Friday, 13 January 2012

The Global Economy - On A Knife Edge

While no real surprise, the credit rating downgrades meandering through Europe only go to reinforce the parlous nature of the global economy and its financial markets.  This is not just because the eurozone, as the world's largest economic entity is almost inevitably lurching into a recession, but because when the public finances of the US are considered, it too is likely to be downgraded further over the course of 2012.

On current projections, the level of net government debt in 2015 with be around 15% of GDP higher in the US than in the eurozone as a whole.  The structure of Congress and the huffing and puffing around the Presidential election means that fiscal settings will more likely drift for longer.  It's not a welcome outlook.

Throw in the fact that monetary policy options in most G7 countries are hamstrung by a zero bound on interest rates and more quantitative easing will be as useful as an ashtray on a motor bike, and it looks increasingly likely that 2012 could be a bad one for the world economy.

Sure, there have been a few snippets of better economic news in the US in recent times, but these could merely be related to unseasonably warm weather rather than a sustainable shift in the growth momentum.  It will be telling as to whether the better news is sustained into March.

For Australia, the government is locking in a pretty dramatic fiscal tightening which for the moment should be continued.  This together with the massive headwinds from the world, mean a lot of the policy lifting will fall to the RBA.  And with the banks signalling clearly that the margin between their retail rates and the RBA cash rate will likely widen, many more rates cuts are destined for 2012.

How low will rates go?

Who knows.  But expect to see the cash rate down to 3.5% by mid year with all the risks skewing to yet lower rates beyond that.

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