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Monthly Economic Indicators

Analysis

Economic developments over July continued to point to a weaker outlook than in the Budget Update. Treasury now considers that growth will be around trend in 2015. Dairy prices continued declining at this month’s auctions and they are now expected to take longer to recover than in the Budget Update, although the easing in monetary conditions provides some offset. That said, the underlying drivers of growth – high migration, robust construction activity and solid labour income growth – remain intact.

Business confidence eased...

The June Quarterly Survey of Business Opinion (QSBO) showed a net 7% of businesses expect the economy to improve over the next six months, down 13 points from the March quarter. The largest falls occurred in the regions most exposed to the dairy sector, a reflection of successive falls in dairy prices since March. However, despite the large fall, business confidence remains around average.

Fewer firms experienced higher trading activity over the June quarter (10%) than the March quarter, around the long-term average, pointing to annual GDP growth below 3% in the June quarter (Figure 1). Similarly, firms’ expectations of their trading activity increasing over the next quarter slipped from a net 26% to a net 13%, although this remains around average. Ongoing expansion was also indicated in the services and manufacturing sectors by the PSI and PMI respectively.

The July ANZ Business Outlook (ANZBO), released July 31, is expected to show a further fall in headline confidence, a result of recent declines in prices at GlobalDairyTrade (GDT) auctions.

Figure 1: GDP growth and own activity experienced
Figure 1: GDP growth and own activity experienced.
Sources: Statistics NZ, ANZ-Roy Morgan

...along with growth in consumer spending...

As well as the decline in business sentiment, consumer sentiment continues to ease. The July ANZ-Roy Morgan Consumer Confidence survey declined an additional 3 points to 116.4 (s.a.), to be below the long-run average. Similar to the business survey, the regions that experienced the sharpest decline were those most affected by dairy. The fall in sentiment was wide-ranging, but the future conditions index showed the largest drop with consumers negative about one-year ahead expectations for the first time since 2012.

Electronic card transaction values increased 0.6% in June, taking the June quarter increase to 1.2%. This rise was almost entirely driven by petrol, a result of prices rising around 9%, with core sales values up only 0.1% in the quarter. This, along with the weaker consumer confidence, points to private consumption growth easing sooner than forecast in the Budget Update, where annual growth of4.1% in December 2015 was expected.

Figure 2: Private consumption and consumer confidence
Figure 2: Private consumption and consumer confidence.
Sources: Statistics NZ, ANZ-Roy Morgan

...and other key indicators...

The weaker outlook was reflected in the labour market. Hiring intentions declined slightly from a net 16% of firms expecting to hire in the next quarter to a net 10%, but remain high compared with the historical average. Firms also found it slightly easier to find skilled labour in the June quarter (from a net -36% to net -30%) but, similarly, firms considered finding skilled labour more difficult than the long-run average. These results point to ongoing positive employment growth in the June and September quarters (June data will be released in early August).

Business investment intentions also slipped slightly, a reflection of a net 2% of businesses expecting lower profits in the September quarter. However, both building (net 5%), and plant and machinery (net 18%) investment intentions remain above long-term averages of -13% and -1% respectively.

...and growth around trend is now expected

Overall, while firms are less optimistic than in the March quarter, and private consumption growth is expected to be below forecast, most indicators remain around their long-run averages. This is consistent with the economy moderating to trend growth (2.5-3.0%), compared to the above 3% growth expected in the Budget Update.

Inflation remains low...

Reflecting the weaker demand in the economy, inflation remained subdued in the June quarter. The Consumers Price Index (CPI) rose 0.4% in the June quarter, to be up 0.3% in the year, in line with the Reserve Bank (RB) June Monetary Policy Statement (MPS) forecast and our Budget Update forecast, although fuel price fluctuations led to differences on a quarterly basis. However, it was slightly lower than many commentators were expecting (0.4% for the year).

The quarterly outturn was driven by contributions from petrol price increases (+0.4% points), a seasonal rise in vegetable prices (+0.1% points) and housing costs (+0.1% points). These were partially offset by price falls for telecommunication services (-0.1% points) and domestic airfares (-0.1% points).

...with tradables inflation tracking nearer to zero...

Tradables prices increased 1.0% in the June quarter, driven by the 8.8% rise in fuel prices, a result of a rise in international oil prices and the depreciation of the NZ dollar against the US dollar. Excluding fuel, tradables prices declined 0.1% in the quarter, owing to the continued effect on prices of the strong NZ dollar over 2014 and early 2015. Business competition continues to play a part, with the average discount increasing for clothing, household contents and vehicles.

The increase in tradables prices in the quarter led their annual decline to slow from 2.4% in March to 2.0%. The annual decline was chiefly a result of petrol prices falling in the December and March quarters, owing to the plunge in international oil prices, along with ongoing falls in durable goods prices. Annual tradables inflation excluding fuel was still negative at -1.2% in June.

...and non-tradables inflation slowing

Non-tradables prices rose 0.1% in the quarter (0.3% s.a.), following a 1.1% rise in the March quarter (0.6% s.a.). The rise in domestic prices continues to be heavily influenced by an increase in housing costs (rent and purchase of new housing), with restaurant and ready-to-eat meals and beer also making significant contributions in the quarter. On the other hand, domestic airfares fell 13.3%, their largest recorded quarterly change, partially owing to an unwind in prices following the Cricket World Cup. Other significant negative contributions were recorded for telecommunication services (-1.9%), and a holiday-related reversal in rental car prices (-7.4%). Electricity prices rose much less than usual, up only 0.6% in the quarter, partly a result of lower lines charges, compared with the usual circa 3.0% rise in the June quarter.

Overall, these changes resulted in non-tradables inflation slowing from 2.3% in the year to March to 2.0% in June, its slowest pace since December 2001 (Figure 3).

Figure 3: Tradables and non-tradables inflation
Figure 3: Tradables and non-tradables inflation.
Source: Statistics NZ

Pricing pressures remain weak...

While inflation remained low in the June quarter, it is unlikely to increase significantly in the near term with indicators of pricing pressures in the economy remaining weak. Similar to the previous two quarters, only a net 7% of firms expect to increase their selling prices in the next quarter (Figure 4). This compares with the long-run average of 32% and is down from 33% in June 2014, despite a net 22% of firms expecting their input costs to increase. Slowing growth, along with the reluctance of businesses to pass on higher costs to consumers and the reduction in ACC vehicle levy rates, indicates that non‑tradables inflation is likely to remain weak in coming quarters.

On the other hand, tradables inflation is expected to increase towards zero, largely as a result of the lower NZ dollar and higher petrol prices. Since July 2014, the NZ dollar has declined 15% on the TWI and 25% against the US dollar. The depreciation of the NZ dollar is expected to start flowing through in coming quarters, although how much and how quickly is uncertain, with weaker growth in the economy now expected.

Figure 4: Pricing intentions and Inflation
Figure 4: Pricing intentions and Inflation.
Sources: Statistics NZ, NZIER, The Treasury

Overall, we expect the September quarter CPI outturn to be broadly in-line with our Budget Update forecast of 0.4% (0.3% annual), with higher local authority rates and petrol prices offset by other weaker non-tradable components owing to more subdued demand and increased capacity.

...as labour supply continues to increase...

Labour supply continues to increase rapidly owing to the high net inflow of migrants. The number of net permanent and long-term migrants was 4,800 in June, a similar level to the previous nine months. This took the annual total to a record net gain of 58,300, slightly above the Budget Update forecast of 56,850 but below the Scenario Two peak of 60,000. The annual net gain was owing to higher arrivals and fewer departures, but departures rose slightly on a quarterly basis and arrivals were relatively flat. Arrivals in the year to June were dominated by increased student numbers, up 7,700 on 2014, although this appears to have levelled off. That said, July tends to have a large influx of students owing to the start of the semester, so these may increase further.

With net migrants declining only slightly on a quarterly basis, the annual inflow is not likely to tail off as sharply as expected in the central Budget Update forecast. Elevated net inflows for longer could result in net annual immigration remaining above 50,000 until March 2016, as illustrated in Scenario Two.

...adding to housing demand

The increase in net migrants continues to add to housing demand. The REINZ house price index rose a seasonally adjusted 2.3% in the June month, resulting in annual house price inflation increasing from 11.8% in May to 14.8%, the fastest rate of growth since May 2007. The housing market continues to reflect diverging regional trends, with the increase dominated by Auckland where the median price rose by 25.8% from a year ago. In contrast, the rest of NZ’s median house price was steady from a year ago.
The diverging regional trend has also been seen in residential building consents.  Auckland consents were up 16.3% in the June quarter (s.a.), while consents were up only 3.1% nationally. Residential consents in Canterbury fell 4.8% in the quarter, back to late 2013 levels, indicating that residential building in Christchurch may have peaked (Figure 5). That said, the QSBO building capacity utilisation reached a new record high of 94.6%, possibly contributing to consent numbers levelling off, albeit at a high level.

Figure 5: Canterbury consents and building activity
Figure 5: Canterbury consents and building activity.
Sources: Statistics NZ, The Treasury

Goods deficit continues to widen...

Merchandise trade data showed a seasonally adjusted deficit of $370 million in the June month, leading to a $460 million deficit for the quarter. Export values rose a modest 0.4% in the quarter, with higher forestry and fruit export values partially offset by lower dairy and meat values. The fall in dairy export values was entirely driven by volumes, with price rising 3.4% in the quarter, a reflection of the brief rally in GDT prices early in 2015. Import values increased 0.4% in the quarter, with an increase in capital goods and mineral fuels partially offset by a decline in consumer goods imports. On an annual basis, the trade deficit widened further to $2.8 billion in June, consistent with our view of the current account deficit widening to 5.6% of GDP by March 2016.

...and commodity prices decline further in June

The ANZ commodity price index continued to decline in June, down 3.1% to its lowest level in three years. The decline was led by aluminium prices (‑6.4%), closely followed by dairy (-4.4%) and meat (-3.4%). All commodities declined in the month except forestry, which rose only 0.1%. Owing to the continued weakness in commodities and the significant decline in dairy prices, a weaker terms of trade is now expected than in the Budget Update.

Dairy prices plunge in July...

Following dairy price falls in June, the GlobalDairyTrade index fell sharply at both auctions in July, by 5.9% and 10.7% respectively, with falls recorded across all products. The index has fallen 41% since March 2015 and is now at its lowest level since December 2002, a continuation of the dynamics of high supply and weak demand. Whole milk powder (WMP) recorded declines of 11.9% and 13.1% in the month, with the average price at the second auction down to US$1,848/mt. WMP is particularly influenced by Chinese demand, with price weakness attributed to high WMP inventories, the weakening Chinese economic outlook and concerns around the stock market affecting buyer sentiment (see further discussions of China’s share market in this month’s Special Topic).
Analysts’ forecasts for the farm gate milk price for the 2015/16 season now range from $3.75 to $5.00/kg MS compared to Fonterra’s forecast of $5.25/kg MS. With the spot price estimated by Agri NZ to be equivalent to $3.17/kg MS, all forecasters are expecting some recovery in dairy prices over the season. Fonterra will review its farm gate price by the end of August, with this likely to be following the board meeting on August 7.

...leading the RB to reduce the OCR...

As widely expected, the RB reduced the OCR by an additional 25 bps to 3.00% at the July interim review, although the tone of the statement was slightly less dovish than the market was expecting. The RB cited low inflation and the softer growth outlook, owing to the rebuild activity in Canterbury appearing to have peaked and the sharp fall in dairy prices, as the main reasons for the reduction. The RB softened its description of the level of the NZ dollar from “unjustified and unsustainable” to say that “further depreciation is necessary”.

The Reserve Bank noted that some further easing seems likely, more explicit language than at the June MPS. Market analysts’ central view is for an additional 25 bps reduction at the September MPS and some are forecasting a fourth reduction by the end of the year.  The market has a 25 bps reduction in September fully priced in and an additional 38 bps of reductions by April 2016.

...providing some offset for dairy exporters

Since the Budget Update was finalised, the reduction in the OCR, along with the depreciation in the NZ dollar earlier and at a faster rate, will provide some offset to weaker dairy prices. Overall, international dairy prices are now closer to Scenario One in the Budget Update than to our central forecast(Figure 6) and are expected to take longer to recover, although the offsetting factors of easier monetary conditions were not present in Scenario One. Together these will reduce some of the declines in national income from lower export revenues relative to Scenario One, with the NZ dollar expected to provide approximately $0.40-$0.50/kg MS to the farm gate price (depending on how much dairy processors have hedged their currency exposure).

Figure 6: Budget Update dairy export deflator forecasts and GDT prices
Figure 6: Budget Update dairy export deflator forecasts and GDT prices.
Source: The Treasury, GlobalDairyTrade

The exchange rate has been volatile

Weaker than expected dairy prices, along with the additional easing in the OCR now expected by the market, contributed to exchange rate depreciation early in the month.  At the start of July, the NZD was trading at 68 cents against the USD and 70.9 on the TWI; by the middle of July it had fallen to 65 cents and 69.3 respectively. However, following the OCR review and the speech by the RB Governor - which analysts saw as indicating more than one additional reduction in the OCR was less likely - the NZ dollar rose to 67 cents and 71.1 respectively. That said, the NZD dollar has fallen more than 10% against the USD and 8% on the TWI in the last three months, which will help boost export receipts and will also eventually put upwards pressure on tradables inflation by making imported goods more expensive in domestic terms.

Global activity picks up but risks high...

Reported data on most of our trading partners were generally positive in July, but risks arising from Greece and China came to the fore in the first part of the month, before declining later. US and UK monetary policy is expected to tighten, but some other central banks eased policy further. Global commodity prices continued to fall, reflecting concerns over the strength of future demand, as well as increased supply.

...as major advanced economies recover...

The US economy continued to strengthen. Non-farm payrolls expanded 223,000 in June, bringing growth in the June quarter (Q2) to 664,000 from 586,000 in the March quarter. The unemployment rate fell 0.2% points to 5.3% in June. Growth in activity was solid in both manufacturing and services, and construction rebounded following higher house price growth. However, retail sales dipped 0.3% in June, and a sharp fall in consumer confidence in July points to soft spending growth.

Euro area developments were positive overall. The unemployment rate remained at 11.1% in May, but down from 11.6% a year ago. Growth in consumer spending was solid, boosted by faster jobs growth and low interest rates. However, growth in industrial activity was soft in Q2 so far. Annual inflation was 0.2% in June, showing a slow pick-up since the start of 2015.  The UK recovery continued, with GDP expanding 0.7% in Q2, driven by services. The unemployment rate rose 0.1% point to 5.6% over the three months to May, but annual wage growth picked up to 3.2%. Meanwhile, the Japanese economy showed a gradual recovery, with conditions facing households and businesses improving slowly.

Australian employment grew 2.0% from a year ago in June, although the unemployment rate rose 0.1% point to 6.0% as the participation rate rose. Retail sales values rose 3.8% from a year ago, supported by faster jobs growth. However, the terms of trade are expected to fall further in Q2 and drag on nominal GDP growth. Annual inflation rose from 1.3% to 1.5% in Q2, driven by higher petrol prices, with core inflation (excluding large price movements) steady at 2.2%.

...and growth in China in line with target

The Chinese economy expanded at an historically slow pace of 7.0% in Q2 from a year ago (Figure 7), but at the government’s target and exceeding market expectations (6.8%). Annual inflation rose to 1.4% in June from 1.2% in May, but remained significantly below the government’s 3% target. House prices continued to recover gradually from large falls over 2014, rising 0.4% in June. However, the Caixin manufacturing PMI (formerly the HSBC PMI) fell 1.2 points to 48.2 in July, showing below-trend growth in industrial activity.

Growth in South Korea was slower than expected at 0.3% in Q2, as the MERS outbreak affected consumption and tourist arrivals. A high exchange rate and subdued Chinese demand also weighed on export growth.

Figure 7: Chinese real GDP growth
Source: Haver

Risks elevated in early July before falling

Key risks weighed on investor sentiment early in July. Chinese equity prices declined 32% from mid June to early July, although markets have since stabilised to an extent and equity prices remain 64% higher than a year ago. Supportive government measures lifted market sentiment, but volatility resurfaced towards the end of July.

The Greek referendum on 5 July resulted in a ‘no’ vote to the EU’s previous bailout proposal, but risks declined as Greece and the EU agreed to negotiate a third bailout. The Greek 5-year bond yields fell from 36% in early July to 16% towards the end of the month. This month’s special topic discusses the impact on New Zealand if developments in Greece and China lead to a major financial crisis.

Fed and BoE on track to tighten policy...

The US Federal Reserve (Fed) affirmed that a rise in the Funds Rate in 2015 is appropriate given the solid recovery in the US economy. The Fed’s July statement noted sustained improvement in the jobs market, and, while board members raised concerns around Greece and China, these risks have receded. The Bank of England Governor Carney indicated that gradual rate increases may occur as soon as the beginning of 2016.

The European Central Bank appears less likely to extend its quantitative easing (QE) beyond 2016, given the tentative pick-up in inflation. However, an extension remains possible if inflation stays significantly below 2% by mid 2016.

...but some central banks continued to ease

Some central banks continued to ease policy. The People’s Bank of China (PBoC) reduced its key policy rates in late June, and analysts expect further easing to support growth and stabilise the stock market. The Bank of Canada lowered its policy rate by 25 basis points to 0.5% and cut its 2015 growth forecast heavily in response to falling commodity export prices.

Markets expect further monetary easing by some other central banks. The Reserve Bank of Australia left its policy rate unchanged at 2.0%, but markets continue to price in an 80% probability of a rate reduction by December 2015. The Bank of Japan (BoJ) remains upbeat on achieving 2% inflation (by mid 2016), citing a strengthening jobs market and the effect of oil price falls receding. However, the BoJ lowered its growth and inflation forecasts, and analysts expect an expansion of its QE programme.

US bond yields higher but NZ yields declined

Global market movements reflected risks and the divergence in policy outlook. The US 10-year bond yield was volatile, falling 7 bps over the month to 2.28%. The NZ 10-year bond yield dropped 26 bps to 3.36%, owing to a sharp fall in dairy prices and the RBNZ’s OCR cut (see p.5). Euro area yields declined from high levels as Greek risks eased.

Commodity prices declined further (Figure 8), reflecting higher global supply but also lower demand from emerging economies. Brent crude oil prices fell 11% to US$53.5/bbl, owing to continued high oil production from Saudi Arabia and North America, and a nuclear agreement between the US and Iran which is expected to increase global supply. Iron ore prices declined 8.8% to US$55.9/tonne owing to increased supply and weaker demand from China.

Figure 8: CRB commodity index
Figure 8: CRB commodity index.
Source: Haver
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