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Monthly Economic Indicators

Commentary

The past month has seen the release of data that confirm a sharp slowing of growth in early 2008 and point to further weakness in the June 2008 quarter.  It is possible that the economy has experienced a technical recession (when real GDP declines for two consecutive quarters) in the first half of 2008.  In addition, economic growth in the year to March 2009 is expected to be weaker than we forecast in the Budget Update, especially if oil prices remain elevated.

The economy contracted in the first quarter …

Real production GDP fell by 0.3% in the March quarter, the first quarterly fall since 2005 and only the second since 2000 (Figure 1).  The decline matched the median market pick but was larger than the 0.1% fall forecast in the Budget Update.

Figure 1 - Real GDP growth(production)
Figure 1 - Real GDP growth(production).
Source: Statistics NZ

The largest negative contribution to the March quarter result came from lower agriculture production and primary food manufacturing, which subtracted 0.4 percentage points from growth.  This was due to drought conditions both reducing the amount of agricultural output and raising production costs due to the need to use supplementary feed.

The goods producing industries also subtracted from GDP, mainly due to the construction sector where there were falls in both residential and non-residential building activity.  Once we subtract primary food manufacturing, which is affected by levels of agricultural production, manufacturing was relatively steady in the quarter.  Services provided some offset to the falls in agricultural production and construction, contributing 0.2 percentage points to growth with increases in personal and community services providing the greatest boost.

… as exports and domestic demand weakened

Real expenditure GDP fell by 0.6% in the March quarter.  A 1.8% decline in exports contributed 0.6 percentage points to the fall in GDP.  Following strong increases in previous quarters, dairy exports fell as drought affected production.  Exports of manufactured food, beverage and tobacco products also fell (again likely due to the drought) as did services exports due to declining tourism.  Drought also led to an increase in meat export volumes as slaughtering was brought forward.

Consumer spending fell 0.4% in the quarter, the first decline in nearly 4 years.  This fall was due to a drop in spending on durables such as vehicles, furniture and appliances and likely reflected the strain on household budgets from rising food and fuel prices and mortgage interest rates.  Slowing housing demand was reflected in a 5.5% decline in residential investment in the quarter.

Business investment also fell, down 1.2% in the quarter, mainly associated with falling investment in non-residential buildings and intangibles (particularly mining exploration activity, following strong growth in previous quarters).  A 5.9% increase in plant, machinery and equipment investment in the March quarter provided some offset and built on increases of around 5% in each of the previous two quarters.  Possible factors behind this include continuing dairy conversions, a relatively high dollar still making imported capital equipment relatively cheap, and efforts to switch from labour following a difficult period attracting workers.  Much of the March quarter increase in plant, machinery and equipment investment was met out of imports.  Plant, machinery and equipment imports rose 8.8% in the March quarter contributing to a rise in overall import volumes of 1.2%.  In contrast, consumer goods imports fell 1.2% in the March quarter. 

Rising stock levels may be involuntary

While an increase in stock levels made a large 0.8 percentage point contribution to GDP growth in the quarter, it is likely that much of this reflects slow sales in the retail sector.  With consumption of durables particularly weak this quarter, it is likely that retailers have been left holding higher stock levels than they would like, possibly leading to further discounting of some consumer goods.

The decline in real GDP in early 2008 came after robust growth in 2007 …

Despite the fall in real GDP in the quarter, annual average growth was robust at 3.0% in the year to March 2008 reflecting growth in previous quarters. With hours worked falling slightly, economy-wide labour productivity growth rose to an 8-year high of 3.1% in the year to March 2008 (Figure 2).[1] The rebound partly reflected the recent economic upturn (productivity tends to be pro-cyclical) and recent business investment. Although a slowing of economic growth in 2008 may have a dampening impact, strong growth in plant, machinery and equipment investment in recent quarters will be a positive influence for ongoing labour productivity growth.

Figure 2 - Labour productivity growth (real GDP per hour worked) and economic growth
Figure 2 - Labour productivity  growth (real GDP per hour worked) and economic growth.
Source: Statistics NZ, Treasury calculations

… and price growth boosted nominal GDP …

Although volumes fell 0.6%, nominal expenditure GDP rose 0.5% in the March quarter and 7.4% in the year to March 2008.  The GDP deflator, the broadest measure of prices in the economy, rose 1.1% in the March quarter and was up 4.9% over the year.  Rising petrol and food prices contributed to private consumption prices rising 0.9% in the quarter, but price growth was again greatest in exports.

… as dairy export prices increased sharply …

The merchandise terms of trade rose 4.1% in the March quarter, above median market expectations of 0.3% and the 3.5% Budget Update forecast.  The increase in the terms of trade to a 34-year high was due to higher export prices more than offsetting higher import prices (Figure 3). 

Figure 3 - Merchandise terms of trade
Figure 3 - Merchandise terms of trade.
Source: Statistics NZ

Export prices rose 4.5% in the March quarter as dairy prices surged 19.7% higher.  The world spot prices for dairy have eased since late 2007, partly owing to increased US dairy production.  This suggests weaker growth in export prices in the near term as contract prices for dairy begin to reflect the fall in the spot prices.  However, export prices will likely be supported by increasing prices for commodities other than dairy.  The ANZ world commodity price index has continued to rise for commodities such as meat and wool (Figure 4).

Figure 4 - Commodity prices
Figure 4 - Commodity prices.
Source: ANZ-National Bank

A 0.3% rise in import prices in the March quarter was largely due to higher oil prices.  Import prices are likely to increase by more in the June quarter as oil prices are considerably higher than in the March quarter (see Special Topic).  Combined with weaker growth in export prices, the terms of trade is likely to be at or near a peak.

… but current account deficit remains high

Despite the large rise in the terms of trade, the current account deficit narrowed only slightly from 7.9% of GDP in the year to December 2007 to 7.8% in the year March 2008 (Figure 5).  The result was larger than our Budget Update estimate of 7.4% and a median market prediction of 7.5%.

Figure 5 - Current account
Figure 5 - Current account.
Source: Statistics NZ

The quarterly current account deficit (seasonally adjusted) rose $410 million to $3.53 billion in the March quarter, driven by a higher value of goods imports (chiefly oil, reflecting increased prices and stock building) and a wider investment income deficit.  One cause of the wider investment income deficit was lower earnings by overseas subsidiaries of New Zealand companies, a reflection of the current tougher international trading environment.  Higher dairy prices boosted the value of goods exports in the quarter even though the drought affected volumes.

Household spending to remain subdued …

Weakness in consumer spending in the March 2008 quarter is likely to persist into the June and September quarters as the Westpac Consumer Confidence Index fell from 96.5 to 81.7 in the June quarter, the lowest since the 1991 recession (Figure 6).  Continuing the weakness in durable consumption seen in the GDP release, a net 11% of respondents say it is now a bad time to buy major household items.  Increasing costs and the prospect of falling house prices appear to be weighing on consumers’ assessment of their financial circumstances, with a net 40.8% of respondents feeling worse off than last year.

Figure 6 - Consumer confidence and spending
Figure  6 - Consumer confidence and spending.
Source: Westpac McDermott Miller, Statistics NZ

A slowing housing market points to weakness in residential investment.  Residential building consents in May were 27% lower than a year earlier, house sales in May were 53% lower than a year earlier, the median days to sell a house rose in seasonally adjusted terms from 45 days in April to 47 days in May, while the median house price for the month of May was flat at $345,000.  One factor that could be positive for the housing market is the net gain of permanent and long-term (PLT) migrants.  The net gain of 1,000 in May 2008 (seasonally adjusted) was the highest since late 2006 and lifted the annual total to 4,900 in the year to May 2008 (Figure 7).  Although it is too early to confirm a positive trend given volatility in monthly data, migration is slightly more positive than in the Budget Update forecasts.

Figure 7 - Net PLT migration
Figure 7 - Net PLT migration.
Source: Statistics NZ

… while firms are pessimistic …

Firms’ expectations of their activity in the coming year, although up marginally from the previous survey, continue to point to a period of weakness in the economy (Figure 8).  A net 4.0% of firms in the June 2008 National Bank Business Outlook (NBBO) expect their activity to fall, compared to a net 4.4% in May 2008.  Of the five sectors, only agriculture has a positive outlook for activity.

Figure 8 - Activity outlook and economic growth
Figure 8 - Activity  outlook and economic growth.
Source: ANZ-National Bank, Statistics NZ

Part of the slowing in GDP growth will be driven by a consolidation in household spending after a period of strong growth since 2000.  A weakening labour market will play a part in this slowing in household spending – in the NBBO, a net 11.9% of firms expect to lower employment in the year ahead (the most since 2000) and a net 74.6% of firms expect the unemployment rate to increase in the year ahead (the worst result since the series began in 1993).  These readings were broadly consistent with a weakening in the Westpac Employment Confidence Index from 128.8 to 120.8 in the June quarter.  Although this index remained in positive territory, it was the lowest reading since the survey began in mid-2004.

… but inflation expectations are elevated

The latest NBBO also pointed to ongoing inflation pressure in the near term at least.  Respondents expect inflation to be 3.5% in 12-months time, up from 3.4% in the previous survey and the second highest figure since 1991.  The NBBO also reported a net 41.2% of firms expect to increase their prices in the next 12 months, up from 36.4% previously.  Although these intentions may not be realised in a difficult trading environment, such an increase has implications for Consumers Price Index (CPI) inflation, which is likely to head higher from 3.4% in the year to March 2008 to exceed 4% in coming quarters.

Nevertheless, the weakening outlook for activity, and as a result non-tradables inflation, means that market expectations are for the Official Cash Rate (OCR) to decline in the second half of 2008.  The weak nature of data in recent months has seen the market price in a larger and more rapid easing in the OCR than was previously the case.

The June NBBO revealed a similar theme with a net 34.8% of firms believing that interest rates will fall in the next 12 months, up from 23.7% in the May survey and 10.9% in the April survey.

International economies also concerned about lower growth and high inflation pressure

June Consensus Forecasts (a survey of global forecasters) showed the growth of New Zealand’s trading partners is forecast to slow to 3.2% in the 2008 calendar year from 4.2% in 2007.  This indicates that the global trading environment will continue to be difficult for New Zealand’s exporters.  While the slowing in growth is broad-based, the low rate of growth in the US and Europe is noticeable.  This reflects the fact these economies have been particularly affected by recent financial market events.  Financial concerns remain to the fore in the US with poor results reported by some investment banks and other financial institutions seeking fresh capital injections.

US and Eurozone consensus inflation forecasts continue to be revised for the 2008 calendar year to 4.0% and 3.3% respectively – these are up about 0.5 percentage points on the equivalent forecast three months ago.  These revisions are consistent with increased concerns about inflation expressed by their central bank officials.  Higher oil prices have been a key driver of inflationary pressures, as discussed in the Special Topic.

Weak economic growth likely to continue

In New Zealand, June 2008 quarter GDP growth is likely to remain weak as both consumers and businesses remained pessimistic.  Further increases in petrol prices, along with the lingering effect of the recent drought (including its impact on electricity production), has also been present in the June quarter.  There is a possibility that a second negative quarter of growth may occur but, with limited partial data available to date, it is too early to provide precise estimates.  Furthermore, tax receipts (one of the most timely indicators of economic activity) remain robust as they rose 6.0% in the 11 months to May 2008 compared to the same period a year earlier, the same as forecast in the Budget Update.

The timing of Easter, which fell entirely in the March quarter, and the leap year will have had some impact on the March quarter figures and will also influence the June quarter results, potentially increasing data volatility.  It is, however, difficult to determine whether the additional day in the March quarter or the loss of two trading days due to Easter will have dominated.

At this stage, near-term growth is coming in weaker than forecast in the Budget Update.  In the year to March 2009, economic growth is expected to come in around ½ percentage point weaker than the 1.5% forecast in the Budget Update.  Nevertheless, positives still exist such as high dairy payouts and personal tax cuts from 1 October and therefore growth is likely to be positive in the second half of the year.  Future Monthly Economic Indicators reports will continue to monitor developments.

Note:

[1]    Official productivity statistics for the March 2008 year are not released until March 2009 and may not show a rebound in labour productivity growth as seen in the economy-wide data as they cover the measured sector (ie, about a quarter of the economy is excluded) and the measure of labour input is paid hours, which have not been as weak as actual hours worked.
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