Monthly Economic Indicators July 2009

Executive Summary#

Analysis#

So far, the economy has performed largely in line with our Budget Forecasts. Indications are that domestic demand declined further in the June quarter and that it will decline to a lesser extent in September, before growing slightly in December.

Retail sales up strongly in May…#

June quarter retail sales volumes are expected to be flat despite a surge in May, boosted by purchases of winter apparel in response to the lowest May temperatures since 1860 for many areas of the country. Consumers brought forward their purchases, driving the clothing and softgoods component up a record 12.6% in the month and contributing around half the 1.6% rise in core retail sales. We expect this effect reversed in June, consistent with previous large weather-induced changes (Figure 1).

Figure 1 – Clothing and softgoods retailing

Source: Statistics NZ, NIWA

… but volumes expected to stall in the quarter#

Retail electronic card transactions fell 1% in the June month, also pointing to a reversal in monthly retailing following May’s large increase. For the quarter as a whole, volumes look to be flat after accounting for price rises in both auto-related components (fuel up 3% and new cars up 4%) and core components (food prices up 1%). June quarter retail sales will be released on 14 August.

Services consumption looks set to be slightly negative, with services activity contracting in the June Quarterly Survey of Business Opinion (QSBO). For the June quarter as a whole, we expect real private consumption volumes to be flat-to-negative, in line with the 0.2% fall in the Budget Forecasts. Such an outturn would be consistent with households saving a high proportion of relief from both the April 1 tax cuts and falling mortgage interest rates.

Outlook for spending weak, with risks#

A key theme in the Budget Forecasts was one of households saving more and spending less over the medium term as the labour market weakens, house prices fall further and willingness to take on debt continues to wane. Risks have emerged since the forecasts were finalised that have the potential to alter the path of private consumption.

The dairy sector is important for regional economies, with changes in income flowing through to spending and investment. The unanticipated rise in the exchange rate may lower the payout for dairy farmers, subtracting from consumer spending growth more than assumed in the Budget Forecasts. In contrast, if the recent stabilisation in housing activity morphs into a genuine recovery, spending on housing-related items will increase, along with wealth effects through higher house prices. On balance, we expect private consumption to remain soft, driven by a weak labour market, with the unemployment rate peaking in the second half of 2010.

Housing activity stabilising …#

The quality-adjusted Quotable Value House Price Index reported an annual fall of 9.3% in the March quarter, identical to the Budget Forecasts. However, the housing market is stabilising following increased activity in the earlier part of the year when buyers took advantage of historically low fixed mortgage interest rates. Statistics from the Real Estate Institute of New Zealand (REINZ) indicate days-to-sell were 40 in June, down from 48 in March (s.a.), while house sales rose 26% in the June quarter.

… coming off a very low base#

Residential building consents also recovered in the June quarter (up 4% excluding apartments), with residential investment expected to follow later this year (Figure 2). In the Budget Forecasts we expected residential investment to begin increasing by the end of 2009, reflecting the lag from increased house sales to building consents, with a further lag to building. So far, residential building activity remains consistent with the Budget Forecasts in the near term, with risks beyond 2009 centred on housing activity recovering, rather than stabilising.

Figure 2 – House sales and building consents

Source: REINZ, Statistics NZ

Net migration set to be higher than forecast ...#

One of the factors supporting the housing market is the recent increase in net permanent and long-term migration, reflecting the intensification of the global financial crisis late last year. On a monthly basis, arrivals exceeded departures by 1,700 (s.a.) in June, bringing the net long-term migration gain to 12,500 in the twelve months to June 2009, considerably higher than the 4,000 assumed in the Budget Forecasts. The number of departures fell to multi-year lows in recent months as job security fears continue to dominate (Figure 3).

Figure 3 – Permanent and long-term migration

Source: REINZ, Statistics NZ

… but expected to ease in the medium term …#

Job prospects in the Australian economy are a key influence for total departures, as Australia accounted for around half of all departures in the past ten years. With the outlook for Australia improving, we expect to see departures increase in the medium term, in contrast to the expected short-term boost in net migration. A similar pattern is expected for departures to the U.K. and while job prospects remain weak there, comfort that the global economy looks to have avoided a major depression is likely to lift departures further from May’s extremely low base (seasonally adjusted monthly departures rose a record 50% in June).

… with implications for the housing market#

The near-term outlook for net migration points to additional support for housing activity, though over the medium term, pent-up demand for work offshore and overseas experiences is expected to unwind, slowing net migration and limiting demand for housing.

A potential recovery in housing activity, coupled with higher-than-expected net migration, poses upside risk for house prices. However, the weakening labour market will moderate the impact over the year ahead. Key labour market data for the June quarter will be released in early August.

Weaker exports in June quarter…#

The Balance of Payments trade balance is likely to be slightly more positive than expected in the Budget Forecasts as import values declined more than export values in the June quarter.
Export values were down 5.4% (s.a.) in June from the previous quarter with falls occurring across most groups. Export volumes generally rose, with noteworthy examples being milk, butter and cheese, and logs and wood (both up 22%), along with a 69% increase in crude oil, as exports from the Maari oilfield began in April.

… and a fall in imports#

The value of imports (excluding large items such as aircraft) fell 8.7% in the June quarter from March, as most categories fell. With company profits down and the exchange rate up, soft business investment was evident in plant and machinery imports, which fell 15% during the June quarter. Partially offsetting the falls were passenger motor cars (which remain at historically low levels) and oil imports, which tend to be volatile owing to irregular shipments.

Assuming the volatile investment income deficit is as anticipated, we expect the June quarter annual current account deficit to fall to (or slightly below) the 7.5% of GDP noted in the Budget Forecasts. The increase in export volumes in the June quarter suggests net exports will add to GDP growth again in the June quarter, although not as much as the previous quarter.

Short-term arrivals up slightly in quarter#

While the weak global economy is undoubtedly affecting arrivals from the northern hemisphere, it appears to be having the reverse effect on visitors from Australia (which account for approximately 40% of arrivals). Short-term arrivals from Australia increased 6% (s.a.) in June from the previous quarter (a 5-year high) and are up 16% on June quarter last year, compared to a 2% increase in total arrivals from the same time last year. The relative proximity, favourable exchange rate, a large winter ski campaign and competitive airfares make New Zealand an attractive destination for Australians in the current environment.

Economic activity less negative in June…#

Weak activity in June was also evident in the QSBO, but to a lesser extent than the previous quarter with a net 36% (s.a.) of firms reporting lower domestic trading activity in June, compared to a net 45% in March. We expect the economy contracted 0.4% in the June quarter, unchanged from the Budget Forecasts.

Building and construction firms reported the most pessimistic result for activity since 1991, confirming our expectations that residential investment declined in the June quarter after being much stronger than expected in the previous quarter. Similarly, merchants reported lower sales (down 8% points to a net -49%), consistent with private consumption contracting in the June quarter as discussed above.

… indicating a recovery later this year…#

However, the outlook is less negative for the September quarter, with only a net 10% of firms expecting trading activity to worsen in the next three months, compared to a net 36% the previous quarter. Coupled with increasing but still negative readouts for profitability, employment and investment, domestic trading activity expectations suggest economic growth in the second half of the year will outperform that in the first half but still be relatively flat (Figure 4).

Figure 4 – Own activity outlook and GDP growth

Source: NZIER, Statistics NZ

… consistent with National Bank survey#

The National Bank Business Outlook (NBBO) for July also pointed to growth over the coming 12 months, with a range of indicators up from the previous month. Firms’ own activity expectations for the year ahead lifted 5% points to 13%, while business confidence continued to increase, reaching its highest level since March 2002 (though this series tends to be volatile).
The Budget Forecasts anticipated real GDP declining 0.2% in the September quarter before increasing 0.2% in December.  Recent data outturns support these predictions.  However, given heightened levels of uncertainty, the September and/or December quarter figures could vary slightly, with the key message being that growth is strengthening but not turning around rapidly. 

Capacity utilisation increases sharply…#

Capacity utilisation - a measure of slack in the economy - rose by a record 4.4% points to 90.7% in the June quarter QSBO. However, the increase should be put in the context of a 17-year low in the previous quarter (which may have been overstated) and few signs of inflationary pressure elsewhere in the survey. The ease of finding both skilled and unskilled labour remained around 30-year highs, firms’ expectations of increasing costs fell to a 5-year low and while pricing intentions turned positive, they remained at recessionary levels (Figure 5).

Figure 5 – Capacity Utilisation, Pricing Intentions

Source: NZIER

Annual inflation falls from 3.0% to 1.9%...#

Consistent with weak demand in the June quarter, annual inflation softened. The Consumers Price Index (CPI) rose 0.6% in the June quarter, driven by a significant lift in food prices in the June month. The Food Price Index rose 2.8% - the highest monthly rise since the GST rate increased in July 1989 - with fresh produce particularly affected. Record-low temperatures in May hampered the supply of vegetables, flowing through to higher prices in June. The 0.6% quarterly increase meant the annual rate of inflation fell from 3.0% in March to 1.9% in June, identical to Budget Forecasts.

Other key contributors to the quarterly increase reflected the general fall in the exchange rate over the past year, with motor vehicles, household appliances, clothing and footwear all recording sizable price rises, lifting tradables inflation to 0.8% on a quarterly basis. Discounting for international travel (-14.4%) and overseas package holidays (-17.7%) partly offset the increases, reflecting weakness in international travel worldwide. On an annual basis, tradables inflation eased, from 1.7% to 0.2%, as the record quarterly increase in June 2008 dropped out of the annual calculation (Figure 6).

Figure 6 – CPI Inflation

Source: NZIER

Non-tradables inflation softened for the third consecutive quarter, increasing just 0.5% as home ownership costs and rents grew only slightly. Currently at a 7-year low of 3.3%, annual non-tradables inflation has begun reflecting the slowing economy and is expected to continue softening in the near term. In this month’s Special Topic, we look at why non-tradables inflation has been persistently high in recent years in addition to providing an outlook for the medium term.

International outlook stabilises …#

The outlook for the world economy stabilised in July as some key indicators and markets became more positive.  Business surveys in the major economies were generally more positive but remained below breakeven, pointing to a lesser rate of contraction.  If the recent trend continues, growth will resume later in 2009 or early 2010.  Industrial production has begun to increase again on a monthly basis in Japan and the Euro area and lesser declines in output are expected in the June quarter in the major economies. 

There were increasing signs of stabilisation in the US housing market, with the key Case-Shiller index up marginally in May.  Housing market stability in the US is crucial for wider financial stability.  Consumer confidence measures remained mixed as unemployment rates continue to increase, although the rate of increase has eased, especially in the US.

There was a recovery in activity in emerging Asian economies, led by a resurgence in activity in China which recorded annual growth of 7.9% in the June quarter, close to its target 8% for the year.  South Korea and Singapore recorded increases in activity in the June quarter and the increased demand from China was reflected in a stronger outlook for the Australian economy.  Concerns remain, however, about the sustainability of the Chinese expansion.

… resulting in upward forecast revisions#

The IMF revised up its forecasts for world growth in 2010 from 1.9% to 2.5% and noted that financial conditions had improved since April.  Consensus forecasts, a benchmark for our trading partner growth assumptions, were also revised up, leading to a slightly more positive outlook for New Zealand.

Commodity prices generally increased, but more for hard commodities than soft.  Equity markets also strengthened with the better-than-expected earnings reports, and financial conditions eased with a narrowing in risk premiums.  Demand for riskier asset classes increased, including the NZ dollar which tested highs of US 66 cents during the month. The dollar was barely affected by Fitch’s negative outlook assessment of New Zealand’s sovereign rating in mid-July. The dollar fell around a cent to under US 65 cents immediately following the announcement of no change to the OCR on 30 July as the accompanying press release warned of the risks to the recovery of a continuing strong dollar.

Special Topic: Non-tradables Inflation#

The Consumers Price Index (CPI) measures changes in the price of goods and services purchased by New Zealand households. The CPI can be split into tradables and non-tradables components. The tradables component comprises the prices of goods and services that are imported or in competition with foreign goods. The non-tradables component comprises goods and services that face little foreign competition, reflecting changes in domestic demand and supply. In this special topic, we look at the non-tradables component, currently accounting for 54% of the CPI.

Non-tradables inflation and domestic demand#

Figure 7 shows the relationship between non-tradables inflation and Gross National Expenditure (GNE – a measure of domestic demand) is relatively strong over time, with non-tradables inflation following the profile of activity with a one year lag. For the past seven years, non-tradables inflation has averaged 4%, mirroring a period of strength in the economy. The current recession has seen non-tradables inflation begin to ease, falling to 3.3% in June 2009.

Figure 7 – Non-tradables inflation and GNE

Source: Statistics NZ

Housing and utilities group drove non-tradables inflation over the past seven years#

As well as having the highest weighting (38%), the housing and household utilities group has increased strongly, contributing to more than half of the increase in non-tradable prices between June 2002 and June 2009 (Figure 8). Within the housing and household utilities group, three of the five subgroups have increased particularly rapidly – home ownership (the cost of building a new house), property rates and related services, and household energy. Out of all the subgroups in the CPI, these three have been the top contributors to non-tradables inflation over the past seven years.

Figure 8 – Contributions to non-tradables inflation

Source: Statistics NZ, Treasury

The housing boom placed pressure on housing construction costs…#

Average prices for existing houses rose 102% in the five years between June 2002 and June 2007, according to Quotable Value New Zealand. Low mortgage interest rates in the initial few years (together with high job security and relatively easy lending criteria), had a direct impact on demand, pushing house prices up. High population growth also placed upward pressure on prices, with net migration - which tends to be a swing variable in population growth rates - increasing to historic highs following the September 11 terrorist attacks.

While existing house prices do not feed directly into the CPI, higher demand was reflected in construction costs, with the home ownership subgroup rising at more than twice the rate of the CPI between June 2002 and June 2009 (Figure 9). The large increase in costs reflected significant price rises in electrical, carpentry and plumbing materials for construction of housing. In addition, wages and salaries for construction workers rose at a faster rate than for the whole economy.

The impact of significant increases in the home ownership subgroup was particularly strong, given it averaged the highest weighting in the CPI over the seven years to June 2009, accounting for 13% of the non-tradables index. In fact, the rapid and sustained increase in home ownership costs was the chief reason for non-tradables inflation remaining elevated over the seven years to June 2009, contributing 19% of the total increase in non-tradables inflation over the period.

Figure 9 – House prices and construction costs

Source: Statistics NZ, QVNZ

Electricity prices have also risen substantially over the past seven years…#

Another key component of the housing and household utilities group is household energy, of which electricity is the main contributor. Electricity prices rose 60% in the seven years to June 2009, contributing approximately 11% of the total increase in non-tradables inflation over this period, despite its weighting being only 6%. Higher-than-usual generation costs were recorded over this period, particularly during 2008 when low lake levels led to generators switching from hydro to costlier sources of power. Price increases have been driven by underlying increases in the cost of generating electricity, particularly with the run-down of the Maui gas field. The cost of building new capacity to meet increasing demand for electricity has also risen sharply.

Property rates and related services – another part of the housing and household utilities group – also rose rapidly in the seven years to June 2009 (up 58%), contributing approximately 8% of the total increase in non-tradables inflation over the period.

Weak non-tradables inflation in the near term  #

Non-tradables inflation is closely correlated with the output gap, ie, the extent to which the economy is above or below its long-term potential. Spare capacity has opened up since the onset of the recession in early 2008 leading to an easing in non-tradables inflation. The Budget Forecasts incorporate a persistent negative output gap, suggesting non-tradables inflation will continue to ease and remain at low levels throughout the forecast period (Figure 10).

Figure 10 – Non-tradables inflation and output gap

Source: Statistics NZ, Treasury

The housing and household utilities group has been the key component of non-tradables inflation over the past seven years. The strong correlation between house prices and home ownership costs is important, as large swings in home ownership costs have the potential to affect the trajectory of non-tradables inflation. The Budget Forecasts incorporate a weak housing market, primarily owing to a higher household saving rate and a weak labour market. This factor will also serve to limit non-tradables inflation.

The weak labour market incorporates low wage pressures, which are a key component of input costs for firms, particularly those in residential construction (mentioned earlier). The global financial crisis has had a strong positive effect on net migration, posing some upside risk to housing activity in the near term. However, as the global economy recovers, we expect this trend to ease, with a generally weak economy keeping non-tradables inflation lower in the medium term.

New Zealand Key Economic Data#

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