0.6 Sep-96

Dec-10

Dec-09

Dec-08

Dec-07

Dec-06

Dec-05

Dec-04

Dec-03

Dec-02

Dec-01

Dec-00

Dec-99

Dec-98

Dec-97

Dec-96

Dec-95

Dec-94

Dec-93

Dec-92

Dec-91

Dec-90

Dec-89

-6% Dec-88

-6% Dec-87

1.0

0.7

Private Demand

Dec-86

1.1

Sep-97

-4%

Index of Export to Import Prices

Annual % change

1.2

Source: ABS, &, NAB Economics

As shown below with GDP likely to go backwards in the second half of 2009 and not return to trend growth till late 2010 unemployment continues to rise – approaching 7% by late 2009 and around 8% by late 2010 – forecasts that, not surprisingly, remain unchanged. Australian Labour Market

Real Output/Expenditure (GDP) - Quarterly

11.0

2.5%

Quarterly GDP

5%

4 per. Mov. Avg. (Quarterly GDP)

10.5 10.0

2.0%

4%

1.0%

0.5%

0.0%

9.5 9.0

3%

8.5 8.0

2%

7.5 1%

7.0

% - ra te

% c h a n g e - 1 2 m o n th s to

1.5%

6.5 0%

6.0 5.5

-1%

5.0 -0.5%

-2%

4.5

UNEMPLOYMENT RATE - RHS

4.0 3.5

D e c-8 5 S e p -8 6 Ju n -8 7 M a r-8 8 D e c-8 8 S e p -8 9 Ju n -9 0 M a r-9 1 D e c-9 1 S e p -9 2 Ju n -9 3 M a r-9 4 D e c-9 4 S e p -9 5 Ju n -9 6 M a r-9 7 D e c-9 7 S e p -9 8 Ju n -9 9 M a r-0 0 D e c-0 0 S e p -0 1 Ju n -0 2 M a r-0 3 D e c-0 3 S e p -0 4 Ju n -0 5 M a r-0 6 D e c-0 6 S e p -0 7 Ju n -0 8 M a r-0 9 D e c-0 9 S e p -1 0

D ec-10

D ec-09

D ec-08

D ec-07

D ec-06

D ec-05

D ec-04

D ec-03

D ec-02

D ec-01

D ec-00

D ec-99

D ec-98

D ec-97

D ec-96

D ec-95

D ec-94

D ec-93

D ec-92

D ec-91

D ec-90

D ec-89

D ec-88

D ec-87

D ec-86

-3% D ec-85

D ec-84

-1.0%

EMPLOYMENT - LHS

Finally, on inflation, the Survey continues to show sharply slowing levels of wages growth and lower capacity utilisation. In the near term (i.e. the June quarter) core inflation may remain higher than expected – but that largely reflects lags. Over the forecast period however we see core inflation falling back to the RBA‘s target by early 2010 and moving sharply lower through the rest of the year. Inflation targeting suggests that interest rates should be adjusted according to where inflation is expected to be in 12 months time - both our and the RBA forecasts have

- 11 -

Embargoed until 11.30am Tuesday 14 July, 2009 inflation at the bottom of the 2-3% target (see chart below) at this horizon and going lower into 2011. Against that, Taylor’s rule would suggest that current rates should be around appropriate. Australian Cash Rate

Inflation (CPI) - Nab's Headline & Core v RBA Forecast & Target

20

Through the year percentage change 5.0

18

Cash - Taylor's rule dd

4.5

16

Cash - actual + forecasts

14

Cash - Taylor's rule gdp

4.0

12 %

3.5 3.0

10 8

2

Sep-10

Sep-09

Sep-08

Sep-07

Sep-06

Sep-05

Sep-04

Sep-03

Sep-02

Sep-01

Sep-00

Sep-99

Sep-98

Sep-97

Sep-96

Sep-95

Sep-94

Sep-93

Sep-92

Sep-91

Sep-90

0 Sep-89

1.0 Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec02 02 03 03 04 04 05 05 06 06 07 07 08 08 09 09 10 10

4

Sep-88

1.5

6

Sep-87

Core CPI Core CPI RBA Headline CPI

2.0

Sep-86

RBA Target

Sep-85

2.5

On interest rates: ¾

We now see the RBA in data watching mode and they are clearly comfortable at the current cash rate;

¾

The RBA will continue to be on hold for some time assessing the impact of what it has already done and the impact of the Government Budget. It will also want time to assess whether recent improvements in the global outlook will be sustained.

¾

If the RBA is to move in the next 3-6 months it will be down. The key drivers here are the extent of the deterioration in activity in the second half of 2009 and the labour market. If these deteriorate more than expected the RBA can use the scope provided by a lower than target inflation forecast to provide additional stimulus;

¾

Against that the RBA clearly sees the current cash rate as significantly below a sustainable medium term outcome – and will wish to raise it back to more normal levels once recovery becomes entrenched. That timing could see the upward adjustment process starting, moderately, in late 2009;

¾

While it is still a very close call the current improved growth momentum probably gives the RBA enough solace to sit out the next 6 months. And hence we have removed our previous expectation of additional 50 points of cuts in late 2009. Clearly however this judgment is very data dependent;

¾

We have the RBA starting to moderately tighten around September 2010 with the cash rate around 3¾% by years end and continuing into 2011 to reach neutral (5 to 5 ½%) by late 2011.

For more information contact:

Alan Oster Chief Economist 03 8634 2927 0414 444 652

- 12 -

Embargoed until 11.30am Tuesday 14 July, 2009

Australian Economic and Financial Forecasts Fiscal Year

Calendar Year

2008/09 -F

2009/10- F

2009 - F

2010 - F

Private Consumption

1¼

¾

1

1½

Dwelling Investment

-1¾

-5¼

-8¼

4½

3

-15

-13

-6

Underlying Business Fixed Investment Underlying Public Final Demand

3¾

4¾

3

5½

Domestic Demand

1¾

-1

-1¼

1¼

Stocks (a)

-1¼

¼

-¾

½

GNE

½

-1

-2

1¾

Exports

2¼

-3¾

-1

-3¼

Imports

-2½

-6

-11¼

¾

¾

-½

-½

1

¼

-½

-½

1

10½

1

3

1¾

Federal Budget Deficit: ($b)

-32

-58

n.a.

n.a.

Current Account Deficit

36

21

32

11

3

1¾

2¾

1

Employment

1¼

-1¼

-¼

-1¼

Terms of Trade

6¼

-12¼

-12¾

¾

Average Earnings

3

2¾

1½

2¾

Total CPI

2

2¼

2½

1½

Underlying CPI

4

2

3¼

1½

5¾

7¾

7

8

3

3

3

3¾

10 Year Govt. Bonds

5½

5¾

5½

5¾

$A/US cents

79

84

83

84

$A - Trade Weighted Index

62

64

63.5

64

GDP – Non-Farm GDP – Farm GDP

(– $b)

(– %) of GDP

End of Period

Unemployment Rate RBA Cash Rate

(a) (b)

Contribution to GDP growth Interest rates and exchange rates for the 2008/09 period are the most current at the time of writing

- 13 -

Embargoed until 11.30am Tuesday 14 July, 2009

Macroeconomic, Industry & Markets Research Australia Alan Oster Jacqui Brand

Group Chief Economist Personal Assistant

+(61 3) 8634 2927 +(61 3) 8634 2181

Vacant John Sharma Ben Westmore

Head of Australian Economics & Commodities Economist – Australia Economist – Australia & Commodities

+(61 3) 8634 2832 +(61 3) 8634 4514 +(61 3) 8634 8602

Dean Pearson Gerard Burg Daniel Farley Brien McDonald Frank Drum

Head of Industry Analysis Economist – Industry Analysis Economist – Property Economist – Industry Analysis Economist – Agribusiness

+(61 3) 8634 2331 +(61 3) 8634 2788 +(61 3) 8634 2168 +(61 3) 8634 3837 +(61 3) 8634 2041

Michael Lee

Senior Economist – Modelling and Econometric Support

+(61 3) 8634 8562

Tom Taylor Robert De Iure Vacant Mark Rodrigues

Head of International Economics Economist – Country Risk Economist – International Economist – International

+(61 3) 8634 1883 +(61 3) 8634 4611 +(61 3) 8634 3050 +(61 3) 8634 1823

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

+(61 2) 9237 1855 +(61 2) 9237 1836 +(61 3) 8641 0978 +(61 2) 9237 1180

New Zealand Tony Alexander Stephen Toplis Craig Ebert Mark Walton

Chief Economist – BNZ Head of Market Economics - BNZ Market Economist - BNZ Market Economist – BNZ

+(64 4)474 6744 +(64 4) 474 6905 +(64 4) 474 6799 +(64 4) 474 6799

London Tom Vosa David Tinsley

Head of Market Economics - Europe Market Economist – Europe

+(44 20) 7710 1573 +(44 20) 7710 2910

Sydney Melbourne Wellington London New York Singapore

Foreign Exchange +800 9295 1100 +800 842 3301 +800 64 642 222 +800 747 4615 +1 800 125 602 +(65) 338 0019

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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- 14 -