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Monthly Economic Indicators

Analysis

Data in April provided further insight into the effects on the New Zealand economy of the devastating 22 February earthquake. Surveys of business confidence taken soon after the disaster point to significant disruption to firms’ trading activity, but were largely isolated to the Canterbury region. More recent data show that the effect on business confidence has been largely temporary, and support an ongoing but gradual recovery through 2011. We expect the economy to expand 1% in the 2011 calendar year, before rebuilding work in Canterbury helps to push economic growth higher.

Earthquake disrupts business activity...

A natural disaster with the devastating force of 22 February’s earthquake directly causes large disruption to economic activity. How firms and households elsewhere respond to such disasters also has a significant bearing on economic growth. Business confidence fell sharply in the first quarter of 2011, according to the Quarterly Survey of Business Opinion (QSBO), as firms factored in the effects of the earthquake. Evidence from the survey suggests that the direct effects of the event on business activity have generally been localised. Surveyed trading activity in Canterbury in the March quarter fell sharply, but actual activity is likely to have fallen by even more given a 40% non-response rate recorded in the region. Nationally, however, firms’ trading activity did not shift to the same degree, easing only 4 points to show a net 5% of businesses experienced a fall in sales. The result suggests that GDP was flat to slightly negative in the March quarter in line with our most recent forecast of a modest contraction.

...but is largely centred in Canterbury

Other indicators released during April also illustrate a largely localised impact on business activity from the earthquake. Both the BNZ Business NZ Performance of Manufacturing (PMI) and Services (PSI) indexes recorded sharp contractions during March in the Canterbury/Westland region (Figure 1). In contrast, despite both activity indexes declining at a national level, the manufacturing and services sectors still noted an expansion in activity.

Figure 1 – National and Canterbury PSI
Figure 1 - National and Canterbury PSI.
Source: BNZ-Business NZ

The economy continues to gradually recover

The disruption to activity evident in survey data should be viewed against a backdrop of an ongoing, albeit gradual, recovery. Other gauges of business sentiment presented in the QSBO are supportive of a recovery. For instance, a net 2% of firms were reported to have increased their workforce in the first quarter of 2010 (consistent with annual employment growth of 2%), and while hiring intentions for the June quarter eased they were again largely influenced by Canterbury businesses. In addition, the agriculture sector, which is not directly captured in the QSBO, continues to benefit from a synchronised lift in commodity prices. The ANZ Commodity Price Index extended its run of gains in March lifting 4.7%, with none of the 17 measured commodities recording declines (the first time in 17 years). Although farm incomes are being boosted by the recent surge in commodity prices, the effects are yet to be fully felt through the New Zealand economy as farmers look to reduce debt.

Moreover, monthly surveys of business sentiment released since the QSBO, such as the BNZ confidence survey and the National Bank Business Outlook (NBBO) indicate that the disruption to business confidence has been largely temporary. According to the NBBO, firms’ outlook for the economy reversed half of March’s fall with a net 14% of businesses expecting better economic conditions in the year ahead (Figure 2). Significantly, firms in the Canterbury region recorded the largest rise in confidence, with residential and commercial construction intentions rising sharply as firms gear up for the rebuild. We anticipate the rebuild will gain momentum through 2012.

Figure 2 – Business confidence
Figure 2 - Business confidence.
Source: NZIER, National Bank

Firms unable to pass on rising costs...

It was evident from the QSBO that firms have faced rising cost pressures in recent months with a net 39% of businesses reporting cost increases in March – almost double the number a year earlier – and an increasing number of respondents are also anticipating higher costs in the coming months. However, faced with a subdued trading environment, businesses are reluctant or unable to pass these cost increases onto customers. While most industries expect to increase prices in the months ahead, a large divergence between cost pressures and pricing intentions is being felt by the retail and building industries. The resulting squeeze on margins has contributed to downgrades of firms’ profit expectations and a net 22% of firms anticipate lower profits in the coming quarter, down from 5%.

...limiting consumer price increases

Limited pass-through of firms’ costs to the prices faced by households was evident in the March quarter CPI. The Consumers Price Index (CPI) rose 0.8% in the first quarter of 2011, lower than many market commentators were expecting. Higher fuel and food prices, in addition to increases in tobacco excise rates, dominated quarterly price movements. However, a lack of price pressure in areas experiencing soft demand led to discounting across a variety of goods and services. Discounting occurred among goods normally sensitive to exchange rate movements, such as furniture and audio-visual and computing equipment, despite the New Zealand dollar remaining relatively unchanged in the quarter. In addition, clothing and communication prices were also discounted more than expected in the quarter.

On an annual basis, consumer prices were 4.5% higher, largely reflecting government-related charges such as last October’s GST rate rise. We believe that the recent run-up in fuel and commodity prices has yet to be fully felt in headline inflation, with providers of transport services expected to pass on cost increases in coming quarters. As a result, inflation is expected to peak in the June quarter at 5.3% before declining to within the Reserve Bank’s target of 1%-3% in mid-2012 as one-off price rises drop out of the calculation.

Auckland region drives housing market...

Housing market activity lifted strongly in March, largely the result of increased sales in the Auckland region (Figure 3). Data released by the Real Estate Institute of New Zealand (REINZ) showed a seasonally adjusted 4.5% rise in national sales, including an 11.7% lift in Auckland alone. The result backed up reports from the Auckland-based real estate firm Barfoot and Thompson, released earlier in the month, which experienced 15.4% higher sales volumes compared to March 2010. Outside of Auckland, however, sales were largely stagnant. For example, excluding Auckland and Canterbury, sales were 2.3% lower than a year ago. Given the significant level of uncertainly following February’s earthquake, sales in Christchurch city continued to decline, but other areas such as Timaru have seen notable interest in property, offsetting Christchurch’s weakness.

Figure 3 – Auckland and total house sales
Figure 2 - Business confidence.
Source:  REINZ

Despite the lift in national sales, the housing market remains subdued with activity at near-record lows. In addition, house prices were largely unchanged in March and the stratified house price index is still around 5% below its late-2007 peak. Furthermore, although the average number of days to sell declined 3 days to 45 in March, the result remains above long-term average levels and has done so since April 2010.

...and leads the economic recovery

Housing market data supports other indicators that suggest Auckland’s economy is outperforming other regions. The cut to the OCR in March, while intended to shore up confidence following the earthquake, is likely to be aiding increased interest in Auckland’s housing market. Furthermore, a housing shortage in Auckland may also be underlying the increased activity. The rising cost of rental accommodation suggests a housing shortfall may be developing, and according to Barfoot and Thompson average weekly rents rose sharply in March (4.8% mpc) and were 8.3% higher than March 2010.

While the Auckland economy might be currently recovering faster than other regions, any divergence is expected to be temporary as farmers begin spending increased incomes and Christchurch’s rebuild ramps up through 2012.

Consumer confidence remains unchanged

In contrast to businesses, consumer sentiment remained subdued in April as shown by the ANZ-Roy Morgan survey. Households were behaving cautiously prior to February’s earthquake by limiting spending, and both the March and April confidence surveys point to further soft spending behaviour to come. One factor behind cautious spending behaviour is households’ high level of indebtedness. This month’s Special Topic examines the implications of household rebalancing on future spending.

The weakness in consumer confidence was predominantly reflected in consumers’ current situation, with a net 21% of respondents pessimistic about their current financial situation (previously 16%). Heavily discounted prices and a need to replace damaged goods are likely to have helped increase the number of households believing it is a good time to purchase a major household item. Households’ desire to replace damaged good was also reflected in spending using electronic cards in March: purchases of appliances jumped 2.5% - more than offsetting February’s decline. Total spending at retail outlets rose 1.3% in the month, and reflects rising petrol prices given spending on fuel has risen for eight consecutive months. Nevertheless, transactions on core retail goods still increased 0.8% in March. We await the March quarter Retail Trade Survey, rescheduled for release on 15 June, to confirm a rebound in spending at retail outlets in early 2010.

World recovery continues

The global economy is still growing strongly, despite many factors threatening to slow it down. Inflation is increasingly becoming a concern globally, with monetary tightening starting to take place in more than just emerging economies.

The IMF released their World Economic Outlook (WEO) during April, and see the world continuing to recover, albeit with more risks, mainly to the downside. Since their January WEO Update, several new risks have emerged such as elevated oil prices and the impact on supply chains of the Japanese earthquake and tsunami; although their forecasts remain largely the same with about 4.5% global growth in 2011 and 2012, they lowered US growth from 3.0% to 2.8% for 2011. US March quarter growth came in below expectations at 0.4%, bringing the annual rate to 2.3%. Forward indicators show growth is expected to improve later in the year.

Global commodity prices still high...

Conflict has continued in the Middle East and North Africa during April, keeping oil prices elevated mainly due to the great deal of uncertainty surrounding the situation. Reports have indicated that Saudi Arabia has cut oil production, after having previously increased output to make up the loss to Libyan production. There are concerns over the impact these elevated oil prices could have on global growth.

...and starting to flow through to inflation

Higher oil prices, as well as other surging commodities, are now clearly starting to impact inflation around the world. Commodity prices have been increasing due to a combination of Middle East unrest, supply shocks from adverse weather and strong demand from emerging economies like China and India. US headline inflation has been accelerating recently with the annual rate in March up to 2.7%, compared to 2.2% in February. Core inflation (excluding food and energy prices) is much lower at 1.2%, allowing the Federal Reserve to rest a little easier.

Euro area annual inflation was also strong, at a more-than-expected 2.7% in March, rising a very strong 1.4% during the month. The European Central Bank (ECB) raised its policy rate by 25 basis points to 1.25% to reduce the increasing inflationary pressures; more hikes are expected later this year. Chinese inflation and growth were also higher than expected at 5.4% and 9.7% respectively, leading to more tightening of Monthly Economic Indicators – April 2011 – The Treasury Page 5 monetary conditions by the People’s Bank of China. Australian March quarter inflation was higher than expected, taking the annual rate to 3.3%, above the Reserve Bank of Australia’s (RBA) 3% upper limit. However, the underlying core rate was significantly weaker than the headline rate, plus the current Australian monetary policy framework allows the RBA to look through events like the recent floods, which impacted on food prices due to crop losses. High oil prices are making things difficult for central banks worldwide; in advanced economies they have to balance controlling inflation and stifling recoveries. In emerging economies the balance is between reining in inflation and maintaining high growth rates.

Figure 4 – Trading Partner Inflation
Figure 4 - Trading Partner Inflation.
Source: Datastream

Global fiscal concerns continuing

Euro sovereign debt woes increased in April. Following last month’s credit downgrades and resignation of the Prime Minister, Portugal’s caretaker government officially requested a bailout from the European Commission (and thus the IMF). The final bailout package, presently being negotiated, will likely be about €90 billion and will require a significant fiscal tightening in order to go ahead. Greek debt has been in the news again, with talk of a restructuring of debt pushing government debt two-year yields above 25% in late April. Both Greek and Portuguese fiscal deficits for 2010 are much worse than previous targets, at 10.5% and 9.1% of GDP respectively. However, the Euro area as a whole improved, with the average deficit decreasing from 6.3% in 2009 to 6.0% in 2010. Total euro area government debt rose to 85.1% of GDP in 2010 from 79.3% in 2009, and will continue to increase until the deficits are brought under control.

Attention this month also turned to the United States’ fiscal issues. Standard & Poor’s lowered the US AAA long-term credit rating to a negative outlook, meaning there is a one-in-three chance of a downgrade in the next two years. Markets initially fell, but soon shrugged off the news, mainly as the US’s fiscal problems were already well known. The US faces a tough situation with a fiscal deficit estimated to be almost 11% of GDP for 2011, up from 8.9% in 2010. Although both political parties agree there need to be cuts, they disagree where they need to be made. Big changes will have to be made during the next few years to bring the deficit to a more sustainable level in the medium and long run.

Japan responds to disaster

During the month the Japanese government approved the first of what will be several earthquake budgets. This budget saw ¥4 trillion (US$48.5 billion, 1% of GDP) allocated for earthquake relief. The government has managed to do this without issuing additional debt so far; they have mainly cut spending in other areas like foreign aid and payments to families, as well as dipping into reserves for pension payouts. Some analysts are tipping that the government will have to spend upwards of ¥10 trillion (2.2% of GDP) for the rebuild. The government will almost certainly have to issue additional government bonds, but is also considering raising an already unpopular sales tax in order to reduce reliance on borrowing. The OECD have downgraded their 2011 growth forecasts for Japan to 0.8%, down from 1.7% previously, due to the wide-ranging impact of the disaster. They boosted their 2012 growth forecast to 2.3%, up from 1.3%, due to the growth impact of the rebuild.

Looking ahead

Labour market reports, released next week, are the major data release in May. Also made public in May will be the government’s Budget, out 19 May, including Treasury’s latest set of economic forecasts.

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