Monthly Economic Indicators January 2008

Executive Summary#

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Commentary#

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Real production GDP grew by 0.5% in the September quarter#

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GDP recorded an increase of 0.5% in the September quarter, the same as forecast in the Half Year Update.  The growth rate in the year to September was 2.7% – the highest rate since March 2006 (Figure 1).

 

Figure 1 - Real GDP

Source: Statistics NZ

The services sector drove most of the growth along with a boost from Tui oilfield …#

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The services sector grew by 0.7% in the September quarter, making the largest contribution to growth.  Within the services sector, all industries made positive contributions to growth with wholesale trade making the largest contribution, growing 1.4% in the September quarter.  The primary sector also made a positive contribution to growth, growing by 3.9% in the September quarter.  Mining and quarrying was the major driver of primary sector growth mainly due to the Tui oilfield commencing production, combined with an increase in offshore drilling activity.  The goods producing sector detracted from growth, largely due to a 2.2% fall in manufacturing activity in September.

 

In addition, annual average labour productivity growth increased to 1.9% in the quarter, from 1.4% in the June quarter.  The rate of labour productivity growth was the strongest in four years.

 

… while in expenditure GDP terms, domestic demand continues to slow#

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Expenditure GDP increased 0.3% in the September quarter.  Private consumption growth slowed further in September, growing by 0.3% after growth of 0.4% in June and the strong 2.1% growth in March.  Residential investment growth also slowed in September falling from 3.5% in June to 1.9%. 

 

The 0.3% increase in private consumption over the quarter was lower than the 0.5% rise forecast in the Half Year Update.  The growth in private consumption in the year to September was 3.9%, increasing from 3.3% in the year to June, but still well down on growth in excess of 6% during 2004 (Figure 2).  There are clear signs that household spending growth has slowed as households have felt the effects of interest rate increases and lifts in fuel prices.  Moreover, the slowing housing market is impacting on households as the growth in their wealth also slows.

 

Figure 2 - Private consumption and residential investment

Source: Statistics NZ

We expect residential investment to fall in the December quarter and into the first half of 2008. Building consents issued fell 5% in December, following a largely flat month in November and a similar fall in October.  Slowing growth in house prices in the December quarter is likely to compound the fall in building consents.  In the December quarter, REINZ housing market data showed a 19% decrease in sales from the September quarter, while the median selling price was unchanged in at $349,000. 

 

Net exports subtracted from growth but will recover as dairy export volumes rise#

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Exports decreased 0.6% in the September quarter mainly due to dairy export volumes falling 15.2%.  The decrease partly reflected a reduction in the export of existing stocks.  Imports increased 0.2% in the quarter.  Taking exports and imports together, the net external sector subtracted 0.5 percentage points from growth.

 

Overseas Merchandise Trade (OMT) data point to a 21% increase in dairy export volumes in the December quarter, more than reversing the decrease in the September quarter.  The OMT data also showed petroleum exports of $759 million, largely from Tui oilfield production, compared to just $90 million in December 2006.

 

As a result, we expect National Accounts data to show a recovery in dairy export volumes in the December quarter and another strong contribution to export growth from Tui oilfield production.  Furthermore, net exports are expected to add to GDP growth.  We expect dairy export volumes to grow steadily in 2008 as production increases in response to high prices, although drought conditions in some areas may constrict production.  (While high dairy prices do not impact directly on real GDP they will increase nominal GDP, hence narrowing the current account deficit.)   

 

Nominal GDP was around $130 million higher than forecast in the Half Year Update#

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Nominal GDP increased 1.3% in the quarter, taking the increase in the year to September to 7.2%.  The 1.3% increase in September was close to the 1.2% forecast in the Half Year Update.  However, following revisions to earlier data, nominal GDP in the year to September was around $130 million higher than forecast in the Half Year Update.

 

Current account deficit widens but should narrow quickly over the coming quarters#

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The current account deficit in the year to September was 8.3% of GDP (Figure 3).  This was wider than the 8.1% deficit recorded in the June year and the same as forecast in the Half Year Update.

 

The wider deficit was mainly due to a larger investment income deficit, partly offset by higher inflows of current transfers.  The goods and services balance was largely unchanged from the June quarter. 

 

Figure 3 - Current account

Source: Statistics NZ

In line with increasing net exports and further increases in dairy export prices, we believe that the annual current account deficit will narrow below 8% in the December quarter and then below 7% by mid‑2008. 

 

CPI inflation was 1.2% in December quarter…#

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The Consumers Price Index (CPI) increased 1.2% in the December quarter, taking the annual rate to 3.2% from 1.8% in September.  The quarterly increase was higher than the 0.9% rise forecast in the Half Year Update as well as most market estimates. 

 

…led by the transport and food groups#

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The major contributions to the quarterly result came from transport and food prices, both printing higher than expected.  The transport group made the largest contribution in the quarter, increasing 3.2%.  The increase in the transport group was driven by higher fuel prices, a seasonal increase in international airfares and higher prices for second-hand cars.  Food prices increased 1.5% in the quarter largely due to higher grocery food prices, including dairy products. 

 

Annual non-tradables inflation eased to 3.5% but tradables inflation increased to 2.8%#

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Non-tradables inflation eased to an annual rate of 3.5% in December from 3.7% in September with a quarterly increase of 0.7%.  This was slightly lower than we expected and is the lowest annual increase in nearly 5 years. The lower non-trabables result partly reflects the impact of the lower prices (as a result of increased government subsidies) for health and education in the previous quarter (Figure 4). 

 

Figure 4 - CPI inflation

Source: Statistics NZ

Annual tradables inflation increased to 2.8%, its highest rate since September 2006.  This outcome largely reflects the increase in petrol prices in the 2007 calendar year (16.9%) and higher food prices, especially for dairy products and meat.

 

Inflation likely to remain elevated…#

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Inflation is currently above the Reserve Bank’s target range.  Although non-tradables inflation eased, due to lower price growth in the housing group and one-off increases in government subsidies in the previous quarter, price increases were still high in the areas of non-discretionary spending of food, fuel and energy.

 

We expect inflation will remain above 3% throughout 2008 as the December quarter result provides a high base for inflation for the next year and resource pressures remain high.  Furthermore, with the scheduled introduction of an emissions trading scheme in 2009, higher fuel and energy prices are likely to have an impact on inflation and inflation expectations.

 

…as inflationary pressures remain strong#

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In line with high CPI inflation in the December quarter, cost and price indicators remained elevated in the December Quarterly Survey of Business Opinion (QSBO).  The net proportion of firms that experienced increased costs remained at 45% in December.  Moreover, the net proportion of firms that intend to increase selling prices increased slightly to 35%.

 

Labour market and capacity utilisation indicators also remained tight.  A net 46% of firms reported increased difficulty finding skilled labour, up from 41% in September, while capacity utilisation among builders and manufacturers increased to 92% in December 2007.  This percentage was the highest recorded since September 2006. 

 

With firms’ cost pressures and pricing intentions remaining high and continued pressure on productive resources, inflationary pressure is likely to remain high for some time.

 

The Reserve Bank kept the OCR at 8.25% in its January review#

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The Reserve Bank of New Zealand held the Official Cash Rate at 8.25% on 24 January.  The Bank noted the growing global uncertainty but expects the New Zealand economy to grow broadly in line with their December Monetary Policy Statement.  The Bank expects inflation to remain above 3% for most of the year but fall within 1-3% over the medium term with current policy settings.     

 

While commodity prices may have peaked#

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World commodity prices, as measured in the ANZ World Commodity Price Index, were unchanged in December, but up 31% on its level a year ago.  World dairy prices fell by 1.8%, recording their first drop since August 2006.  The New Zealand dollar index dropped 0.9% due to a 1.9% appreciation in the TWI largely against the Australian dollar.

 

Dairy prices may have peaked with US dairy production increasing by 3.1% in the year to December 2007, putting downward pressure on world dairy prices.  The Commonwealth Bank’s NZ dairy price index was 2.3% lower in US dollars at the end of January compared to the end of December.  The increase in dairy production in the US comes despite forecasts that high grain feed costs would limit production.  While we are expecting world dairy prices to fall further, the exact magnitude and speed of such declines is a key uncertainty to the economic outlook.  Moreover, severe moisture deficits developing over parts of the country are reducing dairy production and may lead sheep and beef farmers to increase their slaughter levels.

 

After averaging around US$91/barrel in the December quarter, WTI oil prices increased to US$100/barrel on 4 January.  The price of oil increased due to violence in Nigeria, Algeria and Pakistan, the weak US dollar and the threat of cold weather in the US.  Prices have subsequently eased, trading at US$92/barrel on 31 January, largely amid worries about the economic outlook in the US, a big oil consumer.

 

The outlook is for slowing growth …#

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We expect household spending growth to slow further as households feel the effects of interest rate increases and lifts in fuel prices.  Moreover, with significant increases in wealth from rapidly rising house prices coming to an end, consumers may be less willing to increase their consumption.

 

…with other data released in January consistent with slowing growth…#

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Firms’ own activity outlook in the QSBO was relatively stable in the December quarter.  A net 12% of firms expected higher domestic trading activity next quarter, which is consistent with annual average growth around 3% in the year to March 2008 and then slowing through the remainder of 2008 as forecast in the Half-Year Update (Figure 5). 

 

Figure 5 - Real GDP and Own Activity Outlook

Source: NZIER and Statistics NZ

Retail sales fell 0.7% in October and then rose by 2.0% in November while the value of electronic card transactions and credit card billings were largely flat in December.  Much of the increase in retail spending over the December quarter is likely to reflect higher prices, while volume growth is likely to be modest.

 

The Business New Zealand Performance of Manufacturing Index fell from 56.7 to 53.8 in December (readings above 50 indicating growth in manufacturing activity).  The December reading represents slowing growth and further weakness in the goods producing sector in the December quarter, following the negative contribution to growth in the September quarter.

 

…however, the slowdown is expected to be moderate by historical standards…#

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The strong labour market and high dairy incomes will underpin slowing growth, meaning growth is not likely to slow as much as in previous cycles.  We expect employment to remain at a high level and wage growth to remain strong in 2008.  While world dairy prices will come off their peaks, we expect they will remain high, maintaining the boost in dairy farm incomes over 2008.

 

…but global economic developments increase the risks to the growth outlook#

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Global share markets have fallen during January, largely on concerns about the state of the US economy.  Concerns have increased as the fallout from sub-prime mortgage losses becomes more apparent and US data during January have generally been weak.

 

The increased probability of a US led global slowdown poses risks to the growth rate of the New Zealand economy.  On balance, the risks to the economy have moved to the downside relative to the forecasts in the Half Year Update.  This month’s special topic discusses the equity market developments, the outlook for the global economy and implications for New Zealand in more detail.

 

Economy well placed to meet challenges in 2008#

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The New Zealand economy is well placed to meet challenges in 2008 but uncertainty and market volatility is likely to persist in the short term.  In addition, the current high inflation environment further complicates the outlook for 2008.  However, the sound fiscal position; the prospect of tax cuts; and the ability of the Reserve Bank to move quickly on interest rates, if growth and inflation drop more quickly than expected, mean that the New Zealand economy is well placed to meet potential challenges over the next year.

 

We will continue to monitor the financial market developments and the economic situation with next February’s Monthly Economic Indicators focusing on labour market and industry costs data as well as covering the usual sector releases.

Special Topic: Recent global economic developments#

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There is increasing evidence of a slowdown in the United States economy and lower growth in other major world economies. These developments may affect the New Zealand economy through financial and equity markets and through reduced demand for New Zealand export products.

The threats to the outlook are balanced by a number of ongoing positives for the New Zealand economy. However, the risks to the downside have increased since we released our Half-Year Update forecasts and we will continue to monitor developments closely.

Recent developments increase likelihood of recession in the United States#

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Most data for the United States released in January showed that the economy weakened in the final quarter of 2007. The unemployment rate increased from 4.7% in November to 5.0% in December, a 2-year high, and non-Government employment fell in December. The housing market showed continued weakness, with average prices down 10% annually on one measure. The advance release of GDP for the fourth quarter of 2007 showed that the economy grew at an annual rate of only 0.6%.

In response to these adverse developments, the Federal Reserve made an inter-meeting 75 basis point reduction in its funds rate on 22 January and a further 50 basis point reduction at its scheduled review on 30 January (US time). The US administration also announced a US$150 billion fiscal stimulus package.

Weak economic data were also released in other major economies, with business confidence falling in both Europe and the United Kingdom, retail sales generally showing signs of easing and consumer confidence low at the end of last year. In Europe, industrial production fell in November and financial analysts were their most pessimistic in 15 years in January.

Despite the signs of weaker economic growth, inflation in many economies remained high. Headline inflation in the US was 4.1% in 2007; in the EU, the harmonised inflation measure reached 3.1% for 2007 calendar year, confirming the European Central Bank’s inflation concerns. In the UK, retail price inflation was 4.0% in 2007 and inflation was also high in New Zealand and Australia at 3.2% and 3.0% respectively.

The financial market turmoil in the second half of 2007, combined with continuing weakness in the US housing market, led to further difficulties in the banking sector. The exposure of some financial institutions to losses from sub-prime mortgages was apparent with large write-downs at Citigroup and Merrill Lynch, and Countrywide (a mortgage lender) was taken over by Bank of America. Further risks exist with credit downgrades likely for “monoline” insurers (credit default insurers), increasing in turn the need for banks to hold higher amounts of capital. Further large losses were also announced by European and Japanese financial institutions.

Equity markets reacted nervously to economic and financial market developments. Stock markets fell sharply in the first week of January, but were buoyed by the monetary and fiscal policy moves in the US later in the month. The reversal of some rogue trader activity at Société Générale, a major French bank, mid-month may have contributed to renewed weakness in equity markets. At the end of the month, most major stock markets were well down on their end-2007 levels (Figure 6). Falls were not limited to the major economies, with falls in the Shanghai and Australasian markets pointing to risks of flow-on effects from the major developed economies to other parts of the world.

Figure 6 - Equity market prices

Source: Datastream

Commodity markets also reacted to the latest developments. Oil prices receded from their early January peak of just above US$100/barrel, while gold prices rose above US$900/oz as risks of a recession increased. Soft commodity prices were generally stable, although US dairy prices eased slightly, but more on reports of increased US supply than any fall in demand. The Baltic Dry Index fell from its late 2007 peak, indicating reduced demand for bulk commodity shipping space, providing support for forestry returns.

IMF revised its forecasts down#

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These adverse developments in the leading world economies in January 2008 have increased fears that the US economy is about to enter recession or is already in recession and that the other key world economies will follow suit.

The International Monetary Fund revised their forecasts for world growth in 2008 down from 4.4% to 4.1%, a slowing from the 4.9% estimated for 2007. Forecasts for 2008 were revised down for all country groupings, including developing economies. They noted that the risks are still tilted to the downside, with the ongoing turmoil in financial markets a key concern.

Developments could affect the New Zealand economy directly ...#

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There are several channels through which a slowdown in the United States might affect the New Zealand economy. The most direct and immediate would be through financial markets as commercial interest rates increase as a result of the risks associated with the investments in sub-prime mortgages, resulting in a higher cost of credit globally.

To some extent this is already happening. Two-year fixed term home loans have already increased by 0.2 percentage points in New Zealand above 9½%, a 10-year high. Higher interest rates will lead to a slowing in household consumption and further cooling in the housing market. This effect would be offset to some extent by lower central bank interest rates, although spreads between commercial and policy rates have been high recently. Also, some longer-term fixed mortgage rates are easing as international institutions continue to borrow in New Zealand dollars, making more funds available.

Movements in share markets tend to be correlated across countries and the NZX50 has declined 9.2% since the end of 2007. Declines in wealth (either through local or overseas investments) are likely to make households more cautious about their spending decisions. A fall in company valuations would also make them more cautious about committing to investment expenditure.

... and indirectly#

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Other transmission channels are less direct and immediate and depend on other linkages. A recession in the US on its own may not be sufficient to cause a slowdown here, as New Zealand growth remained strong in 2002-03 following the bursting of the dotcom bubble. On the other hand, New Zealand experienced a downturn in 1997-98 when the United States did not (Figure 7).

Figure 7 - US and NZ GDP growth

Source: Datastream, Statistics NZ

The extent of any flow-on from a recession in the US to New Zealand depends chiefly on the extent of “decoupling” in the world economy. Some commentators have claimed in recent years that much of the world economy has become “de-coupled” from the traditional engines of growth, such as the US and Europe, and that they are less important in sustaining world growth as other centres of growth, such as China, India, Brazil and Russia, have increasingly driven world growth.

It is not clear to what extent the rest of the world economy depends on the large developed economies for growth. China is less dependent on the US than previously and has developed more internal momentum and closer linkages with the rest of Asia than before. However, previous links most likely continue to have some strength.

The main way in which a slowing in world growth would affect the New Zealand economy would be through reduced demand for exports, in particular agricultural commodities (such as dairy and meat). Demand for these products would fall as income growth slowed in key markets and prices would fall, leading to lower returns to New Zealand producers. Lower prices would affect the terms of trade, but would likely be offset to some extent by a fall in the value of the New Zealand dollar and oil prices. However, there is no sign of any significant fall in demand at this stage.

There would be both a direct effect as demand from major markets impacted on returns and an indirect effect as the global slowdown affected other economies such as Australia (with less demand for mineral commodities), leading to lower demand for NZ products and services.

There are also some other factors affecting the outlook#

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Recent international economic developments are only one set of factors impacting on the New Zealand economy at present. There are other positive offsetting factors; for example, the terms of trade are likely to remain high even if dairy prices do fall somewhat. The economy has also proved resilient recently and monetary and fiscal policy settings have room to ease if necessary to offset a slowdown. Any such action would also have to take account of inflationary pressures.

Recent slowdowns in the New Zealand economy have generally been the result of a combination of factors rather than any single cause. The 1997-98 recession was a result of the combined effect of the Asian financial crisis, two successive droughts and excessive monetary tightening.

There are other risks to the outlook for the New Zealand economy, although they are not great at present. Dry conditions are currently developing in parts of the country, particularly the east coast of both islands and central South Island, and milk production is being affected in parts of the North Island. Slowing house price growth may affect consumer confidence and domestic demand adversely. Finance company collapses may also have the same effect, but to a lesser extent.

At present, most commentators are forecasting a slowdown in both the US and other developed economies, but few are predicting a high probability of a US recession. Since the Half Year Update, the profile of risks has shifted towards slower growth in the world economy (a risk which was highlighted in the Update). We will continue to report on developments, including the effect of any global slowdown on the New Zealand economy.

New Zealand Key Economic Data#

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Quarterly Indicators#

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Monthly Indicators#

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