Monthly Economic Indicators October 2015

Executive Summary#

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Analysis#

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Economic data released in October point to a stabilisation in the growth outlook for the New Zealand economy, although it remains weaker than in the Budget Update (BEFU). Treasury expects quarterly GDP growth to be around trend in the second half of 2015, supported by net migration, construction activity, consumer spending and housing demand. Combined with sluggish growth over the first half of the year, it is likely that annual GDP growth will be below 2% in the December quarter 2015 compared to the same quarter a year ago.

Consumers Price Index (CPI) inflation remains low, despite higher tradables inflation owing to earlier falls in the New Zealand Dollar (NZD). Low price pressures are evidenced by the Quarterly Survey of Business Opinion (QSBO), which pointed to reduced capacity utilisation and weak pricing intentions by firms, continuing to support market expectations for a cut in the Official Cash Rate (OCR) this year. The NZD Trade-Weighted Index lifted 4.3% in October, but remains 9.5% lower than six months ago. The rebound in the exchange rate likely reflects higher dairy prices, depreciation in the US Dollar (USD) and the stabilisation in the growth outlook.

Business activity growing around trend...#

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Business indicators showed steady expansion in activity. The QSBO for the September quarter pointed to trading activity expanding at a pace consistent with trend GDP growth in the second half of 2015. However, the survey does not include the agricultural sector where activity is expected to weaken. A seasonally-adjusted net 12% of firms expanded their output in the quarter, up slightly from a net 10% in the June quarter. Firms which expect to increase activity in the December quarter also rose, to a net 17% from 13% previously. Growth in sales reflects still-solid household demand, high net migration and tourist arrivals.

A pick-up in activity in the September quarter is also observed in the BNZ-BusinessNZ Performance of Manufacturing Index, which rose to an average of 54.7 in the quarter from 53.0 in the June quarter, although the correlation with growth in the GDP measure of manufacturing activity has been poor recently. The average of the Performance of Services Index in the September quarter also rose 0.4 points to 58.0, driven by strength in the tourism sector. Both indices and the QSBO survey point to moderate growth in business activity in the September quarter, supporting Treasury’s expectation of growth in the quarter (Figure 1) of around 0.6%. Given weak GDP growth in the first half of 2015, around trend growth of 0.6% per quarter in the second half of 2015 would give growth from a year ago of less than 2.0% in the December quarter 2015.

Figure 1: GDP and QSBO firm activity

Source: Statistics NZ, NZIER

...supporting firms’ employment intentions...#

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Higher trading activity supported the demand for labour, with a seasonally-adjusted net 13% of firms in the QSBO reporting an increase in employment in the September quarter, up 2% points from June. A net 15% of firms expect to increase employment in the months ahead, higher than 10% previously. Both skilled and unskilled labour became easier to find in the September quarter, although they remain hard to find relative to history. Labour market statistics for the September quarter are scheduled for release on 4 November.

...although lower business confidence weighs on investment intentions#

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However, business confidence has waned. A net 9% of firms in the QSBO are pessimistic about the prospects for the economy over the next six months, deteriorating from a net 6% optimistic in June. Geographically, confidence fell sharply in the regions most exposed to lower dairy prices. Weaker business sentiment is also evidenced by the ANZ Business Outlook falling to a six-year low in the September quarter. However, these surveys were taken before the most recent rebound in dairy prices.

Falling confidence dampened investment intentions in the September quarter, which continued to fall from their post-GFC high in March. This supports Treasury’s expectations of slower business investment growth in the second half of 2015 than in the BEFU, owing to domestic demand softening to trend, lower export prices and higher cost of capital imports owing to NZD depreciation. However, headline September quarter business investment is expected to be boosted by the arrival of two large aircraft.

Increased spare capacity and lower prices...#

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Business capacity utilisation in the QSBO fell to 91.4% in the September quarter from 93.4% in June, although still above its historical average of 89.1%. The fall was broad-based across industries, with the largest decline evident in the construction industry. The easing in capacity utilisation reduced price pressures throughout the economy.

A net 6% of firms reduced their selling prices in the September quarter, despite a net 19% of firms reporting an increase in input costs (Figure 2). A net 10% of firms in the construction sector cut prices in the September quarter, with margin compression weighing on profitability. Only a net 0.5% of firms expect to increase their prices in the December quarter, despite expectations of higher input costs from a net 17% of firms. Overall pricing intentions have fallen sharply from relatively high levels in 2014, reflecting increased spare capacity, lower demand pressures and ongoing strong competition between firms.

Figure 2: QSBO sale prices and input costs

Source: NZIER

...weighed on September quarter inflation...#

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Lower selling prices in the QSBO contributed to soft inflation in the September quarter, despite it being slightly higher than market expectations. The Consumers Price Index (CPI) increased 0.3% in the September quarter, with annual inflation steady at 0.4%. The trimmed mean measure of quarterly inflation was 0.5%, showing a slight tick-up in underlying inflation from June (0.4%) excluding the impact of large price changes.

Non-tradables prices were flat in the quarter, weighed on by softening domestic demand and one-off falls in health and transportation costs. Partly reflecting easing demand and low wage growth, services inflation fell to 0.6% in the September quarter from 1.2% in June. In addition, transportation and health costs fell 1.5% and 0.6% respectively, owing to one-off policy decisions reducing vehicle licensing fees and raising subsidies for children’s visits to doctors. On the other hand, higher housing costs contributed 0.3% points to the quarterly CPI rise, with local authority rates (which are increased annually and mainly show up in the September quarter) rising 5.7%. The price of building a new house increased 1.4%, driven by strong growth in Auckland.

Tradables prices rose 0.7% in the September quarter, driving headline quarterly inflation, supported to some extent by a lower NZD which increased the prices of imported household durable goods, petrol and package holidays. Seasonally-higher vegetable prices also contributed to tradables inflation. However, annual tradables inflation remained negative at -1.2%, although it was up from -1.8% in June (Figure 3).

Figure 3: Tradable and non-tradable inflation

Source: Statistics NZ

...although inflation is likely to rise from here#

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Annual inflation is expected to rise moderately in the December quarter, and to above 1.0% in early 2016. Annual tradables inflation is expected to continue to increase, as the effect of the petrol price fall in early 2015 drops out of the annual calculation, and as exchange rate depreciation increases the price of imported goods and may allow import-competing firms to increase their prices. However, the recent appreciation in the NZD presents a risk that inflation may not pick up as quickly as expected.

Quarterly non-tradables inflation is expected to gradually rise from September, but is expected to remain relatively low over 2016 owing to increased spare capacity in the economy and softening domestic demand. Annual non-tradables inflation over the coming year will continue to be negatively affected by one-off price falls in the September quarter 2015.

Reserve Bank holds OCR but signals easing#

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The Reserve Bank left the OCR at 2.75% at its October review, but notes that further easing is likely. The Reserve Bank expects CPI inflation to return to within the target range by early 2016. However, to support demand and lift inflation back towards the midpoint of its 1-3% target range, some further reduction in the OCR is likely.

Net migration remains at elevated levels...#

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The net inflow of migrants in September was 5,600, lifting the annual total to a record high of 61,200. Compared to September 2014, arrivals rose 10.1%, driven primarily by migrant workers, followed by Australian and New Zealand citizens and students, while departures rose 1.8%. Net migration in the year to September 2015 was led by a 12.7% rise in arrivals (to 118,900), and to a smaller extent by a 4.0% fall in departures (to 57,600). The largest contribution to the annual increase in arrivals was students (up 26%), followed by people on work visas (up 14%).

Net inward migration from Australia in September remained positive for the sixth consecutive month, bringing the annual net outflow to just 200 people in the September 2015 year. This is significantly smaller than the net outflow in the September 2014 year (6,000 people), owing largely to fewer New Zealanders departing for Australia. Based on the most recent estimate of New Zealand’s population, net migration contributed to around 75% of the population growth of 1.8% in the year to June 2015, up from 1.1% in June 2014.

...and housing demand picks up broadly...#

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Strong population growth and low mortgage rates continued to boost housing demand. According to the Real Estate Institute of New Zealand (REINZ), house sales rose 1.3% in September to be up 38% from a year ago. Auckland house sales were 38% higher than a year ago, reflecting high demand being met by an increased number of houses for sale, but a 0.7% fall in sales in the September month points to greater investor caution ahead of the Reserve Bank’s regional loan-to-value restrictions coming into effect in November, and tighter rules around the taxation of trading in investment properties. House sales in other regions have picked up significantly, with Waikato surging 85% from September 2014 and Northland up 69%. The more broad-based pick-up appears to be driven by home-buyers and investors looking for more affordable options.

With housing demand continuing to outpace supply in Auckland, and demand in other regions picking up, the REINZ stratified house price index rose 2.6% in September, leading annual growth to accelerate from 17% to 20%. Annual house price growth in the September quarter overall was led by Auckland (Figure 4), but price growth in other North Island regions is picking up strongly, while Canterbury also showed a rebound.

Figure 4: Regional house price growth

Source: REINZ

Residential construction is responding positively to strong house price growth. The level of dwelling consents remained at a high level in August despite falling 4.9%, following a 20% surge in July. Auckland dwelling consents declined sharply in August, but driven entirely by the volatile apartments. A seasonally-adjusted 3.1% rise in housing consents still suggests an upward trend in residential construction. Dwelling consents in Canterbury remained at a high level, showing housing construction activity holding up following the peak in the residential rebuild.

...lifting household confidence and spending#

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A buoyant housing market and low interest rates reinforced household confidence. The ANZ Roy-Morgan consumer confidence index lifted 4.1 points to 114.9 in October, showing a stabilisation following sizable falls earlier in 2015. The improvement was driven by a more upbeat view of future economic conditions.

Higher household sentiment supported spending. The value of electronic card transactions rose 0.7% in September, to be up 2.2% in the quarter. A pick-up across most retail categories in the September quarter and a large increase in services spending offset a contraction in fuel sales values as petrol prices rose. Private consumption growth is expected to be around trend in the September quarter at 0.6%.

Stabilisation in dairy and other export prices...#

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The average price at the GlobalDairyTrade (GDT) auctions in October grew 16% from September to US$2,785/mt, despite declining 3.1% at the second auction, with skim and whole milk powder prices leading the rise. The recovery in dairy prices in October followed a 26% surge in September, and the GDT price index is 58% higher than its post-GFC trough in early August.

The price increase was driven by reduced supply, with auction volumes down 32% from a year ago as Fonterra reduced its auction offerings to support prices. Analyst concern over the supply outlook persists as Fonterra forecasts milk production in New Zealand to decline 5% in the 2015/16 season on the back of earlier declines in the farm-gate milk price, and as the El Nino weather pattern may have an impact. The ANZ commodity price index surged 9.3% in September in NZD terms, reflecting higher dairy prices and a weaker NZD. Prices also rose solidly for forestry, horticulture and seafood.

Figure 5: Export prices and dairy prices

Source: Statistics NZ, GlobalDairyTrade

However, the outlook for dairy prices remains weaker than in the BEFU and some retracement in the forecast for prices is expected. Goods export prices are expected to fall in the September quarter owing to the earlier falls in dairy prices (Figure 5), although the recent rise in GDT prices may support a stabilisation in export prices in coming quarters.

...may support export values in late 2015#

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Despite a weaker merchandise trade balance in the September month, goods export values in the September quarter expanded 6.4% from June. A rise in dairy and meat values in the quarter, owing primarily to higher volumes and a weaker NZD, drove export revenues higher. Import values rose 9.2% in the quarter, boosted by the volatile aircraft component, but solid growth in consumption and other intermediate goods imports reinforces Treasury’s view of domestic demand expanding at around trend in the second half of 2015. The seasonally-adjusted merchandise trade deficit in the quarter widened $0.4bn to $1.0bn, as imports increased by more than exports. The GDP measure of export values is expected to rebound in the September quarter, but is likely to be outpaced by import values, pointing to a negative contribution from net exports to nominal GDP.

Visitor arrivals rose 12.2% in September from a year ago, driven by Australian and Chinese arrivals. However, services exports are likely to ease in the September quarter from their elevated levels over recent quarters.

The recent pick-up in dairy prices and the trend depreciation in the NZD, if sustained, will support export revenue in the December and March quarters. However, the external sector recovery may be slower than in BEFU owing to a weaker outlook for the global economy.

Soft global data continue in October#

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Soft global economic data are leading to expectations of accommodative monetary policy being extended further, either through additional quantitative easing, lower interest rates or later tightening. Growth slowed in China in the September quarter and the People’s Bank of China (PBoC) eased monetary policy. Weaker US data pushed out Fed hike expectations and the Fed kept its policy rate unchanged in October, although a December hike is possible. Muted inflationary pressure and risks around emerging market economies mean the ECB could provide additional stimulus in December. The prospect of more accommodative monetary policy has continued to support risk appetite, particularly for equities.

Growth slows in China, PBoC eases...#

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China’s annual growth slowed to 6.9% in the September quarter, the lowest rate since the GFC. The slowdown was driven by secondary industry activity, which includes construction and manufacturing, and is about 46% of the economy. Tertiary industry activity, which represents services and is also about 46% of the economy, continues to strengthen (Figure 6). The data suggest that rebalancing from investment to consumption is underway, which is also evident in solid retail sales, soft industrial production and weaker investment growth. That said, analyst perceptions are that rebalancing remains fragile.

Figure 6: China GDP growth

Source: Haver

China’s CPI inflation in September eased to 1.6% from 2.0% in August and remains below the target of “around 3%”. The PBoC cut the benchmark one-year lending rate and one-year deposit rate 25 basis points to 4.35% and 1.5% respectively. It also cut the reserve requirement ratio 50 basis points to 17.5% for the country’s biggest lenders, and an additional 50 basis points for banks lending to agricultural firms and small businesses in order to stimulate demand.

...and US Federal Reserve holds#

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While the US recovery remains on track so far, softer than expected labour market data, weak retail sales growth, as well as a range of other indicators in combination with Fed minutes and speakers, led to expectations of interest rate increases being pushed back. Accordingly, the Fed held its policy rate in October. However, the Fed statement was more hawkish than September as the reference to global economic and financial market developments was dropped and more emphasis was put on a possible December hike. This has shifted market focus more towards domestic developments and emerging data.

Australian economy maintains steady pace...#

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The Australian economy maintained momentum but low inflation has increased the likelihood of further easing by the RBA. Labour market data have remained broadly unchanged, with annual employment growth at a 4-year high of 2.0% and the unemployment rate steady at 6.2%. However, CPI inflation was below expectations, unchanged from the June quarter at 1.5% in the year to September. Core inflation also remains weak, increasing the chance the RBA will cut in early November. Previously the RBA has appeared comfortable with monetary policy settings and the recent AUD depreciation, noting risks to the outlook remain, particularly regarding a further slowdown in China.

...while the euro area recovery slows...#

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The euro area recovery continues to slow as weak demand from emerging market economies impacts industrial production, unemployment remained unchanged in August at 11.0%, and both headline and core inflation remain weak. The slowdown in emerging market economies and persistently low oil prices continue to pose significant risk to euro area growth and inflation outlooks. In response, the ECB announced it stands ready to provide further monetary accommodation from as early as December, but there has been no clear signal whether this would be in the form of a lower (more negative) deposit rate, or an extension to its Asset Purchase Programme.

Meanwhile, UK September quarter GDP growth of 0.5% suggests the recovery is slowing, albeit only marginally. Services continue to support growth, suggesting domestic demand remains robust. The Rugby World Cup is also providing a temporary boost, which is reflected in solid retail sales.

...and Japan’s data reflects regional slowdown#

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Data for Japan have reflected the regional slowdown. The trade deficit was wider than expected, driven chiefly by weaker exports to China and industrial production fell 1.2% in August. Imports fell 11.1%, reflecting weak domestic demand as well as lower oil prices. That said, Japan’s labour market remains positive on balance, but wage growth is expected to provide little boost to consumption as real wage growth slowed in August, increasing just 0.2% in the year. Job availability is at a 20 year high and the unemployment rate at an 18‑year low, but inflation remains weak at 0.2%.

Global outlook revised lower#

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Consistent with this month’s data, the IMF lowered its world growth outlook for 2015 and 2016 from 3.3% and 3.8% in its July Update to 3.1% and 3.6% respectively. Slowing growth in emerging market economies is expected to continue in the near term, while some pick-up in advanced economies is expected for the remainder of 2015. Downside risks to the outlook have increased.

Equities recover somewhat, but volatility remains#

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Equities have recovered somewhat in October, following a more accommodative monetary policy outlook, which is the result of a weaker outlook for growth and inflation. However, volatility in financial markets has continued from September. The NZ dollar TWI has appreciated 4.3% from September, driven largely by global monetary policy expectations. Reflecting slowing global demand, commodity prices have generally remained weak, including for oil.

Special Topic: International experience with fiscal targets#

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The New Zealand Government recently achieved a surplus on the operating balance before gains and losses, one of its key fiscal targets. This topic examines the international experience with fiscal targets and draws lessons for New Zealand.

Fiscal targets in New Zealand#

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For more than two decades, fiscal policy has been conducted in New Zealand within a framework that emphasises transparency as a key to ensuring fiscal responsibility and sustainability. The principles of responsible fiscal management in the Public Finance Act 1989 have included a requirement for a prudent level of public debt and balancing operating revenues and expenses on average over a reasonable period of time. New Zealand’s fiscal targets have evolved to reflect changes in the state of Government finances, the achievement of previous targets and the country’s economic performance.

The Government sets out its fiscal strategy in the Fiscal Strategy Report,[1] which identifies the fiscal priorities and sets out short-term fiscal intentions and long-term fiscal objectives.

The Government has used a range of targets to support its fiscal strategy, most notably to achieve a surplus on the operating balance before gains and losses (OBEGAL) in 2014/15, and to reduce net debt to a level no higher than 20% of GDP by 2020 (and then maintain net debt within a range of 10-20% of GDP). Other goals have included reducing expenses as a share of GDP to below 30%, managing spending and revenue decisions within operating allowances and funding new capital expenditure from the Future Investment Fund.

On 14 October 2015 the Government released its year-end financial statements, showing that the target of achieving surplus in 2014/15 had been met. This target has been a key fiscal anchor in recent years. The target has focused attention on managing operating revenue and expenses and helped turn around a large fiscal deficit.

New Zealand’s fiscal position is strong internationally. IMF measures of the fiscal balance and debt show New Zealand returning to fiscal surplus earlier than most other developed nations, including Australia (Figure 7), and Government debt peaking earlier and at a lower level than most other developed countries.

Figure 7: General government fiscal balance[2]

Source:  IMF Fiscal Monitor

The achievement of surplus in the 2014/15 fiscal year provides an opportunity to review the current suite of targets and consider whether any changes may be desirable. The objectives of fiscal policy are useful in evaluating fiscal targets and framing the thinking about what the optimal target might be. To elaborate, targets should promote:

• Fiscal Sustainability – ensuring that the government’s revenue and expenses are balanced over time and debt is maintained at prudent levels; and
• Economic Stability – fiscal policy should contribute to economic stability by allowing the automatic fiscal stabilisers to operate and avoiding pro-cyclical changes in discretionary fiscal policy.

Fiscal targets therefore need to balance the objectives of fiscal control while also enabling sufficient flexibility for the operating balance and debt level to fluctuate over the economic cycle. Targets should also be readily understandable by policymakers and the public to promote accountability.

Lessons from other countries for New Zealand#

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The Treasury has looked at the implementation of fiscal rules in other countries to inform thinking about the future of fiscal targets in New Zealand.[3] Fiscal rules have become more prevalent in recent decades. In the early 1990s, there were only seven countries with fiscal rules in place, but the number increased rapidly, particularly in the late 1990s and early 2000s. As of 2014, 85 countries had some form of fiscal rule in place. Budget balance rules and debt rules are the most common, followed by expenditure rules (such as spending caps), which are particularly prevalent amongst advanced economies (Figure 8).

Figure 8: Fiscal rules in advanced economies

Source: IMF Fiscal Rules Dataset (2015)

Most countries have more than one rule in place currently, and the average number of rules has increased over time. This trend partly reflects efforts to broaden fiscal arrangements as debt rules alone proved insufficient in providing operational guidance. The majority of advanced economies have at least a debt rule and budget balance rule (particularly EU members) and these often adjust for the state of the economic cycle. Although many countries adopt budget balance and debt rules, there is still considerable variation in the way these rules are defined and enforced.

International experience shows that relying solely on debt targets may not provide sufficient disciplines on government spending and prioritisation especially during periods of strong revenue growth. Rolling time-frame expenditure rules, as in Sweden, can help to provide greater discipline to government spending decisions. Further, fiscal rules alone do not guarantee improved fiscal outcomes. Supporting institutions, procedures, and commitment also matter. Countries that align fiscal frameworks with medium-term expenditure frameworks that attempt to balance objectives for sustainability and stability are considered best practice.

The global financial crisis (GFC) highlighted numerous fiscal challenges. Following the GFC, many countries have reformed their frameworks either by overhauling existing rules or adding new ones. The new rules have been set to reassure markets and support credible long-term adjustment efforts or to build on pre-crisis reform efforts. These so called “second-generation” fiscal rules have the objective of combining sustainability with flexibility in response to shocks. A key rationale for the implementation of these types of rules has been to avoid fiscal policy becoming procyclical.

There are different approaches across countries to making fiscal targets more flexible. For example:

• cyclical adjustment such that the target makes allowance for the state of the economy (such as structural deficit targets in the European Union);
• “escape clauses” where unforeseen economic shocks allow deviation from the target (e.g. UK target to achieve a surplus on public sector net borrowing in 2019-20 and then every year in ”normal times”); or
• rolling targets where the target is set to be achieved over a moving time frame rather than by a fixed date (e.g. the previous UK fiscal mandate: “achieve cyclically-adjusted current balance by the end of the third year of the rolling, 5-year forecast period”). This approach is forward-looking, similar to the current inflation target for monetary policy in New Zealand.

There has been an increase in the number and complexity of rules, and this has made it difficult to monitor and communicate compliance with rules. In the case of cyclically-adjusted balances there are additional challenges with real-time measurement and communication. Further, it is yet to be seen how these “‘second-generation” rules will perform when faced with future shocks.

Many countries have introduced fiscal councils or reformed budgetary procedures and medium term frameworks. Fiscal councils in particular have been effective for countries where there is not a strong track record for fiscal discipline and fiscal forecasts are perceived as lacking credibility.

Following the GFC there has also been increased attention on fiscal-monetary policy interaction, because monetary policy in some countries has been constrained by the zero lower bound for policy interest rates. This has led to suggestions by some academics that fiscal rules should be contingent on whether interest rates are constrained by the zero lower bound.

Main conclusions#

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The Government’s target for an operating surplus in 2014/15 has been met. It is timely to review the fiscal targets to ensure they are best suited to New Zealand’s current economic and fiscal circumstances.

Most countries have some form of budget balance and debt targets. In addition to fiscal sustainability, international practice has put increased emphasis on fiscal targets that support economic stability.

Fiscal rules alone do not guarantee improved fiscal outcomes. They can help reinforce a broader political and public commitment to sound public finances. Fiscal targets, as they operate in the New Zealand context, can help to provide anchors for the fiscal strategy. This supports transparency and accountability of fiscal policy.

Further reading#

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IMF (2009). Fiscal Rules - Anchoring Expectations for Sustainable Public Finances.

IMF Fiscal Monitor (2015). Now Is the Time: Fiscal Policies for Sustainable Growth.

Schaechter, Andrea, Tidiane Kinda, Nina T. Budina, and Anke Weber (2012). Fiscal Rules in Response to the Crisis - Toward the 'Next-Generation' Rules: A New Dataset.

New Zealand Key Economic Data#

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30 October 2015

Quarterly Indicators#

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Monthly Indicators#

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