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Monthly Economic Indicators

Analysis

The Budget Economic and Fiscal Update (BEFU) was released on 24 May 2012, with our macroeconomic forecasts finalised on 27 April. Since finalising these forecasts, international sentiment has deteriorated as the Greek debt crisis has become more serious. Our BEFU forecasts allowed for some volatility in financial markets and incorporated below-consensus growth for the euro area, covering recent developments to some extent. Our base case is still that Greece remains in the euro area for now and leaders "manage through" the crisis. Therefore, we believe our central forecast track remains valid at this stage, although downside risks have increased. Our downside scenario in the BEFU was based on a global slow-down emanating from Asia, although could also be seen as illustrative of Greece leaving the euro area but contagion remaining limited. In this downside scenario, nominal GDP and tax revenue were $25 billion and $8.1 billion lower than the central scenario over the forecast period, respectively.

Domestic data have been fairly consistent with our BEFU forecasts and point to moderate growth in coming quarters. Treasury forecasts annual average growth to be 1.6% in the March 2012 year, before rising to 2.6% in 2013 and 3.4% in 2014.[1] Other forecasters of the New Zealand economy had published views close to those of Treasury at the time of BEFU's release. The average of 11 other real GDP growth forecasts was the same in the 2012 March year and 0.1% points and 0.3% points below in 2013 and 2014 respectively. The averages of other forecasts are also close to Treasury's forecasts for inflation and the unemployment rate for those years. However, escalation of the euro crisis could see revisions.

Risk of Greek exit increases…

The Greek crisis escalated significantly in May as voters rejected the ongoing austerity in the 6 May election, with almost 70% of votes going to anti-austerity parties. A government was unable to be formed, with a new election to take place on 17 June. The resulting uncertainty has led to the possibility of a Greek exit from the euro area being openly talked about by the ECB and by some European leaders. The main concerns surrounding a Greek exit are the contagion arising from credit losses to the rest of Europe if Greece defaults, weighed up against the cost of any further bailout programme. Of further concern is the withdrawal of funds from the banking system, estimated to be around €700m per day since the election. If this were to accelerate into a full bank run, regardless of how the political situation plays out, Greece could be forced to leave the euro area and adopt a new currency. An exit from the euro would be accompanied by a large devaluation of the new Greek currency and likely partial default on its foreign debt. While the devaluation would help with competitiveness, it would also lead to much higher inflation.

… putting markets into retreat...

The increased risk of Greek exit saw market participants become much more risk averse during the month. Global equities were down around 6% to levels not seen since January. US, UK and German government bonds saw strong safe-haven demand, with yields for all three falling to record-low levels. The USD also strengthened in line with the risk-off tone. Spanish bond yields, on the other hand, have jumped from below 6% to around 6.6%, in part owing to ongoing banking-sector problems. These yields are unlikely to be sustainable for a significant duration of time, and there is increasing talk that Spain could require a bailout. Italian yields also crept up, but not to the same extent as Spain's.

...impacting New Zealand commodity prices...

The risk-off tone seen in global markets has flowed through to impact on New Zealand. New Zealand commodity prices have suffered large falls recently, as they continue to come off their 2011 peaks. While some of these falls can be put down to increased supply, the deterioration in international sentiment has contributed. The ANZ Commodity Price Index fell 4.5% in world terms in April, the largest decrease in over three years, to reach an 18-month low.

The risk-off tone has also resulted in a fall in commodity currencies, including the NZD. The fall in the NZD has helped cushion the fall in commodity prices. The TWI has fallen from 72.2 to 68.4 (5.3%) in May (Figure 1). The updated Fonterra forecast payouts demonstrated some of this effect. The 2011/12 payout was revised down by 30 cents to $6.05 per kg of milk solids (kgMS), while the opening 2012/13 forecast was $5.50 per kgMS. The fall was relatively small considering the GlobalDairyTrade (GDT) index had fallen 20.3% since the last forecast. The GDT only reflects part of Fonterra's supply and the recent fall in the NZD would have helped support the payout. The falls in dairy prices have resulted from high production levels both domestically and internationally and a deterioration in international sentiment. The fall has brought forward the decline we had expected later in the year. Despite the falls in commodity prices, export returns are still high by historical standards; the ANZ NZD commodity price index is still 12% higher than the 2000-2009 decade average, despite a 21% fall from its March 2011 peak.

Figure 1 – TWI & 10-year government bond rate
Figure  1 – TWI & 10-year government bond rate.
Source:  Reserve Bank of New Zealand

...government and household interest rates

New Zealand government bond rates have also fallen significantly over the last month on the back of increased demand, as investors move into less risky assets and look to diversify their holdings out of European debt as the crisis has intensified. The 10-year government bond rate began the month at 3.8% before falling to an all-time low of 3.5% (Figure 1). In BEFU it was estimated that a 1% lower government bond rate would improve the operating balance by around $1.1 billion dollars over the forecast period (to June 2016). If this 30 basis point fall is maintained over the forecast period the government would save around $350 million dollars in interest expenses, if nothing else changes.

The two-year swap rate was down over 30 basis points at one stage this month and is currently trading at a rate just below the OCR. Markets are now pricing in almost 40 basis points of OCR cuts by the December Monetary Policy Statement (MPS) and a more than 50% chance of a 25 basis point cut at the June MPS. Most banks have responded to falling wholesale interest rates (which their funding costs are based on) by cutting fixed mortgage rates by up to 50 basis points. On a $300,000 loan over 25 years, a decrease in the mortgage rate from 6% to 5.5% would save a household $28.77 per week in interest payments. These lower domestic interest rates loosen monetary conditions and provide an offset to negative global developments. When combined with the lower exchange rate, they may reduce the need for the OCR cuts that the market has priced in.

These interest rate falls could reverse if the euro debt crisis worsens significantly. If Greece exited the euro area and contagion occurred, overseas bank funding may become more constrained and expensive. Banks would likely pass these higher costs on to customers in the form of hikes in interest rates. There could be potential offsets through the Reserve Bank cutting the OCR or enacting liquidity provisions set up during the Global Financial Crisis.

Another major channel whereby a deterioration in the global outlook can impact New Zealand is through confidence. ANZ-Roy Morgan consumer confidence fell slightly in May as a decrease in current conditions outweighed a rise in future conditions. However, confidence remains in optimistic territory. The National Bank Business Outlook (NBBO) business confidence measure showed a substantial fall in May, but it remains optimistic and above average.  The fall in confidence was likely influenced by developments in Greece and their potential implications.

Businesses look likely to continue with moderate expansion of production...

The BNZ-BusinessNZ Performance of Services Index (PSI) rose 2.5 points to a highly expansionary 56.7 in April. This contrasts with the Performance of Manufacturing Index (PMI) that fell into contraction (below 50) at 48.0. Combining the two series still gives a relatively expansionary result, with the GDP-weighted Performance of Composite Index (PCI) sitting at 55.6. This figure is consistent with our modest GDP growth forecasts of around ½% over the next three quarters (Figure 2). The JPMorgan global PMI fell to a five-month low of 52.2, with the euro area well below 50, showing New Zealand is relatively well placed in the current global environment, especially with the earthquake rebuild set to be a major growth driver.

Figure 2 – PCI and GDP
Figure  2 – PCI and GDP.
Sources:  Statistics New Zealand, BNZ-Business NZ

The NBBO own activity outlook fell slightly in May but is still consistent with solid growth in coming quarters. The result was fairly strong considering the negative developments occurring in Europe and activity outlook is a better indicator of growth than business confidence which fell further.

...but struggle to pass on cost increases

Releases this month show that business costs are increasing at an annual rate of 2-3%. This compares to business output prices which are increasing at an annual rate of 1-2%. It appears that business margins are being squeezed as a subdued trading environment is constraining firms from fully passing on rising costs to customers. The results fit with corporate tax and other persons tax revenue being slightly below PREFU forecasts in the nine months to March 2012.

Producers Price Index (PPI) input prices rose 0.3% in the March 2012 quarter, as higher electricity generator input prices were partly offset by lower prices paid by food manufacturers, resulting from falls in soft commodity prices. Input prices were up 2.3% for the year (Figure 3).

Figure 3 – Firm costs and prices
Figure 3 – Firm costs and prices
Source:  Statistics NZ

PPI output prices fell 0.1% in the March quarter and were only up 1.6% for the year. Last month's March quarter CPI release also showed annual inflation of 1.6%.

The Quarterly Employment Survey (QES) showed a significant pickup in wages in the March quarter. Total average hourly earnings were 3.9% higher than a year earlier, compared to 2.8% in December. This means real wages rose an annual 2.3% (QES wage growth minus CPI inflation). The Labour Cost Index (LCI), which keeps the quantity and quality of labour fixed, showed a more subdued 2.0% annual increase in wages and salaries.

The Capital Goods Price Index (CGPI) was unchanged in the March quarter, but is up 0.9% for the year. Residential building and civil construction prices are 2.4% and 5.8% higher than a year earlier, respectively. These rises demonstrate some of the pressures developing from the Canterbury rebuild as well as a general pickup in the construction industry.

Weaker labour market headlines...

The Household Labour Force Survey (HLFS) showed the unemployment rate rose to 6.7% in the March quarter, from an upwardly revised 6.4% in the December quarter. Total hours worked were only up 0.1% in the quarter for a 1.1% annual rise. In the QES, hours paid fell 0.5% in March to be up 0.7% for the year. The headlines would suggest limited support for household spending going forward, but there were offsets.

...but details show positive signs...

However, looking at the details of the labour market outturns paints a brighter picture. The rise in the unemployment rate came about because of a 0.6% point rise in the participation rate, to the second highest figure on record of 68.8%, rather than a fall in employment which rose by 9,000. The rise in participation came about chiefly as more people in formal study were actively seeking and available for work. The employment rate (the portion of the working age population in work) actually rose 0.3% points to 64.2% in the quarter.

There are signs of improvement in Canterbury, with the unemployment rate 0.9% points lower over the past year and the employment rate 0.3% points higher. As has been the case in previous quarters, the retail trade, accommodation, and food services industry had the largest decrease in employment for the year. The largest increase in employment for the region was in the construction industry as it gears up for the rebuild.

…supporting modest consumption growth in coming quarters...

Indicators of private consumption are in aggregate consistent with our BEFU forecasts of modest growth in private consumption in coming quarters. While consumption looks to have fallen slightly in the first quarter, this was mostly anticipated as the result of a normalisation following a boost received from the RWC.

Core retail Electronic Card Transactions (ECT) were up 0.7% in April and 1.1% for the year. This was driven by increases in consumables and hospitality spending. Total ECT spending increased 0.6% as vehicle-related spending fell. The momentum in ECT values has picked up slightly with the three-month rolling average up 0.5% from 0.4% in the March quarter, in line with our private consumption growth forecasts for a pickup in the June quarter.

The REINZ house price index fell 0.3% in April and annual growth fell to 2.7% from the strong 4.2% growth seen in March. The growth in house sales has lost momentum in recent months with sales volumes down 8.1% following a 3.8% decline in March. Auckland and Christchurch continue to lead the market in sales volumes and price growth. The trend for house prices is in line with forecast and consistent with our view of a sluggish recovery in the housing market.

Figure 4 – Consumer confidence and consumption
Figure 4 – Consumer confidence and consumption.
Source:  Statistics NZ, ANZ-Roy Morgan

Food prices fell 0.1% in April, following a 1.0% fall in March. Food prices are unchanged for the year, further reinforcing subdued inflationary pressures.  Also, as mentioned earlier, consumer confidence remains in optimistic territory. The housing market recovery, subdued inflationary pressures and optimistic consumer confidence are consistent with our forecast consumption growth of around 1/2% in the next few quarters (Figure 4).

…following post-RWC slump

Core retail sales volumes experienced the largest quarterly contraction in the 17-year history of the series, dropping 2.5% in the March quarter. A rise in vehicle-related sales meant total volumes were down a lesser 1.5%, but still the largest fall in three years. This followed 2.3% and 1.8% rises in the September and December quarters respectively, boosted by the RWC. The fall in sales was broad based with contractions in 10 of the 15 store types, but the main driver was a 7.4% drop in supermarket volumes. While the core sales volume result appeared weak, it was understandable in the wake of the RWC and we had factored a fall in retail sales into our March quarter GDP pick. However, the weak result does provide some downside risk to our flat private consumption forecast. Abstracting from the volatility caused by the RWC, core sales are still up 3.2% for the year.

Euro weakness leads to deterioration in the global outlook...

In addition to the ongoing risks of a Greek exit from the euro area, data have been on the weak side. GDP growth was flat in the March quarter, albeit above expectations, driven by 0.5% growth in Germany. However, the growth outlook is poor, with the manufacturing PMI declining to 45, driven by falls in the German PMI. The overall services PMI also fell during the month, remaining well below the expansionary 50 level.

… which along with softer domestic data sees policy easing to support growth in China

Data for April revealed a softer picture for China, with authorities responding with a loosening in monetary and fiscal policies. Industrial production growth eased to 9.3% from 11.9% in March, well below market expectations. Retail sales growth disappointingly eased to 14.1%. Fixed asset investment was also below the market pick. The HSBC manufacturing PMI also fell slightly, signifying its longest below-50 run since the GFC.  As mentioned above, authorities responded to the softness, lowering the reserve requirement ratios (RRR) 50 basis points, and also announced subsidies for energy-saving appliances and other products. Additional loosening is also expected over the coming months, likely through more RRR cuts and investment spending. Annual inflation declined in line with expectations to 3.4% in April, after 3.6% the previous month, allowing authorities to ease.

Moderate growth in the US…

The moderate US recovery is ongoing, with GDP rising 0.5% in the March quarter, up 2.0% for the year. Private consumption was up 0.7%, a strong sign for retail and the labour market. On the other hand, the government's ongoing fiscal consolidation saw the sector again have a negative contribution to growth; this is expected to continue, and could be even larger in 2013. Our second special topic this month looks at the trade-off between austerity and growth in the USA and Europe compared with New Zealand.

The labour market recovery continued at a modest pace, with US non-farm payrolls rising below expectations at 115,000 in April, although upwards revisions over the previous two months helped to temper market reaction. The unemployment rate edged lower to 8.1%, although this was largely owing to another decline in the participation rate, now at 63.6%, its lowest level since the 1980s (Figure 5).

Figure 5 – US unemployment and participation
Figure 5 – US unemployment and participation.
Source:  Haver

Other data were mixed, with industrial production up strongly in April, and existing and new home sales up in the month. On the other hand, regional PMIs generally declined and retail sales were flat.

... with mixed signs in Australia

Weaker-than-expected inflation and GDP outturns, as well as a softening in other data including the PMI and terms of trade, saw the RBA cut its policy rate by a greater-than-expected 50bps to 3.75%. Some commentators expect further cuts. The main risk to the Australian economy is still a hard landing in China, which could possibly be precipitated by a severe euro area crisis. If this were to happen, there is still significant room for the RBA to cut its policy rate, and the government is in a relatively strong position to provide fiscal stimulus.

However, if the downside risks do not eventuate, the rate cuts may not be necessary, especially if the labour market continues its recent trend. Australian employment growth was stronger than expected in April, and along with a decline in the participation rate, brought the unemployment rate down from 5.2% to 4.9%. Retail sales fell slightly in April following a strong 1.1% increase in March, in part owing to seasonal effects. Overall, retail sales look be on a slightly improving trend.

The Australian Budget was also released during the month. As expected, it revealed a forecast of a small surplus of 0.1% of GDP in the 2012/13 year. This implies a fiscal contraction equivalent to 3.1% of GDP over the next year, although in reality, owing to the type of cuts and possible slippage, the macroeconomic impact of the contraction is likely to be less than half the budget figure.

Trade balance falls into deficit

A deterioration in the global outlook will be a negative for New Zealand trade, likely resulting in export demand declining and commodity prices dropping further. Already, the annual trade balance has declined to a deficit of $541 million for the April year, the first deficit recorded since March 2010. Export values fell slightly in April to be down 17% for the year, driven by a decline in dairy and meat export prices. A fall in crude oil imports, partly offset by a large increase in imports of plant and machinery, drove a fall in merchandise imports for the month with little change from the previous year. The outlook is for the trade balance to decline further over the year ahead as import demand rises, partly due to the earthquake rebuild, and the terms of trade continue to fall.

Overall, despite a deterioration in the global outlook as a result of the escalation of the Greek debt crisis, the central scenario from our BEFU forecasts remains valid at this stage. Downside risks have increased and our downside scenario can be seen as indicative of Greece leaving the euro area with limited contagion. Domestic data, for both businesses and households, are consistent with modest growth in coming quarters, before a ramp-up in the Canterbury rebuild leads to a pickup in economic activity.
  • [1] These forecasts were finalised before Statistics NZ revised past GDP on 15 May. All graphs and figures in the MEI text refer to the old GDP. The tables at the end and the Chart Pack show the revised data. Our first special topic looks at the revised GDP data
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