WEEKEND ECONOMIST: Healthy outlook

After a round of better-than-expected US earnings results, we can expect some positive data here and overseas. But the outlook for shares is mixed and rate hike next month is still possbile.

Despite softish US economic data, sharemarkets and and other risk assets generally rallied over the last week on the back of better-than-expected US earnings results and signs that Europe is holding up far better than feared in the face of its sovereign debt crisis.

The very short-term outlook for shares is mixed. Strong profit results in the US have been providing a lift and the Australian profit reporting season next month may provide a similar lift for Australian shares in August. Against this though, double-dip concerns are likely to persist for a while and suggest that we may still see more weakness into the seasonally weak months of September and October. However, we remain of the view that a double-dip recession globally will be avoided, and with shares now very good value, monetary conditions likely to remain favourable and China likely to start relaxing its tightening measures in the next few months, shares are likely to stage a strong rally in the December quarter and through 2011.

US earnings reports have been very good with excellent results from companies such as Apple, Coca Cola, Morgan Stanley, Caterpillar and UPS. In fact, 85 per cent of the 162 S&P 500 companies to have reported so far have exceeded expectations. Much of the strength in earnings has come from growth in emerging countries and it's also worth noting that top-line revenue growth has been a bit more mixed.

Europe appears to be weathering its sovereign debt crisis remarkably well, with business-conditions indicators actually rising in July on the back of strength in Germany and France, industrial orders surging higher in May – no doubt helped by the fall in the euro and consumer confidence actually improving in July. UK retail sales also came in stronger than expected in June.

In Australia, a 16.1 per cent rise in export prices in the June quarter which resulted in a 13.9 per cent boost to the terms of trade provides confirmation that higher prices for coal and iron ore will provide a massive boost to national income and hence the Australian economy. The Reserve Bank effectively warned that the election is no barrier to doing its job and that should June quarter inflation data come in on the high side it stands ready to raise interest rates at its August meeting.

Against this backdrop, the big event in Australia in the week ahead will be the June quarter inflation figures due for release on Wednesday, given that a worse-than-expected result could trigger a rate hike right in the middle of the election campaign. Our expectation is that headline inflation rose 0.9 per cent or 3.3 per cent year on year, but because this will be boosted by an increase in tobacco excise it will be necessary to focus on the underlying rate of inflation which we expect to rise 0.7 per cent in the quarter or 2.9 per cent over the year. If this is the case it would be broadly in line with RBA expectations and shouldn’t be enough to justify an imminent rate hike, but of course if underlying inflation is 3 per cent or above then the pressure to raise interest rates again next month will intensify.

In the US, data for new home sales are likely to show some stabilisation after recent falls, consumer confidence is likely to remain soft and durable goods orders are likely to rise after a fall in May. US June quarter GDP data is expected to show growth running around 2.5 per cent annualised, consistent with a continuing but sub-par recovery compared to past recovery cycles. The US profit reporting season will continue with another 155 S&P 500 companies due to report.

Dr Shane Oliver is head of investment strategy and chief economist at AMP Capital Investor