The quarterly CPI increase of 0.4% was a welcome respite from the increases of the last year.  The annual rate fell to 4.6%.  Over the year growth funds lost 3.1%, balanced funds lost 0.6%, while conservative funds gained 1.7%.  The 5.0% loss across all funds in real terms was disappointing.

 The outlook for the Australian and New Zealand economies is clouding, although still better than most Western economies.  Both are dependent on international commodity markets and are vulnerable to a further global recession.  Australia is still heavily dependent on the Chinese demand for its raw minerals.  The high Australian dollar has severely eroded manufacturing exports.  China’s growth has slowed and could fall further in 2012.  In the meantime hard commodities prices have fallen, the spot price for copper dropping 25% in September.

 The latest ratings downgrades of New Zealand by both Standard & Poors and Fitch are a reaction to the high private borrowing, a persistent government deficit and the lack of structural reform to reduce these.  There is also nervousness that the major Australian banks could be downgraded, thus increasing their costs of borrowing as international credit markets tighten.  Heavy exposures to the mining industry and to the (still overvalued) Australian housing market are other sources of vulnerability for the Australian banks (which are major players in New Zealand).

 Debt woes are still hampering the global recovery, with those in Europe proving to be the least sustainable.  The announcements this week of 50% write-downs on Greek debt by the banks and a much enlarged rescue fund are light on detail, but indicate that the major European players would prefer a move towards further fiscal integration to disintegration of the Euro.  While the markets have responded favourably to this news, we reserve judgement until the debts have either been forgiven or arranged to be repaid.

 The Bank of England has continued its quantitative easing programme in an effort to reduce borrowing costs although this is likely to increase inflation.  With recent U.K. annual inflation already about 4.5%, any further rise will be bad news for savers - especially since further easing is expected in the New Year. 

 The sell-off of stock markets has been combined with a strengthening of the U.S. dollar as the Euro has weakened.  This has benefited exporters in both Australia and New Zealand.  We are still concerned by the American economy because of high unemployment and political paralysis.  The latest quantitative easing by Ben Bernanke called ‘twisting’ (selling short-dated treasuries and buying long-dated ones) has forced down the yield on long-dated bonds thus reducing the income for savers and weakening the balance sheets of defined benefit pension plans.  Whilst inflation is contained at present this process will damage the U.S. public sector balance sheet when interest rates eventually rise to counter rising inflation.

 The next three to six months will be volatile for stock markets with potentially more falls as investors come to terms with the difficulties faced by politicians and central bankers.  The austerity measures will cause further unrest and won’t be as effective at solving the problems as policymakers hope.  Another credit crunch is the biggest risk.