Hot spots: Australia. (International Section).

The Australian economy is in its 1 12th consecutive year of expansion, having been able to avoid contagion from the Asian financial crisis, the assorted currency and debt debacles in Latin America that followed, the worldwide technology bust, slumps in many of its key export markets, and even a drought that reportedly was the worst seen in a century In the final quarter of 2002, however, the real gain in gross domestic product did slow to 0.4% (q/q) from 1.0% in July-September, and the advance for last year as a whole, at 3.0%, was less than some pundits had anticipated.

Some signs of weakness persisted in the first quarter of this year. Consumer and business confidence continued to be undermined by uncertainty over global economic conditions and by the nervousness generated by the then impending war in Iraq. The economy shed 42,800 jobs in March, following a decline by 12,300 in February. This caused the national unemployment rate to rise to 6.2% of the labor force from 6.0%. Moreover, consumer prices spiked upward in January-March, by 1.3% to where they were 3.4% higher than a year earlier. This put headline inflation substantially above the Reserve Bank's target range of 2%-3%. Concurrently, producer prices rose by 0.7% to a level 1.9% higher than a year before, suggesting that there is still pressure in the pipeline.

At that, most of the producer price rise was due to higher food and oil prices, and world market quotations for petroleum have been falling in recent weeks. The so-called "underlying" measure of inflation, which the Australian Bureau of Statistics calculates, rose in January-March by just 0.5%, or by 2.1% year-on-year. As for unemployment, it is a lagging indicator that will presumably continue to climb for a few more months, but should then fall back again to levels below 6.0%.

Consumer as well as business sentiment has improved strongly since the end of the Iraq war, mirroring a similar surge which occurred at the termination of the first Gulf War in 1991. The Westpac Melbourne Institute's consumer sentiment index jumped by 10.9% in April, posting its fourth largest rise in the survey's 29-year history and erasing the cumulative 9.7% fall registered in the preceding two months. The rise in confidence should give a boost to retail sales. Also of help to the economy will be the interrelated recovery of the Australian equity market.

There is some concern that the cost of Australia's participation in the Iraq war will tightly circumscribe Treasurer Peter Costello's ability to give the economy a shot in the arm with the 2003/04 budget (to be unveiled on May 13). But indications are that this cost is far from dramatic (currently estimated at between AUD 500 million and AUD 1.2 billion) and that the fiscal household plan will aim to maintain economic growth without being allowed to slip into the red. So, on balance we still think that the chances are good for real GDP growth on the order of 3.25% - 3.50% in the current calendar year and for an expansion of 3.75% - 4.00% in 2004.