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[pic] |2 August 2010 | |

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|Economic environment for the lamb industry |

|Australian economy: Rob Brooker |

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Key Points

• The global economy is now recovering: annual growth is expected to be at least 4% over the next two years. The effects of recent financial market turbulence associated with concerns about European sovereign risk have been offset by a stronger growth outlook for the industrialising economies.

• The pace of the recovery varies greatly across regions. East Asia and Latin America are driving global growth, while European prospects look extremely weak, with continuing risk of contagion. US data imply annual growth at a touch over 3%.

• Annual growth in Australia’s major trading partners is expected to average 5% over the next few years, higher than global growth because of the significance of China and India to Australia’s exports. This can be expected to maintain upward momentum in Australian commodity prices and terms of trade.

• Australia’s lamb export markets, with a relatively large US component, are expected to grow at annual rates of between 3½% and 4%.

• In Australia, cautious consumers, rising interest rates, the passing of the fiscal stimulus, falling and volatile equity markets and concerns about European debt and Sino-American growth have slowed activity and new orders (especially retail). But prospects are for growth to strengthen from a rising terms of trade, strong major trading partner growth and falling unemployment.

• Core inflation should test the upper bounds of the RBA target range, so we expect interest rate rises to begin again in late 2010 and to peak at 5½% in mid-2011.

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The global economic outlook

There has been a bout of renewed instability and weakness in global financial markets through the past few months with big falls in equity prices, increased volatility (Chart 1) and wider spreads on debt instruments (Chart 2). Commodity prices have also softened.

Key drivers of concern are:

• Fear of sovereign default in Europe and associated contagion (Chart 2);

• Signs that growth in the US may be slowing;

• Fears that China is either a bubble, or the authorities have over reacted, and growth will slow dramatically.

While fears of a double dip have clearly risen we still do not see that prospect as likely (indeed we would still see it as highly unlikely). For us the main risk of a double dip relates to sovereign risk and contagion from Europe.

|Chart 1: VIX index |

|[pic] |

|Source: Bloomberg |

|Chart 2: Benchmark 10-year bond yields (%) |

|[pic] |

|Source: Datastream |

That said while the pace of global growth may have peaked it is clearly not going backwards (Chart 3). The long-running national business surveys show such a picture. Also there is still considerable confidence among businesses in the big developed economies with generally positive survey readings on future trading conditions.

|Chart 3: Global industrial output and PMI surveys |

|[pic] |

|Source: Datastream |

Our global GDP forecasts are for 4½% growth in 2010, 4¼% in 2011 and 4% in 2012. This reflects a sharper than previously expected rebound in Latin American economies (and especially Brazil).

Key lamb markets

The key export markets for Australian lamb are the United States, the Middle East and China. Other Asian economies, Europe and Japan are also significant. Taken as a whole, we would expect annual growth in this aggregated market to average around 4% in 2010 and 2011, easing to 3½% in 2012.

United States

The US economy grew by 2½% in the year to March. That said, the policy led stimulus has passed and concerns remain that fears of European contagion and slower consumer spending will crunch activity.

While activity has slowed and is likely to slow further, current data (manufacturing and labour force data) is still consistent with on going slower growth. Further past relationships (from assets prices and policy fundamentals) suggest growth of around 3% is still in prospect.

Interestingly there are also signs of increased credit availability by financial institutions in the USA (Loan Officer Survey).

Middle East

According to the IMF, the economies of the Middle East are benefiting from a rising global demand for oil and expanding government spending programs, although high debt levels are beginning to act as a constraint. Heavy investment and rising natural gas production are expected to boost growth in Qatar to double-digit rates, growth in Egypt of at least 5% is expected on the back of government stimulus measures, and government infrastructure spending will support more moderate growth in Saudi Arabia and Kuwait.

Property market issues are expected to weigh on growth in the United Arab Emirates, while prospects in Dubai remain clouded in the aftermath of the Dubai World debt crisis. Stimulatory policies in the United States are supporting economies with currencies pegged to the US dollar (Saudi Arabia and the UAE).

China

Chinese growth in the year to March 2010 is estimated at 11.9% (and annual growth has been revised up for 2009 to 9.1%). The Chinese have moved to tighten policy to prevent bubbles developing. That has been successful – albeit some fear that it has been overdone. Manufacturing has slowed as reflected in PMI measures but growth in production is still around 15%. Overall we continue to expect growth of around 10½% in 2010 and around 9% in 2011.

Indeed Chinese attempts to slow their economy (including a slightly more flexible currency) are indicative of concerns by authorities of the risk to overheating rather than a crash.

The causes of this strong interest in dwelling ownership have been widely canvassed, including shifts in consumer preferences and tax policies favourable to house ownership.

That growth has flowed into Non Japan Asia where the tigers are likely to grow by around 5½% in 2010.

Europe

Europe remains deeply depressed. We still expect growth of less than 1% in 2010 – with only little better growth in 2011. Southern European economies remain even more depressed – and in the medium term could still well default.

The UK is only slightly better placed – and has seen aggressive fiscal tightening. Overall we expect growth of only 1¼% and 2% over the next 2 years (following falls of -4% in 2009). Monetary policy is likely to be more accommodating to help cushion the tighter fiscal stance. Thus in the UK we have delayed the start of the tightening cycle till mid-2011 (and mid-2012 for Europe).

Japan

The Japanese recession has been one of the worst, but there are now signs that the economy is returning to growth. The Japanese recovery began in late 2009. The latest Tankan survey (Chart 4) puts the recent recession into perspective and suggests that moderate growth will continue into mid-2010.

|Chart 4: Recovery in Japan |

|[pic] |

|Source: Datastream |

Global summary

Our global growth forecasts are summarised in Table 1. Overall, we expect the world economy to grow at between 4% and 4½% over the next few years. Our major trading partner economies are expected to grow more rapidly than this, at perhaps 4½ to 5½%, reflecting the significance of China to Australian trade. However, our aggregate lamb export market is likely to grow less rapidly than either our MTPs or the world economy, at between 3½ and 4% annually. This reflects the relatively greater importance of the more slowly growing US economy to the lamb sector (24% of lamb exports, compared with 6% of total Australian exports) and the lesser importance of the fast-growing Chinese economy (15% of lamb exports, 21% of total exports). Partly offsetting this, lamb exports to slower-growing Japan are relatively under-represented.

|Table 1: Global economic forecasts |

|[pic] |

|Source: NAB |

The Australian economic outlook

The moderation in the growth performance of the Australian economy in the March quarter continued into the June quarter. According to the NAB business survey, business conditions have been trending sideways so far in 2010. Outcomes for other indicators are consistent with this: building approvals have been softening, retail trade has continued to grow modestly and new vehicle sales have edged up. Employment growth, albeit a touch lower than in early 2010, remains robust, leading the unemployment rate to decline to 5.1% in June.

Euro-centric turbulence in global financial markets has contributed to domestic uncertainty and equity prices remained volatile and soft into July. With much consumer spending already having been shifted into last year by government cash drops, retailers have been under increasing pressure so far this year.

Recent rises in interest rates have also had a dampening effect on consumers. In addition, house price growth has shown signs of easing recently, despite an ongoing housing shortage.

The key positives for the domestic outlook are large increases in the terms of trade associated with higher minerals contract prices (already reflected in the monthly export data), ongoing solid major trading partner growth, and employment security associated with low levels of unemployment. Agreement appears to have been reached between the Commonwealth and the large mining companies concerning the new minerals tax regime, although negotiations will continue over the details of its implementation.

Business investment is likely to be supported by the terms of trade and an extensive pipeline of resource and infrastructure projects.

GDP growth is forecast to be 2¾% in 2010 and 3½% in 2011. In financial year terms, GDP growth is now expected to be:

• 3% in 2010/11 (was 3¼%)

• 4% in 2011/12 (was 3¾%)

Given the recent moderation in domestic growth and disturbed conditions in global financial markets, it is likely that the RBA will defer further increases in the cash rate until later in the year. We now expect the cash rate to reach 5% by the end of 2010, and to rise to 5½% by mid-2011.

Core inflation is now expected to run at 3% through 2010 and to begin to edge down towards the end of 2011.

Our detailed domestic forecasts are shown in the attached table.

Labour market conditions

Although employment growth trended down in the first half of 2010, it has been sufficient to reduce the unemployment rate to 5.1% in June. Forward indicators suggest continuing solid growth ahead. The NAB employment index has weakened recently, but is still firmly in positive territory (Chart 5). ANZ internet job ads have been rising but newspaper ads have softened. Both the SEEK (net) new job ad index and the DEEWR skilled vacancy index have edged up only marginally over recent months.

|Chart 5: Employment |

|[pic] |

|Source: NAB Business Survey |

We expect the unemployment rate to be 4¾% by the end of 2010 and 4½% by the end of 2011 (Chart 6).

|Chart 6: Labour market outlook |

|[pic] |

|Source: ABS, NAB |

Consumer demand and housing

Retail trade growth has declined from monthly trend rates as high as 0.5% in mid-2009 to below 0.2% during the first half of 2010. According to the NAB business survey, retailing conditions have been trending down into negative territory throughout 2010 and margins have continued to tighten. Personal and household goods retailing has been particularly soft. In a sign of increasing caution, consumer sentiment declined in June from reasonably strong levels to below its long-term average.

A slowing was to be expected given that last year’s growth was boosted by government subsidies and interest rates are now higher.

For 2010/11, low unemployment and strong income growth should see stronger growth in consumer spending despite rising interest rates.

Population growth and the worsening housing shortage can be expected to support housing prices and dwelling investment.

Private and public investment

The total value of non-residential building approvals has been edging down in recent months. There is little sign that the withdrawal of the public sector building stimulus is being offset by increased private sector approvals. Private sector approvals have actually fallen recently, with the phasing out of the education stimulus. Public sector approvals have continued to decline in total, with about half of the contraction associated with reductions in education approvals (Chart 7).

|Chart 7: Public sector stimulus |

|[pic] |

|Source: ABS |

Net exports

Commodity prices fell in May and remained at lower levels in June on the back of Euro financial market turbulence and concerns about US and Chinese growth. Despite these declines, negotiated contract prices for Australian iron ore and coal have risen sharply, and were reflected in a strong turnaround in the balance on goods and services in April and May. The improvement in commodity prices is expected to inject $50 billion of income into the Australian economy.

|Chart 8: Commodity price outlook |

|[pic] |

|Sources: Thomson Datastream and NAB |

Looking forward, bulk commodity prices are expected to strengthen (Chart 8), but export volumes are likely to take longer to respond to improving relative prices, and import demand should respond to rising incomes. We expect net exports to continue to detract from GDP growth in 2010/11.

Costs and prices

With tightening labour markets we are already seeing wages move back towards annualised growth rates of 4%. This is particularly evident in the mining industry and in Western Australia. Against this, we are seeing signs of discounting in retail prices.

Exchange rate and interest rates

The likely strength of commodity prices means that the Australian dollar could reach around US90c by the end of 2010 and US91c by mid-2011. Improvements in the US economy should lead to rising US interest rates which, along with a slowing in commodity price growth, might bring the Australian dollar back to around US87c by the end of 2011.

Given the recent moderation in domestic growth and disturbed conditions in global financial markets, it is likely that the RBA will defer further increases in the cash rate until later in the year. We now expect the cash rate to reach 5% by the end of 2010, and to rise to 5½% by mid-2011.

Australian summary

We expect growth to accelerate going forward as the income gains from the rising terms of trade flow through to consumption and investment, underpinned by low and falling unemployment.

|Chart 9: Economic forecasts compared |

|[pic] |

|Sources: NAB, Commonwealth Economic Statement and Pre-Election Fiscal |

|Outlook, RBA Statement on Monetary Policy |

Implications for the lamb industry

Seasonal conditions in the domestic lamb industry have recently improved, leading to stock rebuilding and reduced production. Together with higher global demand, especially as preferences in East Asia shift towards higher protein foods, this has contributed to upward pressure on domestic lamb prices.

Economic growth in Australia’s lamb export markets is likely to be highly variable, ranging from very strong growth in China, through solid growth in the Middle East, moderate in the US and Japan and poor in Europe. The resumption of growth in the minerals sector is likely to weigh on returns to agriculture generally and lamb producers in particular through upward pressure on the exchange rate. This pressure is unlikely to ease until well into 2011. In addition, producer incomes are likely to be affected by rising fuel prices and higher interest rates.

Financial conditions in Europe should be watched closely because of ongoing concerns about sovereign risk and its potential impacts on the cost and availability of global finance.

Domestic demand conditions are likely to improve over the next few years in line with the forecast growth in GDP and incomes.

Australian Economic and Financial Forecasts

| |Fiscal Year |Calendar Year |

| |2009/10- F |2010/11-F |2010 - F |2011- F |

|Private Consumption |2½ |3¼ |3 |3½ |

|Dwelling Investment |1½ |6½ |4 |13¾ |

|Underlying Business Fixed Investment |-4 |8 |1 |13 |

|Underlying Public Final Demand |9 |2½ |9¼ |-1 |

|Domestic Demand |3¼ |3¾ |4¼ |4½ |

|Stocks (a) |¼ |0 |½ |0 |

|GNE |3¾ |3¾ |4¾ |4½ |

|Exports |2¼ |6½ |4 |7½ |

|Imports |6¼ |10¾ |14¼ |11 |

|GDP |2¼ |3 |2¾ |3½ |

| – Non-Farm GDP |2¼ |3¼ |3 |3½ |

| – Farm GDP |1 |-1½ |-1¼ |2½ |

|Federal Budget Deficit: ($b) |-45 |-31 |n.a. |n.a |

|Current Account Deficit (– $b) |63 |43 |55 |40 |

| (– %) of GDP |4¾ |3 |4 |2¾ |

|Employment |1¼ |3¼ |2¾ |3 |

|Terms of Trade |-4¼ |14½ |11 |11¼ |

|End of Period | | | | |

|Average Earnings |1 |4½ |3¼ |4½ |

|(Nat. Accts. Basis) | | | | |

|Total CPI |3¼ |3¼ |3¼ |3 |

|Underlying CPI |2¾ |3¼ |3 |2¾ |

|Unemployment Rate |5.1 |4½ |4¾ |4½ |

|RBA Cash Rate (b) |4.5 |5¼ |5 |5½ |

|10 Year Govt. Bonds (c) |5.0 |5¾ |5¾ |5¾ |

|$A/US cents (c) |85 |91 |90 |87 |

|$A - Trade Weighted Index |66.5 |71¼ |71¾ |68 |

|(c) | | | | |

a) Contribution to GDP growth

b) Current

c) Current at time of writing

Macroeconomic, Industry & Markets Research

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