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Growth in activity remained brisk but subdued price pressures raise revenue risks

Employment grew strongly in the September quarter, reflecting the brisk pace of expansion in output over the past 12 months, which helped lower the unemployment rate to 5.4%.  Hourly wage growth has been relatively subdued, increasing 2.3% in the year to September, but so too has the cost of living, resulting in moderate gains in real purchasing power.  These real gains were evident in retail sales data for the September quarter, which showed growth in the volume of goods and services sold outstripping growth in the value of sales. 

Reinforcing the subdued price environment, dairy export prices fell further as did international crude oil prices, and the exchange rate rose.  In sum, inflation seems unlikely to rise at the pace expected in the Pre-Election Economic and Fiscal Update (PREFU) and export receipts may be weaker than expected.  As a consequence, interest rate rises by the Reserve Bank are likely to be more gradual than previously assumed, and the government’s tax revenues will not rise by as much.

Increased employment...

According to the Household Labour Force Survey (HLFS), the number of people in employment rose by 18,000 (0.8%) in the September quarter, driven by the addition of 14,000 (0.8%) people in full-time employment.  Compared to the same time last year, the total number of people employed increased by 72,000 (3.1%), with 66,000 of those employed full time. 

The unemployment rate fell to 5.4% from 5.6% in the June quarter (Figure 1), despite a 0.1% point increase in the participation rate to 69.0%. 

Jobs filled in September’s Quarterly Employment Survey (QES) recorded a similar gain, up 1.0% in the quarter and 3.0% in the year to September.  However, in contrast to the HLFS, most of the jobs gained in the quarter were part-time, which kept total paid hours flat in the quarter, and 3.3% higher than a year ago.  Hours paid in the business services industry, which are a direct input into production GDP, fell sharply and completely reversed the previous quarter’s gain.  Business services contributed 0.4% points to the June quarter’s 0.7% increase in real GDP, so the most recent outcome implies a similar sized negative contribution from that industry. 

...and moderate wage growth...

Private sector hourly earnings were 2.9% higher than in the same quarter a year ago, down a little from 3.1% in the quarter prior.  Public sector wages increased 1.0%, and growth in total average hourly earnings eased to 2.3% from 2.6% in the year to June.  After adjusting for inflation, real wages increased 1.3% in the year, above the post-2000 average of 0.9%.

The increase in total hours paid, combined with the increase in earnings, resulted in a 5.0% rise in total weekly gross earnings.  Overall, labour income growth was consistent with our PREFU forecasts, and September quarter tax revenue from source deductions was close to forecast.

Looking ahead, the lower unemployment rate is expected to generate upward wage pressure and there was some evidence of this in the September quarter Labour Cost Index. Private sector wage costs increased 1.9% in the year to September, up from 1.8% in the year to June, and the proportion of private sector wages increasing from the same quarter a year ago was the highest in three years.  Public sector wage growth eased to 1.1%, the smallest annual increase since 1995, and restricted total annual wage growth to 1.7%.

Figure 1: Unemployment rate and wage growth
Figure 1: Unemployment rate and wage growth.
Source: Statistics NZ

The unemployment rate is only slightly above its post-2000 average (Figure 1), suggesting that the QES measure of wage growth should be trending towards its post-2000 average of 3.4%, as forecast in the PREFU. Crucially however, inflation has been more subdued than expected - last month we noted annual inflation in the September quarter was weaker than expected in the PREFU - which means that cost of living wage adjustments, and thus overall wage growth, are likely to be weaker than forecast in the PREFU over the year ahead.  As a consequence, tax revenue from source deductions may grow more slowly over the coming year than forecast in the PREFU.

...provide support for growth in real activity...  

In addition to rising incomes, households are benefiting from falling retail prices, which were 0.6% lower than in the previous quarter according to September’s Quarterly Retail Trade Survey.  The boost to purchasing power was evident in the 1.5% gain in sales volumes, the largest quarterly gain in over two years.  Strong population growth is also boosting retail sales and quarterly growth in per capita terms was a bit lower, at 1.0%.  Compared to the same quarter a year ago, total retail sales volumes are 4.9% higher, the population is 1.7% larger and retail sales per capita have increased 3.2% (Figure 2).

Figure 2: Retail sales and population growth
Figure 2: Retail sales and population growth.
Source: Statistics New Zealand

A similar pace of retail sales volume growth is anticipated in the final quarter of the year following a 1.5% increase in the value of Electronic Card Transactions in October, and continued high, albeit easing, levels of consumer confidence.

A recovery in agricultural production and processing from the drought that affected June quarter output will provide further support for third quarter GDP growth. However, the weakness in paid hours noted above presents downside risk to the PREFU forecast of 1.0% real GDP growth. On the other hand, the ANZ Regional Trends report for the September quarter showed economic activity across the regions was 1.1% higher than in the June quarter.

...but subdued price pressures pose downside risks to nominal GDP in the short-term...

Large falls in dairy export prices over the third quarter, combined with September’s lower CPI outturn, compound the downside risks to our 0.4% nominal GDP growth forecast.  These risks have been reinforced by declines in the Producer Price Indexes, and for transport equipment and plant and machinery in the Capital Goods Price Index.  The construction sector is one of the few areas where price pressures are evident - compared to the same quarter last year residential building costs increased 4.7% and non-residential building costs increased 4.1% - although even here there was some easing in the quarterly pace of price growth.  Growth in residential building consents has eased in recent quarters and has likely peaked in annual terms, which suggests that the annual rate of price increases may also be close to its peak.

...and into 2015...

The weakness in prices has continued into the December quarter.  The ANZ Monthly Inflation Gauge for October showed little sign of increasing inflation pressure with prices outside the housing group remaining flat.

Dairy prices at the GlobalDairyTrade auctions fell further in November, leading to increased speculation that Fonterra will reduce its forecast current season milk payout from $5.30 per kilogram of milk solids to below $5.00 per kg/MS. Through its effect on income growth, a lower dairy price will be a restraining influence on domestic demand and inflation over the year ahead.

A more immediate source of lower domestic prices is the fall in international crude oil prices over the month.  Brent crude oil fell from US$87 per barrel at the start of the month to US$78 at the time of writing, reflecting some easing in global demand as well as the ongoing impact of increased US supply.  For the domestic economy, the lower oil prices should lead to lower petrol prices and less inflation in the December quarter.  They will also help to keep the global inflation impulse low (Figure 3).  The exchange rate is applying further downward pressure on tradables inflation - the Trade Weighted Index appreciated 2.5% over the month.

Figure 3: Crude oil prices and inflation in the US and China
Figure 3: Crude oil prices and inflation in the US and China.
Source: Haver

...which will impact on tax revenue growth

Consistent with these signs of weak price pressures, the Reserve Bank’s December quarter survey of expectations showed the average 1-year-ahead inflation expectation was 1.6%, down from 2.0% in the September quarter survey.  The average of 2-year-ahead inflation expectations was also lower, down to 2.1% from 2.2% previously.  Reflecting the fall in inflation expectations, expectations of 90-day interest rates 1-year-ahead were down 25 basis points to 3.9% (90-day rates are currently a little below 3.7%), and 1-year-ahead expectations of annual hourly wage growth eased to 2.5% from 2.6% previously.

In general, the PREFU forecasts were similar to the average expectations of CPI inflation and short-term interest rates reported in September’s survey, so downward revisions to these variables can be anticipated in the Half Year Economic and Fiscal Update (HYEFU).  This will have broad implications for growth in tax revenue, through growth in the value of sales of goods and services, and thus GST revenues and corporate taxes, as well as revenue collected on interest earned through Resident Withholding Tax, and on labour income through source deductions.

A more complete assessment of the outlook for the New Zealand economy will be released as part of the HYEFU on 16 December.

Migrant inflows support housing market

There was further strength in net migration inflows in the October month, with a net gain of 5,200 recorded.  The record 47,700 inflow for the October year was led by more student arrivals particularly from India and more New Zealand citizens returning from Australia. 

The housing market is a focal point for the demand effects of migration and, to date, the impacts on the housing market have been limited relative to previous migration cycles.  Annual growth in the Real Estate Institute’s house price index eased to 3.9% in October from 4.1% in September and 9.9% in October 2013.  This contrasts sharply with the rapid and rising house price inflation (annual growth peaked at 24% in late 2003) at a similar point in the early 2000s migration cycle.

Limits on loan-to-value ratios (LVR) have been a key restraining influence.  The Reserve Bank’s November Financial Stability Report noted that the LVR limit was a temporary policy but that it was likely to remain in place as long as “there is a risk of a resurgence in house price inflation, particularly in light of strong migration inflows”.

Figure 4: Household saving revised up
Figure 4: Household saving revised up
Source: Statistics NZ

The adoption of new standards for compiling GDP, SNA 2008, increased the historical level of nominal GDP by $5 billion (2.2%) in the year ended March 2014 and increased national and household saving measures (Figure 4).  Revised real GDP figures, which have been rebased to the 2009/10 year, will be released, along with September quarter GDP, on 18 December.

Uneven global outlook leads to policy easing

Growth across the developed world continued to be unbalanced, with weak euro area growth and contraction in Japan in Q3. The Bank of Japan (BoJ) expanded its quantitative easing (QE) programme in response to weak domestic demand. Leaders of the G20 met in Brisbane to discuss strategies for a broader recovery, and agreed to introduce policies aimed at lifting investment and boost the G20’s GDP by 2% by 2018.

Chinese economy remained weak in October

Chinese activity softened further as the housing market slowed. Industrial production (IP) and fixed investment grew at a slower annual pace in October, which was reflected by a fall in the PMIs. Growth in nominal retail sales slowed (to 11.5%), although sales volumes were stable as inflation was low (1.6%). The housing market slowdown continued, with declining home sales and house prices, and total credit growth weakened owing to lower lending to property developers. The People’s Bank of China cut its one-year deposit rate by 25 bps to 2.75% and its lending rate by 40 bps to 5.6%, and some analysts expect further policy easing in early 2015.

Australian activity increased slightly, but still soft

Australian activity showed some pick-up. Jobs growth rebounded in October, returning to its recent trend of 0.9% on a year ago, although the unemployment rate remained high at 6.2% and wage growth was weak. Retail sales values grew 6.8% on a year ago in September, boosted by iPhone 6 sales, and Q3 private consumption growth is expected to be solid. The NAB business conditions index surged in October, but a fall in business confidence suggests that firms viewed the improvement in conditions as temporary.  The outlook for the mining sector remains weak as iron ore prices have dropped below $US70 a tonne, down 50% since November 2013.  More positive was the announcement of a free trade agreement with China, which is expected to support resource and services exports, and increase Chinese investment in Australia.

The housing market moderated: annual house price growth fell to 9.1% in Q3 and dwelling approvals were down from early 2014. Some analysts forecast 0.7% growth in Q3 GDP, supported by consumption and exports but offset by lower residential investment growth. Q3 GDP will be released on 3 December.

Uneven developed world growth...

The US and UK recoveries continued. The US economy grew 1.0% in the September quarter, driven by business investment and net exports, while the PMIs indicated solid growth in activity in October. Non-farm payrolls rose 214,000 in October and the unemployment rate fell to 5.8%. Consumer confidence rose to its highest level since late 2007, supporting retail spending. The recovery in the UK labour market slowed slightly, with jobs growth easing in the three months to September and the unemployment rate steady at 6.0%. The PMIs pointed to slower but still solid growth in activity in October, while retail volumes expanded strongly. Housing demand has started to moderate, suggesting an impact from the Bank of England’s (BoE) removal of mortgage support.

Figure 5: Major advanced economies’ growth
Figure 5: Major advanced economies' growth.
Source: Haver

While the US economy strengthened, growth remained weak in the euro area and was negative in Japan (Figure 5). Euro area GDP rose only 0.2% in Q3, with weak growth in Germany (0.1%) and a contraction in Italy (-0.1%), while the PMIs indicated continued low growth in activity in Q4. Inflation remained low at 0.4% in October, reflecting weak demand and falling energy prices. The Japanese economy entered recession in Q3, contracting 0.4% as investment and inventories fell. Consumer and business confidence declined in October, still affected by the sales tax rise in April and a softer labour market, with the unemployment rate rising to 3.6% in September.

...with further easing in the weaker economies

Further policy support is expected in the weaker economies. The BoJ increased the size and maturity of its asset purchase programme owing to weak domestic demand and disinflationary risks. Japanese Prime Minister Abe called a snap election scheduled for 14 December, seeking a stronger mandate to delay the second sales tax rise to 2017 and introduce structural reforms. The European Central Bank stated that sovereign bond purchases may be used to boost growth and inflation.

Monetary policy is expected to tighten in the US and UK in mid to late 2015. The US Federal Reserve’s policy outlook for 2015 appears broadly unchanged following the large market volatility in October. The BoE appears slightly more supportive as it lowered its near-term inflation forecasts, reinforced by low inflation in October (1.3%); however, markets still expect the BoE to raise its policy rate in the second half of 2015.

Markets stabilised and NZD appreciated

Global markets rebounded from the volatility in October. The Nikkei and the S&P500 reached all-time highs, and the Stoxx600 regained its level in late September. Sentiment was supported by solid US data, policy actions in Japan and expectations of further easing elsewhere. Government bond yields were higher compared to October as demand for safe assets fell. While markets have stabilised, further volatility is likely as US and UK monetary tightening becomes more imminent.

The NZ dollar strengthened against the major trading partner currencies over the month. The TWI rose 2.5% to 78.4 at the end of November, appreciating strongly against the Australian dollar, yen and euro as they weakened against the US dollar. The NZ dollar may resume its depreciation against the US dollar and pound in coming months, but may strengthen further against other currencies owing to an uneven growth outlook across major economies.

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