Economic forecast for 2001

Zurich Financial Services vice president of fixed interest and foreign exchange Anthony Michael says there are three main themes driving the Australian economic situation for the year ahead.

The global economy, particularly the extent to which US growth slows, will decide whether there will there be a soft or hard landing.

The second point is cutting official interest rates, when will the central banks do this and by how much. Michael says there is already plenty of evidence that growth is slowing and the US Federal Reserve Bank should lead the way with cuts in the first or second quarter of next year. Other central banks should then follow, with the Bank of England and the Reserve Bank of Australia (RBA) dropping rates in the second or third quarter, and

Consumer reaction to a softer employment market and ongoing evidence of slower growth will also be an issue, given the low level of consumer savings and generally high levels of consumer debt. Michael says consumers have been used to strong growth, rising asset prices, low inflation, declining unemployment and falling interest rates.

"If some of these factors unwind then consumers may decide to rebuild savings and growth could slow a lot more than the current consensus.

"We also face the prospect of an election next year so to some extent the

policy statements on offer could directly affect the economic situation," Michael says.

Looking at investments Michael says the first 2 quarters of the year should be a continuation of the past two with falling bond yields, pressure on corporate earnings, general sharemarket weakness and average investment returns.

But he says bond yields have already experienced the bulk of decline.

In the second half of the year Michael says his team expect better investment returns, particularly once the central banks ease interest rates and the outlook for growth improves.

"We think that as long as the core rate of inflation is forecast to return towards the middle of the RBA's 2-3% target range, then official cash interest rates could conceivably move towards five and a half percent by the end of next year," he says.

The falling interest rates will affect different investment sectors and Michael says Zurich expects resources, gaming, banks and retail to perform well.

Their three picks by sector are; BHP, WPL, SGW, - ALL, TAH, TAB, - MBL, NAB, WBC, - HVN, WOW, BBG, - WES, COH, BRL.

Zurich's forecast for the All Ords at the end of next year is 3500.

Although the $A is expected to increase in the next 12 months, Michael says the increase does rely on a modest decline in global growth rather than a recession/hard landing.

"We expect the $A will recover against a weaker $US and could rise somewhere between the 58 to 60 cents region over the next 12 months," he says.

Michael says the higher $A will take some pressure off interest rates but will affect the growth of exports as they will become more expensive. A higher AUD will also reduce the returns from investing in International Equities during the year.

"In any event, we expect annual returns from International Equities to decline dramatically in coming months," says Michael.

Reading through the data, Michael says it is somewhat difficult to get a good feel for the future economy.

"Working out what will be going on this year is affected by data that is distorted by the introduction of the GST and then the Olympics last year," he says.