THE BIG PICTURE: Why the Queensland floods shouldn’t slow Australia’s economy

One thing we can never escape here in Australia is natural disasters. Whether it is drought, floods, bushfires, cyclones or hailstorms, natural disasters are part and parcel of our wide, brown land. And the Queensland floods are no different. While clearly historic in size and significant in magnitude, Australians are dealing with the immediate issues, and when the waters subside, we will deal with the necessary clean up and rebuilding.

The Queensland Premier has estimated the cost of the floods at $5 billion. But estimates will change over time. First the floodwaters need to subside so that the impact to buildings, farms and infrastructure can be derived. And any estimate of the total cost involves actuarial assessments by insurance companies, builders and valuers. It needs to be remembered that we have a $1,300 billion economy and the Federal Government finances are in good shape, so the impact can be absorbed. Floods are also less damaging than cyclones or hail storms.

There have been some suggestions that the floods have pushed down the value of the Aussie dollar and may end up pushing up interest rates. Blame that on slow news days early in the year. The Reserve Bank will look through the short-term flood impact. And I suppose that the euro is also weaker because of our floods?

Some prices for fruit and vegetables will rise and some supplies will fail to reach markets at all. But shortfalls may be met via imports in some cases, by frozen product or supplies from other regions of Australia. It may be that growers from other regions will lift supplies to meet market demands. And consumers will substitute high-priced or unavailable items for other fruit, vegetables, frozen product – or do without completely.

What about the impact on the economy? In the short-term there is the impact of lost production and activity. But in many cases this will be made up over time. Given that the floods have hit early in the quarter, lost production may be made up over February and March, minimising the impact to GDP. There may be a modest reduction in export output in the March quarter that will be recovered over the June and September quarters. Further, any reduction in building and production over the March quarter will be offset by repair and rebuilding activity over the remainder of the year. We see no reason to change our GDP growth forecasts of 3.5% for 2011.

The cost of the floods will be met by governments, donations, reinsurance and private individuals. But the net cost is a different figure. Some coal and farm producers in other parts of the country will benefit from increased prices and demand. And builders, construction companies and retail operations will face increased demand for services and goods when repair and rebuilding work get underway.

The week ahead

Recent data indicates that the Australian economy ended 2010 with a whimper rather than a bang. Admittedly the data released so far covers so called “second tier” indicators. But there is a rash of “top tier” or “top shelf” indicators to be released in the coming week such as retail sales and employment, so we will get a better sense of how the economy was tracking late last year. And in the US there will similarly be a raft of ‘top shelf’ indicators.

On Monday retail sales results will be released. Unfortunately the data covers November, not the keenly-awaited December figures. For that, we need to wait another month. But for the November figures, we expect that spending lifted by around 1% in the month. That may appear encouraging, but that is until you consider that sales slumped by 1.1% in October.

Still, anecdotes from retailers suggest that consumers embraced the discounts on offer in December which adds to the more positive trends gleaned from the Commonwealth Business Sales Indicator in the last few months. Buoyed by a solid jobs market, consumers are emerging from their burrows, albeit cautiously.

Data on job advertisements will also be released on Monday. In recent months hiring demand has remained resilient, but it will be interesting if the trend has been maintained in light of weakened business activity.

On Tuesday, data should indicate that Australia notched up yet another solid trade surplus in November courtesy of the mining boom with a figure near $2 billion expected.

On Wednesday four indicators are slated for release – housing finance, credit card lending, tourist arrivals and departures and job vacancies. Most interest will be in the data on new home loans, but a flat result is expected. While the number of loans to owner-occupiers likely rose by 0.5% in November, the value of all loans, including loans to investors, probably eased 0.5%. The Reserve Bank lifted rates at the start of November so future results may prove even softer.

One area where the economy has been performing very well is in terms of job creation. On Thursday the employment results for December will be released and we are tipping a 25,000 lift in jobs, consistent with recent data showing a rise in job advertisements. If the participation rate eases from record levels, the jobless rate could also ease from around 5.2% to 5.0%.

In the US, there is a bevy of top shelf indicators to be released, but the first one doesn’t appear until Thursday. Earlier in the week wholesale sales figures are released on Tuesday with export and import prices, the Beige Book and the monthly budget on Wednesday.

On Thursday, the producer price index and international trade figures are released while consumer prices, retail sales, industrial production and consumer sentiment are all scheduled for Friday.

Most interest will be in the activity indicators – sales and production – and the results should confirm that the economic recovery is firmly grounded. Overall economists expect that retail sales lifted 0.7% in December while production rose by 0.4%.

Apart from US data, investors will also be focussed on the latest economic information from China. The monthly export and import figures are expected on Monday. Other indicators such as retail sales, production and the December quarter GDP figures are generally released around mid-month, but no set time has been scheduled as yet.

Sharemarket

The gap between the All Ordinaries index and S&P/ASX 200 is the widest in 30 months, standing at 107 points. And the differential is not far off the widest level recorded of almost 129 points. So what does it all mean?

Essentially it highlights the fact that smaller companies have been driving our benchmark indexes higher while the ‘big caps’ have been taking a breather. Over the past six months the Small Ordinaries index powered higher by almost 29% while the ‘big cap’ ASX20 index lifted just 10%. In part, the out-performance of small caps suggests an underlying confidence in the market.

However, it also occurred at the same time that the Aussie dollar lifted sharply, making Aussie big cap companies less competitive for global fund managers. So if the differential starts to narrow in coming days, investors have to first ask why it is occurring before then attempting to determine if it is a positive or negative signal for the broader market.

Interest rates, currencies & commodities

It is always difficult to make sense of trading activity at this time of year. Late in the calendar year, some fund managers and hedge funds are focussed on squaring off their accounts for the month, quarter or year while others are attempting to paint their portfolios in the best light possible by executing last minute trades. Then at the start of the year investors of all descriptions are actively involved in structuring their portfolios for the period ahead.

These exercises in bookkeeping and strategic allocation are probably the only way to explain the machinations on currency and commodity markets. One moment the Aussie dollar is riding high at a 28-year high of US102.50c and the next minute it is struggling to maintain its grip on parity with the greenback. Certainly there have been no dramatic fundamental economic changes to justify the volatility. Or for that matter to explain the sharp falls in commodity prices including a drop over US$40 an ounce in the gold price.

Craig James is chief economist at CommSec.