Time for RBA action as evidence of slowdown grows

MAD May has transformed the global economic outlook like no other month since September 2008 brought the collapse of Lehman Brothers.

Capital has taken wing over the last four weeks, fleeing equity markets and the securities of vulnerable countries and seeking safe haven in the bond markets of the handful of highly rated countries, including Australia.

A run of weak data from the four corners of the globe has extinguished hopes that the pall of the global financial crisis was at last beginning to lift.

The figures of one month do not give a clear direction, but at the moment a simultaneous global slowdown looks like the most likely path.

When the Reserve Bank reduced interest rates by 50 basis points last month, the decision was driven by concerns over the domestic economy.

Minutes of the May meeting recorded that global conditions "appeared to have stabilised", apart from Europe and that even there, "consumer confidence had improved".

The bank's May Monetary Policy Statement adopted the 3.5 per cent global growth forecast which the International Monetary Fund had published two weeks previously.

The fund's forecast marked an upgrade from its review of the outlook in January. It expected stronger growth in the US, Japan and China and a shallower recession in Europe as policy interventions by the European Central Bank and other authorities calmed markets.

"With the passing of the crisis, and some good news about the US economy, some optimism has returned," the IMF's chief economist, Olivier Blanchard, wrote.

He argued that optimism should be tempered, as both the efforts by banks to raise capital and by governments to rein in deficits would continue to suppress demand.

In fact, optimism vanished within days.

The fund's forecast, replicated by analysts around the world, has been that the weakness would be concentrated in the first half of this year with recovery as the year progressed.

The world would return to trend growth of 4.1 per cent by 2013. The IMF expected Europe to lift from a recession of -0.3 per cent growth this year to 0.9 per cent next, the US lifting from 2.1 per cent to 2.4 per cent and China from 8.2 to 8.8 per cent.

The developments of the last month have thrown this into doubt.

Westpac international economist Huw McKay says it now seems the good surveys in December and January cannot simply be extrapolated into the blue yonder. "Europe is going to contract for a protracted period. This is not a typical two-quarter thing.

"Once you pencil that in, the world's open economies -- the manufacturing exporters of Asia -- are going to do worse than you would have expected."

The big developments of the month are fresh doubts over the strength of the US recovery, a run of much worse-than-expected reports on China and, above all, the crisis in Europe.

News from other major economies, including Brazil and India, suggests a global slowdown.

The US had generated surprisingly strong growth late last year, with its GDP growing at 2.8 per cent in the December quarter.

Its jobless rate, which had peaked at 10.9 per cent in March 2010, came down to 8.1 per cent.

The pointers to recovery included strong business investment, some stabilisation in house prices and reasonable growth in consumer spending.

Parts of that story are still intact, but monthly jobs growth slowed from 275,000 at the beginning of the year to little more than 100,000 in March and April and only 69,000 in May. Household incomes are contracting, so the outlook for consumer spending growth is limited. Consumer confidence remains depressed.

US growth was only 1.9 per cent in the March quarter. It is getting harder to see the US driving recovery in the advanced world, especially with harsh budget cuts scheduled from the beginning of next year.

China was the greatest surprise. The standard view was that the slowdown in growth from 9.2 per cent last year to the IMF's forecast of 8.2 per cent this year reflected the government's efforts last year to cool inflation, and it would bounce back to 8.8 per cent next year.

However, a run of reports showing growth in investment at its lowest level in a decade, weak imports and exports, and industrial production growth at its lowest since the financial crisis have caused a reappraisal.

Chinese authorities were as shocked as anyone else by the data, and have been bringing forward infrastructure spending. Although official news agency Xinhua says there is no stimulus spending package, Standard Chartered's widely respected China analyst, Stephen Green, says the policy announcements of the past few days "certainly quacks like a mini-stimulus package".

It has been the politics, rather than the economics, of Europe that have grabbed the headlines over the last month. The election of socialist Francois Hollande in France and the strong showing of the Left in the Greek election led the OECD's chief economist, Pier Carlo Padoan, to refer to "political contagion", as voters across Europe showed signs of rejecting the austerity packages markets believe necessary to solve the debt crisis.

Markets have in turn doubted the resolve of governments, pushing yields on the bonds of Italy and Spain to new heights.

While the risk of financial breakdown remains, it is the slowing of Europe's economy that is dragging the global economy back.

The March quarter was stronger than expected because of German-led export growth, but unemployment is now rising in Europe's strongest economies and business surveys across the zone point to contraction.

The sense of simultaneous global slowdown is compounded by weaker growth in India and Brazil. India recorded growth at an annual rate of 5.3 per cent in the first quarter, against the IMF's forecast of 6.9 per cent growth for the year, and growth of 9.2 per cent at this time last year.

Brazil's economy grew by only 0.2 per cent in the first quarter.

The developments of the past month will have central banks and governments crafting policy responses.

However, the ammunition thrown at the crisis over the past five years is generating diminishing returns. The Reserve Bank is unusual in still having scope to cut rates and it should make use of it at its meeting tomorrow.