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Monthly Economic Indicators

Commentary

Following recent data releases, we consider the economy contracted in June 2008, its second consecutive quarterly decrease.  Inflation is currently high, but should eventually ease as a result of continuing weak GDP growth, although international developments will remain important.  With downside risks to growth and inflation expected to ease from a peak in September, the Reserve Bank cut the Official Cash Rate by 25 basis points to 8.0% on 24 July.

Inflation rose in June…

Annual CPI inflation increased to 4.0% in the June quarter, up from 3.4% in the March quarter.  The CPI recorded a quarterly increase of 1.6%, the largest increase since June 1990 (Figure 1).  The result was at the higher end of market expectations, and higher than the Reserve Bank’s latest published forecasts and our Budget Update forecast.

Figure 1 – CPI Inflation
Figure 1 – CPI Inflation.
Source:  Statistics NZ

…due to higher fuel and food prices…

The main contributors to higher inflation in the June quarter were fuel and food.  Price increases in the transport and food groups contributed 1.2 percentage points to CPI inflation in the June quarter.  Tradable inflation was 2.3% in the June quarter and 4.8% annually (Figure 2).  Fuel and food prices were the main contributors to this elevated rate of tradable inflation. 
Non-tradable inflation was 0.9% in the June quarter and 3.4% annually.  The main contributor to non-tradable inflation in the June quarter was the housing group, particularly electricity and construction costs.  In the near term, construction cost inflation should ease to reflect the current slowing in the housing market. The slowing in the housing market was reflected in some moderation in rent inflation to 0.7% in the quarter, down from 1.2% in the March quarter.

Figure 2 – Tradable and Non-tradable Inflation
Figure 2 – Tradable and Non-tradable Inflation.
Source:  Statistics NZ

…and will increase further in September…

Inflation is currently above the Reserve Bank’s medium term target range of 1-3% on both non-tradable and tradable measures.  One-off increases in government subsidies lowered the prices of doctors’ visits and early childhood education in mid-2007.  This effect will drop out of the annual CPI inflation calculation in the September quarter, resulting in higher annual inflation.  Higher food and fuel prices and a fall in the New Zealand dollar also pose upside risks to inflation.  We expect annual inflation to peak around 5% in the September quarter.

…reflecting higher cost pressures...

Inflation is likely to remain high as more firms intend to raise prices due to increased cost pressures and reduced profit margins.  The Quarterly Survey of Business Opinion (QSBO) showed a net 68% of firms experienced increased costs in the last three months, up from a net 59% in the March survey.  In addition, a net 71% of firms expect cost increases in the next three months, up from a net 62%. This is the highest level of firms expecting cost increases since December 1982.  Cost pressures are coming from rising wages, raw materials and electricity prices.  Firms are also expected to face higher costs of credit following the sub-prime mortgage crisis in the US.  

…and rising pricing intentions

With higher costs eroding profit margins, more firms are expecting to increase prices.  A net 49% of firms intend to increase selling prices, up from a net 45% and the highest figure since March 1987 (Figure 3).  Although pricing intentions have increased, firms will find it difficult to pass these higher costs onto consumers in an environment where households are pulling back on spending.

Figure 3: CPI inflation and Firms’ Pricing Intentions
Figure 3: CPI inflation and Firms’ Pricing Intentions.
Sources:  NZIER, Statistics NZ

More firms are expecting activity to decline…

Firms’ own activity was down in the June quarter and more firms are expecting activity to be down in the September 2008 quarter, according to the QSBO.  A net 18% of firms reported a decrease in their own activity, which is up from a net 7% in the previous survey and is the largest reported decrease since June 1998.  In addition, a net 18% of firms expect their own activity to decrease in the next three months.  This is up from a net 8% and is the equal highest number of respondents expecting a decrease since 1982 (all figures seasonally adjusted). 

Figure 4 – Real GDP and Own Activity Outlook
Figure 4 – Real GDP and Own Activity Outlook.
Sources:  NZIER, Statistics NZ

The decline in business activity is one factor leading us to consider that real GDP fell in June for the second consecutive quarter (Figure 4). Combined with a weaker activity outlook we expect annual average growth in real production GDP in the calendar 2008 year to slow to ½% - ¾% while the expenditure measure may even turn negative.  These results are supported by the National Bank Business Outlook survey which showed firms’ activity outlook weakened further in July 2008.  The net percent of firms now expecting activity to weaken is at levels comparable to the 1991 recession.

…and profitability to decrease…

In line with a decline in June quarter business activity, more firms expect profitability to decline in the September quarter.  A net 40% of firms expect profitability to decline in the next three months, up from a net 33% in the March survey, the highest figure since 1982.  With profitability expected to decrease, firms’ employment and investment intentions have also declined.  A net 6% of firms intend to reduce staff in the next three months and difficulty finding skilled and unskilled labour has fallen, pointing to a weakening labour market.  Investment intentions have also fallen with a net 17% of firms expecting to reduce investment in plant and machinery.  With lower profits, a slowing labour market and weak spending, we expect tax receipts to be less than forecast in the Budget Update for the year to June 2008. 

…partly due to a lack of demand

The fall in profitability, both experienced and expected, is due to weakening demand from households and increasing cost pressures.  More firms are now reporting demand as the main constraint on production as opposed to supply factors such as labour, finance and capital.  This further suggests that demand is weakening and that pressure on resources is easing.  A net 59% of firms identified a lack of demand as the main factor most limiting output expansion, up from a net 49% in March (Figure 5). 

Figure 5 – Orders as the main constraint
Figure 5 – Orders as the main constraint .
Source:  NZIER

Consumer spending weakens…

Demand has weakened as households come under pressure from rising food and fuel prices.  The food price index shows that food prices increased 8.2% in the year to June 2008, the highest annual increase since June 1990.  High food prices have been driven by increased global demand, and supply reductions due to drought and competing land use from biofuel production.  
Fuel prices have also increased strongly and although they have eased recently from a peak of around $2.19 per litre, 91 octane is still currently above $2.00 per litre, which is approximately 50 cents more than a year ago.  The recent fall in the price of petrol reflects the decrease in the international price for oil due to easing tensions in the Middle East and a weaker world outlook.  This month we look at the world economic outlook in the Special Topic

…as indicated by weak retail sales…

Total retail sales fell 1.2% in May and reflected a sharp fall in motor vehicle retailing.  Core retail sales (retail sales ex-auto) rose 0.7% in May, with the increase largely reflecting higher food prices.  Core retail sales excluding supermarket and grocery stores fell 0.3% in May.  With the price of these staple goods increasing, spending on more discretionary goods has fallen.  Retail sales excluding food and petrol have fallen steadily on an annual basis since mid 2007.  Motor vehicle retailing has fallen 18.0% since May 2007 and is another sign of households pulling back on purchasing big-ticket items.  This pull-back on spending is likely to have continued with electronic card transactions data and consumer confidence suggesting retail sales were soft in June. 

…and consumer confidence

Consumer confidence fell in July with a net 27% of respondents believing that the economy will deteriorate during the next 12 months, as measured by Colmar Brunton.  The total value of electronic card transactions in retail stores fell 0.4% in June and was up only 0.5% in the quarter. Excluding the auto industry, electronic card transactions fell 1.2% in June and 0.6% in the June quarter, the largest quarterly decline since the series began five years ago.  With CPI inflation at 1.6% in the June quarter, both retail sales volumes and real consumption growth are expected to be negative in the June quarter.

Finance companies have suspended around $1 billion of investors’ money in July and are now part of the growing number of finance companies collapsing or freezing funds.  With increased uncertainty among investors, we will likely see a further pull-back in discretionary spending as wealth falls.

Housing market weakens

The housing market is also weakening.  House sales remained weak and were 42.4% lower in June 2008 compared to a year ago.  The median number of days to sell a house has increased to 51 days and is up 77% from a year earlier.  Median house prices were 3.4% off their peak in November 2007 at $340,000 in June 2008, according to data from the Real Estate Institute of New Zealand. 

Weakness in the housing market is currently being reflected in residential building consents.  The number of consents excluding apartments fell 13.3% in the June month and have been trending down.  With building consents traditionally following house sales with a lag, real residential investment is expected to contract in both the June and September 2008 quarters, subtracting from real GDP growth (Figure 6).

Figure 6 – House Sales and Real Residential Investment
Figure 6 – House Sales and Real Residential Investment.
Sources:  Statistics NZ, REINZ

Increased borrowing costs and weak net migration have contributed to the slowing in the housing market.  The two-year fixed rate is currently around 8.95%, up from around 8.2% two years ago.  Based on these rates a person with a $200,000 mortgage would pay an extra $29 a week on interest payments alone.  The demand for housing has also fallen due to a drop-off in net permanent and long-term migration.  There was a net gain of 4,700 permanent and long-term migrants in the 12 months to June 2008, down from a net gain of 10,000 in the 12 months to June 2007.  However, net migration remains moderately positive and higher than forecast at the Budget Update as the increase in arrivals offset the increase in departures. 

Export volumes are falling

Net exports are expected to detract from real GDP growth in the June quarter as exports fell and imports increased, according to merchandise trade data.

Export values fell 0.5% in the June 2008 quarter, seasonally adjusted.  With the ANZ commodity price index (in New Zealand dollar terms) increasing in the June quarter, this suggests that most of the decline in exports was volume based.   Falling dairy exports, partly offset by higher crude oil exports, were the main contributor to the fall in total exports.  Dairy export volumes fell 15.2% in the June quarter and reflect the impact of the drought on agricultural production.  The value of crude oil exports rose 56.6% in the quarter and was due to higher oil prices and a recovery in volumes from the timing of shipments. 

Imports grew 8.5% in the June quarter due to large one-off capital imports (oil related) and large aircraft imports.  Consumption imports increased 3.1% in the June quarter.  This increase was surprising given the weak retail environment and may lead to more discounting than normal in order to avoid a large build up of stock.  Overall the merchandise trade deficit in the 12 months to June fell to $4.5 billion from $4.8 billion in the 12 months to May 2008 (Figure 7).

Figure 7 – Merchandise Trade – 12 month totals
Figure 7 – Merchandise Trade – 12 month totals.
Source:  Statistics NZ

Inflation will ease in the medium term

With demand and capacity constraints easing, inflation will fall in the medium term.  The Reserve Bank cut the Official Cash Rate (OCR) by 25 basis points to 8.0%, the first cut since June 2003 (Figure 8).  Immediately following the cut the New Zealand dollar fell 1% across the board with the Trade Weighted Index falling from 66.9 to 66.3. 

Figure 8 – Official Cash Rate
Figure 8 – Official Cash Rate.
Source:  Reserve Bank of New Zealand

In reducing the OCR, Governor Bollard noted that “the cost of funds raised abroad by banks has been rising in recent months as the international financial situation has deteriorated.”  He also noted that “today’s cut will help to mitigate the effect of these increases on the actual borrowing costs paid by firms and households.”  Following the announcement, banks have generally reduced their two-year fixed mortgage rates by around 25 basis points to 8.95%.  This reduction in the two-year rate was somewhat surprising given that the global credit squeeze has increased the premium that banks pay for funding offshore.  However, this reduction could reflect competition among banks and the easing bias in the Reserve Bank’s statement, “Provided that the outlook for inflation continues to improve and there is no excessive exchange rate depreciation, we would expect to lower the OCR further.”

The reduction in the two-year fixed rate will provide some relief for households in that those rolling over their fixed term loans will be paying less in interest than they otherwise would have.  The combined effects of tax cuts on 1 October 2008, recovery from the drought, high export prices, the weakening New Zealand dollar and more reductions in the OCR should see quarterly growth pick up in the December quarter and early next year.

Coming up

Key data to be released in August relate to the labour market and retail sales.  The labour market data will be watched closely to see how employment and unemployment have responded to an easing in demand and whether wage pressures are easing.  These will provide further information on the strength of the economy.

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