Monthly Economic Indicators April 2008

Executive Summary#

• Economic growth appears to have slowed in the March quarter
• The outlook for domestic demand is for continuing weakness
• Inflationary pressures remain firm and show few signs of easing
• World developments still a concern for growth

Economic growth appears to have softened in the March 2008 quarter. Surveys showed that business conditions have deteriorated markedly since last year. Activity and business confidence indicators fell sharply across the majority of sectors and regions despite capacity utilisation reaching record high levels. Firms' outlook for activity and profits also fell, leading to large falls in investment intentions.

The slowdown in domestic demand was also evident in recent developments in the household sector. House sales in the March month fell further, while the number of building consents also declined, implying residential investment will soften in subsequent quarters. Retail sales eased in February and recent electronic card transactions suggest consumer spending will continue to moderate in March. High interest rates and rising costs have been weighing heavily on households and, as a result, we believe private consumption growth softened in the March quarter.

A decline in exports in March also pointed to weak growth in the quarter. Annual inflation lifted from 3.2% in December to 3.4% in March. Key contributors to the higher outturn were price increases for food, transport and housing. Dairy products and petrol prices rose more than 20% in the past year, reflecting rapidly rising commodity prices. The proportion of firms planning to increase prices in the next three months rose as they seek to pass higher costs on to consumers. Recent trends in both food and energy prices and their impacts on the New Zealand economy are the focus of this month’s Special Topic: The impact of food and energy prices on the New Zealand economy.

Some stability returned to international credit markets in April as participants felt that the worst might be over, but economic data generally showed weakness in the US economy and some weakness in Europe. However, inflation remained high in major economies, largely because of increases in food and energy prices. The European Central Bank held its policy rate constant in view of high inflation, but central banks in the UK and US cut their rates a quarter of a percentage point in response to weak demand. There was continuing volatility in equity and financial markets and the NZ dollar eased slightly towards the end of April.  

Commentary#

Declining activity from firms, weakening domestic demand and slowing merchandise exports all indicate weak economic growth over the March quarter. Firms’ profit expectations have fallen as business confidence and activity levels dropped off in March. A larger number of firms face cost increases and intend passing these to consumers. Households are also coming under increasing pressure as rising prices for food, fuel and housing, in addition to high interest rates, continue to reduce discretionary spending.

Business conditions have deteriorated...#

The Quarterly Survey of Business Opinion (QSBO) showed that firms' own activity was down in the March quarter. On a seasonally adjusted basis, the net balance of firms reporting a decrease in activity was 7% compared with 6% reporting an increase in the December quarter. The outlook for firms also deteriorated since the previous survey. On a seasonally adjusted basis, 8% of firms were expecting a decrease in their own activity in the next three months - a large decline from the previous survey when a net 12% of firms expected an increase.

Figure 1: Real GDP and Own Activity Outlook

Source: NZIER, Statistics NZ

The relationship between the outlook for firms' own activity and real GDP (Figure 1) - in addition to sharp falls in business confidence - suggests economic growth slowed in the March quarter. The weaker outlook for activity, combined with higher costs (discussed below), led to a sharp fall in profit expectations. A net 33% of firms surveyed expected a decline in profitability in the three months ahead - the most negative for twenty-five years. The National Bank Business Outlook (NBBO) in April also reported firms' profit expectations were deteriorating.

... and investment intentions are down...#

The weaker outlook for activity and profits and high interest rates appear to have affected investment decisions as the net balance of firms intending to increase investment over the next twelve months fell considerably in the QSBO. Investment intentions were also weak in the NBBO this April as the net percentage of firms expecting to increase their investment in the next twelve months turned negative.

Employment intentions eased in the QSBO as the net proportion of firms intending to increase staff over the next three months fell from 14% in the December survey to 0% in the March survey. There were also some signs of easing shortages in the labour market. Firms reporting it had become harder to find skilled labour fell 10 percentage points to a net 36%, with a similar drop for those reporting difficulty finding unskilled labour. The falls in both employment intentions and difficulty finding employees suggest job growth may be starting to moderate. However, these falls do not necessarily mean labour market pressures have eased, as the QSBO also showed that shortage of labour was the main constraint on expansion for 23% of firms, a 3-year high.

... despite capacity utilisation being high#

Given the decline in activity, it perhaps came as a surprise that capacity utilisation increased further in the March quarter according to the QSBO. The 92.6% figure was the highest-equal recorded since the series began in 1961. Many firms are finding capacity constraints to be an obstacle to expanding their business and this is adding to inflationary pressures (Figure 2).

Figure 2 - Capacity Utilisation, Pricing Intentions

Source: NZIER, Statistics NZ

Inflation is high…#

Annual consumer price inflation lifted from 3.2% in December 2007 to 3.4% for the year to March 2008. The main contributors to the higher inflation were food, transport (both reflecting rising international commodity prices) and housing. Within the food group, grocery prices increased 3.6% in the March quarter chiefly because of increases in cheese, bread and butter. Within the transport group, large quarterly increases in fuel prices (4.0%) dominated seasonal falls in international and domestic airfares given the higher weighting of fuel in the CPI. The quarterly increase in the housing group (up 1.0%) came about largely due to a rise in rents. Rents increased 1.2%, which was more than the rise in construction costs, as the housing market eased and investors sought to cover increasing borrowing and maintenance costs.

There were some offsetting factors as the groups which include apparel and household items recorded decreases in the quarter. Despite the offsets, the headline measure remained above the top of the medium-term target range of 3% this quarter.

Figure 3 - CPI Inflation

Source: Statistics NZ

… in both non-tradables and tradables#

Non-tradables inflation was 1.1% in the March quarter and steady at 3.5% annually (Figure 3). The largest contributions to the quarterly increase came from the housing group, education costs (with annual adjustments to secondary and tertiary fees in the March quarter) and cigarettes and tobacco (as a result of the excise duty adjustment on 1 January each year).

Tradables inflation was 0.2% in the March quarter and 3.4% in the year to March. Greater discounting of durable items such as appliances, clothing and footwear (end of summer sales) and electronic goods led to the lower-than-expected outturn. Price discounting for durables is consistent with weaker consumer demand as the effects of higher food and fuel prices and higher interest rates reduce discretionary spending.

Core inflation has eased…#

In some OECD countries a distinction is made between headline and core inflation; headline inflation includes all items, whereas core excludes food and energy. Core inflation (Figure 4) has eased over the past twelve months and is now only 1.7% on an annual basis, showing that food and fuel are currently the main drivers of higher headline inflation. Prices for dairy products and petrol have both risen more than 20% in the past year due to unprecedented global demand for commodities, combined with reduced supply in some cases. The main reasons for excluding food and energy prices are that they tend to be more volatile and are set in world markets. Recent trends in world commodity prices and impacts on the New Zealand economy are the focus of this month’s Special Topic.

Figure 4 - CPI Inflation and Core Inflation

Source: Statistics NZ

… although headline inflation is expected to remain high in the near term#

Inflationary pressures look set to remain firm over 2008. The proportion of firms reporting increased selling prices in the QSBO rose from a net 28% in the December survey to a net 42% in the latest survey – the highest figure since March 1987. In addition, the net balance of firms intending to increase prices in the next three months rose to the highest point in more than twenty years. The Reserve Bank left the Official Cash Rate (OCR) on hold at 8.25%, balancing high inflation pressures against the weak outlook for growth. However, the market interpreted a softer tone in April than in the previous review.

Spending growth is slowing…#

Increases in food and fuel prices were reflected in February retail sales easing 0.7% for the month as sharp falls in motor vehicle retailing (-5.8%) more than offset increases in supermarket and grocery sales (1.6%). Motor vehicle retailing has fallen for the third consecutive month as rising food and fuel costs and higher borrowing costs squeeze spending on big ticket items. The less volatile core retail series (retail sales ex-auto) rose just 0.2% in February reflecting an easing in sales of consumer durables due to lower volumes and/or price discounting.

Electronic card transactions in March fell in both total (-0.3%) and core retail stores (-0.1%) while total domestic credit card billings also fell, down 2.7%. These weak data indicate that retail sales may have been flat or even slightly negative in the quarter once we remove price increases. (Figure 5). March quarter retail sales figures will be released in mid-May.

Figure 5 - Electronic Cards and Retail Sales

Source: Statistics NZ

Other indicators also suggest that consumer spending has softened since last year. Car registrations fell sharply in March as they did in February, while the latest ONE News Colmar Brunton poll continued to show deteriorating consumer confidence. After we account for flat retail sales, we are anticipating private consumption in the first quarter to be weaker than forecast in the Half Year Update.

… leading to weaker domestic demand#

Other economic factors are also leading to a slowing in domestic demand. These other factors include lower net migration inflows and higher interest rates, both of which are leading to a marked slowing in the housing market. Permanent and long-term net migration to New Zealand rose slightly to 4,700 in the twelve months to March from 4,600 in the twelve months to February, but remains at low levels compared with recent history. Mortgage rates continue to rise. The average 2-year rate is currently around 9.7% - up more than 50 basis points since the most recent increase in the OCR in mid-2007 (Figure 6).

Figure 6 - Two-year Fixed Mortgage Rate

Source: RBNZ

Housing market continues to deteriorate…#

According to REINZ, house sales fell 31% in March (seasonally adjusted) – the fourth consecutive monthly decline, with house sales under $400,000 falling substantially. The number of residential building consents in March followed the lead of previous house sale declines, falling 9% in total and 14% excluding apartments. Although the fall in March sales and consents may have been overstated to some degree by the Easter holiday, the result is nonetheless indicative of a rapidly slowing housing market. Low annual net migration, high interest rates and diminishing confidence are contributing to downward pressure on house prices. QVNZ reported average house prices fell from $393,000 in the three months to February to $389,000 in the three months to March – a fall of around 1%.

… contributing to the slowdown#

The slowing housing market is affecting economic growth in part by lowering private consumption. As house prices fall, we expect to see lower growth in spending as households feel less wealthy and choose to delay purchases of nonessential items. In addition, a direct effect of a slowing housing market is fewer sales of household durables such as home furnishings.

Merchandise trade also implies weakness#

Seasonally adjusted export values eased 1.4% in the March quarter from the record level in the previous quarter. It is likely that total export volumes fell once we consider that prices (particularly for dairy products) have remained strong this year. By component, dairy product volumes fell 4.1% in the quarter due in part to the drought, while meat exports rose 5.0% as slaughtering was brought forward, again, due to the drought. Export volumes of crude oil fell sharply in the quarter, possibly due to shipment dates.

Import values grew in the first quarter, also coming in below market expectations at 0.4%, implying flat volumes. Imports of consumption goods fell 1.9% in value, providing further evidence of weakening demand. Overall, the trade balance fell to a $50 million deficit in the March month, well below market expectations of a $400 million dollar surplus. The deficit in the twelve months to March also increased from $4.4 billion to $4.5 billion (Figure 7).

Figure 7 - Merchandise Trade - 12 Month totals

Source: Statistics NZ

Some stability returning to credit markets#

Global credit markets started to stabilise in April following the heightened uncertainty in March. Credit spreads for US (and Australian) banks declined further in April, indicating lower costs of borrowing and easier access to credit.  However, the spreads are still higher than in late 2007 and well above those in the first half of 2007.

But economic data remain weak …#

Economic data from the US in April were generally weak.  Consumer confidence remained soft, the housing market eased further, core retail sales were flat in March, but the initial estimate of GDP growth in the March quarter was 0.6% (annual rate), slightly better than expected.

There were also some weaker data from Europe, suggesting that the effects of the financial crisis are spreading beyond the US.  In the UK, quarterly growth in December 2007 was confirmed at 0.6% and the early estimate for March 2008 was 0.4%, the lowest in 3 years.  The UK housing market weakened further in April.

There were some signs of easing in the Australian economy, with falls in business confidence and consumer sentiment, and building approvals fell slightly in the year to February.  China reported GDP growth of 10.6% in the year to March, with no signs yet of any effects from the US slowdown.

… and inflation high#

Food and energy prices contributed to higher inflation in the major economies in the March quarter.  Headline inflation in the US was 4.0% in the past year, but core (excluding food and energy prices) was 2.4%.  Headline inflation out-turns in other major economies were also elevated.

The European Central Bank held its policy rate steady at 4.0% as inflation remains high, while the Bank of England responded to the weak housing market by cutting its policy rate 25 basis points to 5.0% and increasing liquidity.  The US Federal Reserve cut the funds target rate 25 basis points to 2.0% at the end of April (Figure 8).

Figure 8 - Central bank interest rates

Source: Datastream

Equity and financial markets fluctuate#

Despite some worse-than-expected first quarter earnings reports in the US, the Dow Jones Index continued to increase over most of April.  Hawkish comments from the European Central Bank led to a strengthening of the Euro almost to US$1.60, before the US dollar recovered towards the end of April.  Oil prices reached a nominal record of US$120/barrel because of US dollar weakness and supply disruptions, but subsequently eased.  The NZ dollar traded mainly in a range from US78-80 cents in April but dipped below US78 cents at the end of the month as the US dollar strengthened and markets took account of the softer tone from the Reserve Bank of NZ and weak economic data.

Special Topic:  The impact of food and energy prices on the New Zealand economy#

Global food and energy prices have risen to their highest levels since the early 1970s driven by sustained periods of growth in the emerging economies, production shifting to biofuels and bottlenecks in global supply channels.  High world prices have flowed into New Zealand consumer prices, stretching household budgets.  The impact of higher prices for staples like milk and petrol is immediate, but what are the wider implications of rising food and energy prices?

With a large agricultural surplus, New Zealand is one of the few economies well placed to meet the challenge of these high prices.  Food exports are a large component of New Zealand’s merchandise exports, and price rises for these exports lead to a higher terms of trade, raising incomes or nominal GDP.  In addition, New Zealand is also not as vulnerable to oil price shocks as in the past.  Overall, the higher costs faced by households must be weighed against the benefits of a high terms of trade. 

Global food price boom now following resource boom#

Industrialisation in emerging economies, especially China, led to a resource boom, pushing up prices for metals and energy.  These economies are now enjoying the benefits of rapid economic growth with higher incomes leading to demand for other commodities (and higher prices), in particular for food (Figure 9).  As incomes grow in these countries, food preferences also change towards a diet with more protein, thus amplifying the increase in demand for products such as meat and dairy, which in turn increases the demand for grains as stock feed.

Figure 9 - Commodity Price Index ($US)

Source: The Economist

While the sustained income growth in emerging economies is the major driver of commodity price growth, other factors have also contributed.  Supply disruptions, including drought in Australia and geo-political events in several oil producing countries, have restricted both oil and food supplies.  In addition, climate change and energy security policies promoting biofuel production have led to agricultural resources switching out of food production.  And more recently, investors have turned to commodity markets looking for better returns, following slumping equity and financial markets. 

Movements in domestic prices have reflected these global price trends with food and energy prices making the largest contributions to high consumer price inflation of 3.4% in the year to March 2008 quarter.  The Food Price Index increased 6.0% in the year to March 2008 with dairy prices increasing 20%.  Similarly, petrol prices were also up by 20% over the same period.

High food and energy prices lead to tighter household budgets…#

Price rises for food, energy and other non-discretionary goods or staples constrain household budgets.  As a result, the higher prices for these staples lead to lower consumption of other more discretionary items like eating out and to the delay of purchases of durables like whiteware and televisions.  Figure 10 shows when inflation spikes as it did in mid-2006, durables consumption tends to fall.  Following the spike in inflation in December 2007 and March 2008, we expect a fall in durables consumption to follow.

Figure 10 - Durables Consumption and Inflation

Source: Statistics New Zealand

New Zealand household spending has begun to reflect this dynamic.  Retail sales fell 0.7% in February after the modest 0.3% rise in January.  Allowing for price increases, these data are consistent with softening real private consumption growth in the March quarter and illustrate the squeeze on household budgets through food and energy prices, not to mention high mortgage rates.  

… although higher food export prices increase both rural and urban incomes…#

As a large exporter of agricultural commodities, New Zealand is well placed to benefit from high food prices.  Dairy farmers are already benefitting from high prices with Fonterra forecasting a payout of $7.30 per kg of milksolids for the 2007/08 season, up $2.84 (64%) from last season.  The payout increase reflects high world dairy prices with the average ANZ world dairy price index for the March 2008 year up by 83% compared to the average for the previous year.

While dairy prices have come down from their recent peak, they are expected to remain at a high level.  In addition, the outlook for other agricultural export prices, including meat, is positive.  As a result, we expect agricultural export prices to underpin the terms of trade in the medium term.  The high terms of trade will boost nominal incomes in rural districts such as the Waikato.

The high terms of trade are reflected in the high exchange rate and hence support the real incomes of all New Zealanders.  A strong dollar lowers the cost of imports and allows higher real consumption – cheaper goods means you can buy more of them.  In effect, the high terms of trade lift the exchange rate, spreading the benefits beyond rural areas to urban consumers too.

…while high oil prices impact less than before#

New Zealand is also a net importer of oil, so in general, higher oil prices lead to a lower terms of trade and partly offset high dairy prices.  However, New Zealand’s net dependence on oil imports has lessened with increasing local production from the Tui oilfield.  Crude oil is now a major source of export revenue.  In the year to March 2008, crude oil export receipts exceeded each of aluminium, fruit and seafood, reaching $1.8 billion from $0.4 billion in the March 2007 year.  Moreover, the volume of oil exports is likely to grow as more fields come into production. 

Another less direct benefit of high oil prices is their link to dairy prices (Figure 11).  Oil-producing countries, enjoying the benefits of current high prices, are among our largest customers for dairy products.  In the year to March 2008, seven of our top 20 export markets were oil-producing countries, including Saudi Arabia, Indonesia and Venezuela.

Figure 11 - Oil and ANZ World Dairy Prices

Source: Datastream, ANZ

Fuel and food commodity prices should moderate, but will remain high#

We expect fuel and food commodity prices to moderate as producers increase production and speculation in commodity markets decreases.  World dairy prices have already dropped 6% from their peak in November 2007.  However, with the growth prospects of emerging economies still good, we expect commodity prices to remain high by historical standards. 

We expect New Zealand households to adjust their spending patterns to allow for the current high price of fuel and food, resulting in lower real consumption growth in calendar 2008.

New Zealand Key Economic Data#

Quarterly Indicators#

Monthly Indicators#