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Monthly Economic Indicators

Analysis

Data released over June helps us assess the current state of the New Zealand economy. March quarter GDP and balance of payments data also provide useful platforms from which to consider a couple of the major issues facing the economy, namely the outlook for growth and the risks associated with imbalances such as New Zealand’s high level of net international liabilities. Given renewed nervousness in financial markets about global economic growth, there is increased risk associated with high levels of external debt, particularly in an environment in which investor sentiment can change rapidly.

Economic recovery continues…

Real production GDP rose 0.6% in the March 2010 quarter, the fourth consecutive quarter of expansion (Figure 1). This was slightly weaker than the 0.8% growth in the Budget Forecasts. The pace of growth was also lower than the 0.9% recorded in the December quarter.

Figure 1 – Real GDP
Figure 1 – Real GDP.
Sources: Statistics NZ, the Treasury

… despite weak services sector

A key driver of this moderation was the service sector, which recorded no growth in the March quarter, the weakest result in a year. With services flat, growth was driven by primary and manufacturing industries. Although the impact was large in some regions, the national impact of drought was small as agriculture production rose 0.8% in the quarter, including a rise in dairy production. Some drought impact may be felt in the June quarter or next season.

Recession impacts linger, with activity still below pre-recession levels

The recession saw real GDP fall 3.4% below its December 2007 level by March 2009. Over the past year the economy has clawed back just over half of this reduction with real GDP now 1.6% below the December 2007 level. However, this underplays the impact of the downturn on the economy as part of this recovery reflects population growth. In per person terms, real GDP fell 4.8% below its December 2007 peak by June 2009 and has to date recovered about one sixth of this, with the level of real GDP per capita still around 4% below its December 2007 level.

The current recovery is not expected to be as strong as was experienced after the 1997/98 downturn. This reflects a more cautious approach by consumers given high debt levels in an environment which views debt as more risky, significantly deteriorated fiscal positions in a large number of economies necessitating relatively large-scale fiscal consolidation, and a reduction in credit availability at the more speculative end of the investment spectrum. This expectation of a more muted recovery appears to be playing out. Real GDP increased by 5.7% in the first four consecutive quarters of growth following the 1997/98 downturn, but only 1.9% in the latest recovery.

Export growth was stronger than anticipated but consumption weaker

Real expenditure GDP also increased 0.6% in the March 2010 quarter. The increase in expenditure GDP was led by a 3.4% increase in goods exports, with log exports and non-primary manufacturing key factors. This was partially offset by lower services exports, driven by a fall in overseas visitor spending. Imports increased 1.8% in the quarter, boosted by the acquisition of the HMNZS Otago, but were still 15% lower than their peak in mid-2008. Net exports made a slightly larger contribution to March quarter growth than was anticipated in the Budget Forecasts.

On the other hand, real private consumption and investment growth was weaker than we anticipated. Real private consumption grew 0.2% in the March quarter following increases of 0.8% in the previous quarter and 0.9% in the September 2009 quarter. Residential investment rose only 0.5% after a 4.7% increase in the previous quarter. Public consumption rose 1.7% boosted by the acquisition of HMNZS Otago.

Muted consumption continues in June quarter…

Relatively weak private consumption growth looks to have continued in the June quarter based on indicators such as retail sales and electronic card transactions. Total retail sales fell 0.3% in the month of April, while retail transactions on electronic cards recovered just 0.4% in May following a 2.2% decline in April. These data point to subdued consumer spending in the June quarter as a whole, although lower food prices in April and May will cushion the impact on volumes to some degree.

… but higher confidence should eventually flow through to spending

Consumer confidence figures point to a pick-up in consumer spending later in the year. The Westpac McDermott Miller measure of consumer confidence increased from 114.7 in March to 119.3 in June. Consumers remain more upbeat about future conditions relative to the here and now, although most of the improvement in the June quarter related to present conditions.

Housing data remain weak

Data relating to the housing market remain weak. The number of house sales slipped back by 3.6% in May (seasonally adjusted). Sales levels remain low, although seasonally adjusted sales for the June quarter as a whole should be above the weak March quarter figure. The time taken to sell a house also crept up over the three months to May, while prices eased slightly.

Figure 2 – Consents and residential investment
Figure 2 – Consents and residential investment.
Sources: Statistics NZ, the Treasury

Building consents for new dwellings (excluding apartments) eased 9.5% in May. Consents data are volatile on a monthly basis but recent developments imply downside risk to our residential investment forecast (Figure 2).
Slowing migration will also affect the demand for housing. Net migration gains slowed in the year to May, reflecting fewer arrivals and a pick-up in departures (particularly to Australia), continuing a development that has occurred since January this year. The annual net gain from permanent and long-term migration in the year to May was close to 18,000, down from a recent peak of 22,600 in the year to January.

Weaker consumption growth and stronger exports relative to the Budget Forecasts indicate slightly more rebalancing in the economy than was anticipated. The recent consolidation by households is also apparent in credit data. Consumer credit contracted by 2.5% in the twelve months to May, with the rate of growth in housing credit also remaining weak. At this stage, the rebalancing in the economy is only slight and is yet to be sustained for any length of time.

More cautious behaviour from households, including slower residential investment, is pointing to slightly weaker near-term growth than was expected in the Budget Forecasts. However, in the absence of significant external shocks, further economic recovery can be expected.

Economic recovery set to continue over 2010

The National Bank’s Business Outlook points to continuing economic recovery over the year ahead. Associated with this rise in activity should be an increase in employment. The level of business confidence and expectations of firms’ own activity levels remain elevated. However, consistent with much of the latest data, a degree of caution was apparent, with expectations slipping back relative to earlier highs. This was the case across most of the survey measures, including overall confidence, investment intentions, employment and profits.

In its June Monetary Policy Statement, the Reserve Bank increased the Official Cash Rate to 2.75% from 2.5%, the first change since April 2009. This reflects a view that the need for unusually supportive monetary policy is reducing as the economy enters its second year of recovery.

Rising commodity prices boost incomes

Rising commodity prices played a key role in the largest increase in the merchandise terms of trade since 1976, as measured by the Overseas Trade Indexes (OTI). The merchandise terms of trade increased 5.9% in the March quarter, following a similar 5.8% increase in December 2009.

Figure 3 – Merchandise terms of trade
Figure 3 – Merchandise terms of trade.
*SNA measure is the measure used in the GDP data.
Sources: Statistics NZ, the Treasury

While still a little below the 2008 level, the merchandise terms of trade is significantly higher than over most of the period since the mid-1970s (Figure 3). Despite a slight 1.2% decline in world commodity prices in the month of June, the ANZ commodity price series remains near record highs, suggesting further increases in the terms of trade are likely. A high terms of trade is an important factor supporting incomes, including government taxation revenue.

Nominal GDP in line with forecast

Consistent with the OTI data, a large increase in the goods terms of trade was recorded in the GDP data and this drove the increase in the GDP deflator. A 1.8% increase in the GDP deflator, together with the 0.6% increase in real expenditure GDP, meant nominal GDP increased 2.5%. The level of seasonally adjusted nominal GDP matched the Budget forecast.

Lower food prices and a higher exchange rate dampen the inflation outlook slightly

Domestically, price developments have been reasonably weak in the June quarter. Lower food prices suggest that consumer price inflation is likely to be lower than the 0.7% quarterly increase predicted in the Budget Forecasts. With the dampening impact that a higher than anticipated exchange rate will have on tradables inflation, there is a reasonable chance that annual inflation will peak below the 5.9% figure in the forecasts. Nevertheless, a peak well in excess of 5% is still considered likely.

Current account deficit smallest in 2 decades

The annual current account deficit narrowed to 2.4% of GDP in March 2010 from 2.9% in December 2009. The main driver of this reduction was a fall in the investment income deficit due to lower profits of foreign-owned firms operating in New Zealand and higher profits from New Zealand-owned firms operating abroad. Higher dairy prices contributed to a larger goods surplus.

The reduction in the current account deficit was broadly in line with the 2.6% current account deficit forecast in the Budget Forecasts. We still expect the current account deficit to widen from here, with the deficit to exceed 4% of GDP in the second half of 2010, before rising further. This rise will partly reflect the one-off nature of the bank tax cases with IRD, which will begin to fall out of the annual calculations from the June 2010 quarter. However, it will also reflect a recovery in the New Zealand economy. A rise in import volumes and investment income is expected as domestic demand continues to recover (albeit slowly).

Taking the April and May merchandise trade data for the June quarter as a whole suggests a fall-back in dairy export volumes in the quarter (possibly drought related). This contributes to a slightly weaker outlook for goods export volumes as a whole, although growth in nominal goods exports is likely to be similar to forecast owing to slightly more positive prices. Import growth for the June quarter looks a little weaker, partly reflective of subdued domestic demand. These differences from forecast are likely to be relatively small and therefore do not substantially change our view as to the likely path taken by the current account deficit.

High net foreign liabilities remain a risk…

As of 31 March, New Zealand’s net international liabilities stood at $166.7 billion or 88.9% of GDP (ie, international liabilities exceed international assets). This, however, represents the second quarter in a row that net international liabilities have declined. In December 2009 New Zealand had net international liabilities of 90.6% of GDP, down from 93.3% in September 2009. These changes reflect valuation changes and therefore are unlikely to continue over a sustained period.

Figure 4 – International assets and liabilities
Figure 4 – International assets and liabilities.
Sources: Statistics NZ, the Treasury

… and are likely to trend higher

Valuation changes aside, countries running consistent current account deficits will see their net international liabilities increase over time. In the current global economic climate, greater attention is being paid to such imbalances. To stabilise New Zealand’s net international investment position (as a percentage of GDP) would require continued surpluses in the combined goods and services balance in the order of 1¼ to 2¼ percent of nominal GDP. This contrasts to an average 0% (ie approximate balance) over the past decade.

Figure 5 – Goods and services balance to stabilise net international liabilities (as % of GDP)
Figure 5 – Goods and services balance to stabilise net international liabilities (as % of GDP).
*assumes 5% per annum nominal GDP growth, 8% return on net international liabilities, and a transfers surplus of 0.4% of GDP per annum
Sources: Statistics NZ, the Treasury

Over the past decade, the current account deficit has largely been the result of private sector savings being insufficient to fund private sector investment. Government surpluses meant that from a savings and investment perspective the government sector was having an offsetting impact. This is no longer the case.

Even stabilising New Zealand’s net liabilities is a substantial task

Achieving consistent goods and services surpluses of the magnitudes referred to above would require a significant change in economic behaviour and a marked departure from past trends. Part of this behaviour change would need to manifest itself in a substantial and sustained increase in national savings. Periods when a combined goods and services surplus of the magnitude required have been achieved have been associated with a low exchange rate. A supportive global economic climate also assists. However the risks associated with the world economy have increased. Global economic sentiment has been volatile and subject to significant swings. This volatility is likely to remain a feature of the financial and economic landscape for some time.

Financial contagion fears ease...

Worries that the debt problems experienced by Greece will spread to other European and major economies eased somewhat in June. Sovereign funding worries have partially subsided after European countries, including Portugal, Spain, Ireland and Italy, had relatively successful government bond auctions, with some risk appetite returning to markets. The major beneficiaries have been commodities and “risk currencies”. Oil prices have rebounded from their $US68 per barrel low towards the end of May to an eight-week high over $US78 and the New Zealand and Australian dollars have risen over 4% against the United States dollar (USD) from May’s lows.

.... but global slowdown worries rise

Germany, France, Japan and the UK all announced major austerity measures to cut their significant fiscal deficits. While these measures will be positive in the long run, by improving global imbalances and government finances, there will likely be a short-run negative effect on world growth. In addition, US data releases have led to doubts over the sustainability of the US recovery. March quarter GDP and May non-farm payrolls were weaker than expected. The US housing market is also showing signs of renewed weakness, although this may be a temporary effect from the expiry of home-buyer tax credits.

At the end of June worries about the global recovery intensified due to a run of poor data on the USA, Japan and China. This led to large falls in equities, commodities and “risk currencies”.

These concerns have resulted in “safe-haven” demand for gold, as well as US and German government bonds. Gold recently hit a record high, and US two-year and German ten-year bond yields record lows. New Zealand Government interest rates have also eased noticeably over the last couple of months, with 10-year bond rates falling from 5.9% in early May to around 5.5% throughout June, indicating that New Zealand is not seen as a high risk sovereign borrower by markets.

International announcements grab headlines...

China announced the end of a 23-month peg of the Yuan to the USD. The CNY/USD will be reset each morning, allowed to move +/-0.5% within each day and will be referenced against a basket of currencies rather than just the USD, allowing for a slow rise against the USD over time. Markets interpreted this as positive for global rebalancing and a sign of the strength of the global recovery. The announcement was aimed at increasing the flexibility in the exchange rate as a way of limiting currency speculation and relieving political tensions ahead of the G20 summit in late June. The Yuan fluctuated against the USD following the announcement, but has appreciated about 0.5% in the subsequent week.

World leaders agreed at the G20 summit to reduce government deficits in most developed economies by 2013. In addition, the Bank for International Settlements called for monetary tightening to avoid distortions and risks to financial and monetary stability. This month’s special topic examines the implications for New Zealand of fiscal consolidation in Europe.

The US Congress approved a financial reform bill, which included a ban on most proprietary (banks trading for own profit on their own account) and derivative trading. The bill was less restrictive on banks than expected, which eased worries about financial regulation slowing the global recovery.

...and Greece came back into focus

Greece’s €110b bailout package announced in May somewhat relieved Greek funding worries. Recently, however, these concerns have reappeared and their five-year sovereign CDS spread (the cost of insuring against default on government bonds) has risen back to record highs, suggesting markets do not believe the package and austerity measures announced will fix their solvency problem.

Figure 6 – Sovereign 5-year CDS spreads
Figure 6 – Sovereign 5-year CDS spreads.
Source: Bloomberg

Banking sector worries heighten...

A number of European banks have had their credit ratings downgraded in June, while many are relying on funding from the European Central Bank (ECB) for liquidity. This has resulted in increased banking sector fears, with the three-month Euro area interbank interest rate (EURIBOR) hitting a nine-month high and the US LIBOR-OIS spread (a measure of banking sector risk) continuing to increase.

... highlighting a risk for New Zealand...

New Zealand’s floating exchange rate, independent monetary policy, relatively low levels of government debt, and the strong Australasian banking system place New Zealand in a much stronger position than embattled economies such as Greece and Portugal.

The biggest risk to New Zealand from the sovereign debt crisis is through the banking sector and financial markets. If banking sector worries spread to the rest of the world, New Zealand banks may find it harder to raise money on foreign wholesale markets, which make up a large part of their funding. If funding costs rise worldwide, higher interest rates will be passed on to New Zealand borrowers. The result may be credit constraints and higher debt servicing costs, dampening the ongoing recovery.

...although direct economic risks are small

Europe makes up a relatively small part of New Zealand’s trade (around 12% of New Zealand’s exports), so any slowdown in the region will not have a major direct impact on the New Zealand economy. European problems could indirectly affect New Zealand through our other trading partners. New Zealand’s biggest export destinations are Australia and emerging Asia, which continue to lead the world recovery with strong economic data outturns, although there are concerns about weaker growth in China in the second half of 2010.

Overall, international and domestic developments over June lead us to believe the economy will continue its relatively gradual recovery over the year ahead. Our view as to the most likely path the economy will take remains consistent with the Budget Forecasts. Nevertheless, downside risks have increased significantly and near term growth may be a little weaker than forecast.

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