Australian & New Zealand Weekly

Week beginning 13 April 2009

• Australia: RBA to be cutting rates in H2 2009.
• Australian data: Westpac leading index and import prices.
• New Zealand data: CPI and retail sales.
• US: busy data week with inflation, retail and factory reports.
• Key economic & financial forecasts.

Australia: RBA to be Cutting Rates in Second Half of 2009 - Banks' Reaction will Determine the Lowpoint

The Reserve Bank announced a 25bp cut following the Board meeting on Tuesday. Westpac had consistently argued that the Bank was likely to keep rates on hold for a number of months to assess the impact of the recent aggressive rate cuts and substantial fiscal stimulus packages which are being implemented by the Government. The other argument in favour of a pause was to allow the Bank to conserve some flexibility to deal with potential further shocks, both domestic and international, over the course of 2009.

In moving to cut by a further 25bp's the Bank has reacted to two significant issues. The first one appears to have been the release of revised world growth forecasts by the OECD which painted a decidedly darker picture of global prospects than had been the consensus. In this regard, the Statement notes "most assessments of the near-term [global] outlook have been further marked down". We have had a more pessimistic view of world growth than consensus but now find the OECD estimates too pessimistic. We forecast OECD growth of -3% in 2009 compared to the OECD's forecast of -4.3%. As has been the case in the past, the International Agencies are sometimes slow to identify major issues and can then belatedly overshoot on some forecasts. We expect this forecast by the OECD will be no exception. If we are right then the RBA is unlikely to receive yet further global news to require another global growth downgrade over the next few months, taking some pressure off the need to move on rates again in the near term.

The second significant issue has been a lowering of the domestic growth outlook to formally include a recession. The Statement notes "The Australian economy is contracting". Previously the Bank was forecasting flat growth in 2009. Westpac has been forecasting negative growth in 2009 since early January and we suspect that the Bank would have seen all the risks to be in that direction since about that time as well. Consequently we assess that the most important driver of this decision has been the global growth view.

The future path of rates depends on whether you adopt a view that the Bank has decided that the 'pause' approach which we saw in March has been jettisoned to get continuous stimulus into the system as early as possible, or whether they still see the attraction of holding back some flexibility to be able to deal with future shocks - either global or domestic.

We still favour the latter approach and hence expect there will be an extended pause until around August before we see another move, which is likely to be a cut of 50bp's.

Despite market pricing consistently indicating a low point in this cycle of 2.5% we are sticking with our view that rates will eventually bottom out at 2% or lower. Our most likely low point target of 2% has been predicated on the view that the banks would be constrained in their ability to pass on any further cuts to mortgage rates if official rates go below 2%. The reaction of the banks to this latest 25bp cut clouds this issue. Three banks passed on a less than expected 10bp's and one passed on zero. Markets might start to interpret those actions as indicating that the point at which banks decide not to pass on any further rate cuts is nearer than we had anticipated.

On the other hand it may be that banks will be able to sustain modest rate cuts for longer than we had originally expected. That possibility leaves the window open for the low point in the cash rate to go below our 2% target.

Mortgages now represent more than 50% of banks' assets. Business loans represent most of the rest with a small proportion in personal loans including credit cards and margin loans. The liabilities of banks are dominated by domestic and offshore wholesale liabilities; retail deposits (including non interest bearing) and capital/float. Pricing of the wholesale liabilities tends to move with the bank bill curve while NIB/capital/float are interest free (expected return on capital will however be affected by the overall interest rate environment). Retail deposit rates will be partly affected by market rates although other issues will always distort this relationship. For example we estimate that since the RBA has cut the cash rate by 425bp's the banks have cut the prime variable mortgage rate by around 375bp's while retail deposit rates have only fallen by around 200-250bp's.

In particular, banks are attempting to lower their reliance on offshore wholesale funding given the uncertainties and rising costs which have resulted from the global financial crisis. That emphasis on retail deposits as a more stable source of funding has been the key driver behind the resilience of retail deposit rates. This policy stance has undoubtedly been benefitting household depositors with deposit rates not falling as much as would have normally been expected from the aggressive easing by the RBA.

In particular if this trend of resilience of retail deposit rates to official rate cuts continues it might be that retail deposit rates are still "competitive" even if the RBA has cut rates to as low as 2%. That would give the banks greater scope to respond to rate cuts below 2% since there would be scope to lower asset rates if there was some flexibility in the retail deposit space.

Certainly we expect that the RBA will be needing to be seen to be continuing to cut rates in the second half of 2009. The twelve month period (2009 H2-2010 H1) is likely to see the sharpest increase in the unemployment rate. That period is also likely to be associated with a substantial slump in consumer confidence.

Following the release of the April Consumer Sentiment Index I noted, "Superficially, we should be encouraged that the average level of the Index over the last 6 months is higher than the average of the previous 6 months by 4.4%. However it would be premature to argue that the Index has passed its lows in this cycle. We note that in the early stages of the last recession the Index also appeared to have recovered from its lows. The average for the 6 month period November 1989 - April 1990 was 4.3% above the average for the previous 6 month period. However, the average for the following 6 month period (May 1990 - October 1990) plunged to 15.1% below that level. That period coincided with the first half of the 12 month period when we saw the most rapid increase in the unemployment rate during the last recession when it increased from 5.9% (March 1990) to 9.4% (April 1991). Given the disturbing signals from all the leading employment indicators which are pointing to a rapid increase in the unemployment rate over the next 18 months, we are likely to see the Index reaching new lows over that period. "

During that recession the RBA cut rates from 18% to 5.75% over a two and a half year period between January 1990 and July 1992. In the period (March 1990 - April 1991) when the unemployment rate was increasing most rapidly it cut aggressively by 500bp's.

Retaining some flexibility for the equivalent period in this recession and even pushing rates lower than 2% if policy is still getting traction from the banks seems to be an attractive option for the RBA.

Australia: Data Wrap

Mar TD-MI inflation gauge

• The TD-Melbourne Institute inflation gauge dipped 0.1% in March (-0.12% to two decimals) following a 0.7% jump in February and 0.8% leap in January.
• The main sources of lower prices cited were petrol (main drag; reported to have fallen 5%), tobacco, rents and dairy products. Partially offsetting increases were noted for fruit and vegetables, insurance services, and books, newspapers and magazines. With a much higher +0.44%mth result from Mar-08 dropping out, annual growth in the gauge fell to 2.6%yr from 3.1%yr previously, the lowest since Dec-08.

Mar ANZ job ads

• Newspaper job ads fell 6.6% in March after a 25.2% plunge previously, allowing their rapid downtrend to continue at -8.5%mth and -55.3%yr (vs -9.2%mth and -52.5%yr previously). Internet job ads fell 8.6%.
• The net result was a 8.5% fall in total job ads after a 10.4% drop previously, their 11th consecutive fall. This continued the rapid downtrend in the total series at -7.5%mth and -43.6%yr (vs -8.1%mth and -39.2%yr previously), the weakest annual pace since May-1991 (a combined newspaper and internet series did not exist back then, but we have spliced newspaper ads onto the total series to back-cast a longer total ad history).

RBA policy announcement

• The Reserve Bank announced a 25bp cut following Tuesday's Board meeting. See Bill's p2 article for more insight into the outlook for policy.

Apr Westpac-MI Consumer Sentiment

• The Westpac-Melbourne Institute Index of Consumer Sentiment increased by 8.3% in April from 85.6 in March to 92.7 in April.
• This was a surprisingly strong result. It follows last month's display of resilience, when the index fell by just 0.2% in the face of a barrage of disturbing domestic and international news including the Australian economy being widely reported to be in recession following the 0.5% contraction of GDP in the fourth quarter and the US sharemarket falling by 20% over the month. At the time we speculated that the surprisingly resilient result could have been a lagged positive response to the announcement of the Government's $42bn fiscal stimulus package and the 1% cut in mortgage rates as the banks fully passed on the Reserve Bank's cut of 1% in the overnight cash rate.
• This month there has been more positive economic information. Concerns about the global economy have eased as sharemarkets boomed. Both the US and Australian markets have risen by around 20%. The Australian dollar, which is seen as a proxy for global risk was up by 11.6%. We have found that generally Australians respond positively to a rising Australian dollar. Finally, despite recent increases in the oil price, petrol prices were down slightly on the month by 1.3%.

Feb housing finance

• The recovery in demand for housing finance continued in February. Housing finance to owner-occupiers increased by 0.4%, while new lending showed a more substantial gain, rising 3.2% (ie excluding refinancing). Households are clearly responding to the very low interest rates that are now in place and to the bolstered First Home Owners scheme. New lending to owner-occupiers has rebounded by 22% from the low of six months ago.

Mar employment

• After several months of resilience, total employment began to reflect the persistent weakness in leading indicators of labour demand in March, with a 34.7k fall (consensus -25k, Westpac f/c -30k) after a 1.1k rise previously. The breakdown was weak again this month also, with full-time jobs down 38.9k after a 51.4k fall previously, the 6th fall in the last 8 months. This saw the deterioration in the underlying trends gather pace. Total employment trend growth fell to +0.42%yr from +0.65%yr previously (lowest since Jul-93) and the monthly trend has (with revisions) now been in decline for 4 months. Full-time trend growth fell to -0.54%yr from -0.18%yr previously (lowest since Dec-01) and the monthly full-time trend has now been in decline for 7 months.
• Historically, months of employment weakness of this magnitude have been accompanied by sharp pullbacks in the participation rate. However, in this cycle, participation is holding higher than usual, a likely function of higher participation from those nearing retirement age (from the destruction of superannuation wealth) and for females (with job losses anecdotally led by traditional male-dominated industries). In March, the participation rate held steady at 65.5%, providing no partial offset to the jobs fall, pushing the unemployment rate to 5.7% from 5.2% previously (consensus 5.4%), the highest since Oct-03.
• The signals from our preferred leading indicators of employment (Westpac-ACCI Labour Market Composite, detrended job ads, and our business survey composite labour demand indicator) suggest this gathering pace of deterioration in jobs growth will continue through 2009. Most of these indicators remain consistent with our forecast for jobs growth to decline to around -1.5%yr at end-2009, although historically high consumers' unemployment expectations imply risks to the downside. On the assumption of a typical pro-cyclical pullback in the participation rate, this would lift the unemployment rate towards 7% at end- 2009. However, if the participation rate continues to display resilience and holds its current level to end-2009, a fall in jobs growth to -1.5%yr would lift the unemployment rate towards 7.5%.

Apr MI consumer inflation expectations

• Consumers' inflation expectations edged higher in April, with the median expectation rising to 2.4% from 2.2%. Nevertheless, their downtrend continued, falling to 2.11% from 2.22% previously, the lowest since January 1998.
• The median expectation of managers and professionals fell to 1.8% from 2.2% previously, taking their trend to a new record low (data commenced 1995) of 1.70%. The trend net balance expecting higher prices overall fell to a new record low of 42.3% from 42.7%, and the proportion of respondents expecting inflation within the 2% to 3% target band rose to 10.7% from 9.9%, the highest since April 2008 and therefore well above its twelve month average of 8.7%.

Apr Westpac-MI unemployment expectations

• Consumers' unemployment expectations saw their second consecutive fall in April, halting their rapid trend deterioration. The unemployment expectations index fell 3.6% in April to 175.27 after a 0.7% fall previously, the first consecutive falls since April and May 2007.
• These consecutive falls have been sufficient to halt the rapid uptrend in the series, with trend growth now -0.1%mth and +44.6%yr (vs +0.9%mth and +49.0%yr previously). Their trend deviation from their full history average also edged lower for the first time since October 2007, to 43.5% from 44.9% previously. Nevertheless, it remains much higher than the peaks of the 1990/91 recession (31.5%) and 1982/83 recession (35.6%), and remains consistent with a rapid deterioration in jobs growth through 2009.

Round-up of local data released last week

Date	Release	Previous	Latest	Mkt f/c
Mon 6	Mar TD-MI inflation gauge	0.7%	-0.1%	-
	Mar ANZ job ads	-10.4%	-8.5%	-
Tue 7	RBA policy announcement, 2:30pm	3.25%	3.00%	3.25%
Wed 8	Apr Westpac-MI Consumer Sentiment	85.6	92.7	-
	Feb housing finance (no.)	4.3%	0.4%	2.0%
Thu 9	Mar employment chg	1.1k	-34.7k	-25k
	Mar unemployment rate	5.2%	5.7%	5.4%
	Apr MI consumer inflation expectations	2.2%	2.4%	-
	Apr WBC-MI unemployment expectations	-0.7%	-3.6%	-

New Zealand: Week ahead & Data Wrap

A drawn-out recession

The New Zealand economy, still wearing the bruises from the domestically driven recession of 2008, has had to contend with a deeper, globally driven downturn in the first half of 2009. And a key activity indicator this week provided little hope of a significant turnaround this year.

The March Quarterly Survey of Business Opinion was, on balance, even weaker than the horrendous details of the December 2008 survey. Firms' expectations of domestic trading activity picked up slightly, with a net 39% expecting conditions to get worse over the next three months, compared to a net 41% in December. But these were easily the two worst reads on record for this survey (since at least 1970).

The domestic trading activity measure is a useful indicator for contemporaneous GDP, and the latest read suggests some downside risk to our forecast of a 1% contraction in Q1 GDP. Indeed, eyeballing the relationship between the two would suggest a quarterly fall of more like 3%. However, we caution that the survey doesn't capture agriculture or government activity, which have been two relatively bright spots in the economy lately.

The details of the survey were even weaker than in December. Investment and employment intentions fell to new record lows, indicating that firms are still deep within the retrenchment phase. Profit expectations remained extremely weak, with a net 45% of firms expecting profits to fall in the next quarter.

Capacity utilisation fell sharply again to 86.3% - in the last three quarters, this measure has fallen from a record high to a 17-year low! Some of the weakness in manufacturing capacity will have reflected a lack of supply in meat processing, as a high drought-induced slaughter last season has led to a shortage of livestock this season.

But there is evidence that demand is a growing concern as well. The vast majority of firms (77%) cited a lack of sales as the main constraint on expanding output. And this weakness in demand is now being felt intensely in international markets - a record 54% of manufacturers reported a fall in export orders in the last quarter. The collapse in global trade in recent months has been felt more keenly in high-end manufacturing, but even as a producer of 'necessities' such as food, New Zealand is still clearly exposed.

Labour market conditions have taken a dramatic turn for the worse in the last year. The ease of finding labour, both skilled and unskilled, is now the highest in more than 30 years. A net 36% of firms intend to shed staff over the next three months, the highest ratio since September 1991. And a net 31% reported a fall in labour turnover, suggesting that workers are becoming more appreciative of the jobs that they have.

The QSBO provides little support for the RBNZ's forecast that business activity will stabilise in the second half of this year. To add insult to injury, the recent rise in interest rates and the NZ dollar have left overall financial conditions much tighter than the RBNZ was counting on. To us, the survey seals the economic case for a 50bp cut at the 30 April OCR review.

But the big unknown is how much weight the RBNZ will place on the perceived need to “retain competitiveness in the international capital markets”, as noted in the March Monetary Policy Statement. In short, this translates to maintaining a margin over interest rates in Australia, our closest peer and one of the dwindling number of countries that have not resorted to a near-zero interest rate policy. The RBA's 25 basis point rate cut this week leaves both countries with a cash rate of 3%, though longer-term market rates are higher in New Zealand.

We have noted before that this is hardly a matter of concern for policy rate decisions - if investors demand a premium for lending to New Zealand, then they will get one. But it leaves the RBNZ with a stark choice: either take their chances with lower interest rates, or accept a more drawn-out recession and/or a slower recovery.

The key data next week is the CPI for the March quarter. We expect a 0.3% increase for the quarter, with food and electricity being the main positive contributors. This would bring the annual rate of inflation down from 3.4% to 3.0%, and a further fall is on the cards as last year's spike in fuel prices starts to drop out of the equation. More importantly, the ongoing recession means an increasing amount of slack in the economy, which will keep inflation pressures subdued over the next year or so. It is this outlook, more so than the moderation in current inflation, which gives the RBNZ licence to cut rates further.

Round-up of local data released last week

Date	Release	Previous	Latest
Tue 7 Apr	Q1 NZIER business confidence	-64%	-65%
Thu 9 Apr	Mar electronic card transactions	0.6%	-0.5%

Data Previews

Aus Feb Westpac-MI Leading Index

Apr 15, Last: -3.1% annualised

• The annualised growth rate of the Westpac-Melbourne Institute Leading Index, which indicates the likely pace of economic activity three to nine months into the future, was -3.1% in January, well below its long term trend of 3.2% and in deeply negative territory consistent with contracting economic activity.
• The monthly components were mostly firmer in February. Dwelling approvals jumped 7.8%, the first rise since June last year. Money supply growth stepped up again to 1.5% from 1.3% in Jan and 0.3% in Dec. However, shares continued to cop a battering, the ASX200 down another 5.5% in February, though it has rallied strongly since mid-March. US industrial production (also a component of the Australian leading index) fell a further 1.5% in the month as well.

Aus Q1 international trade price indexes

Apr 17, Export: Last: 15.9%, WBC f/c: -7.0%, Mkt f/c: nya

Import: Last: 10.8%, WBC f/c: -0.3%, Mkt f/c: nya

• Q4 export prices surged a record 15.9% led by gains in coal and metalliferous ores as lower USD prices were more than offset by valuation effects of the 24%qtr drop in the AUD/ USD. With the AUD MTWI -18.5%, core import prices jumped 19.2% and food prices rose 17.1%, more than offsetting a 25.2% fall in petroleum, lifting the total MPI 10.8%qtr.
• USD commodity prices continued to drop in Q1, with falls in base metals and broader non-rural prices driving a further 9.1% fall in the USD RBA commodity price index. The AUD/USD fell a further 1.1%qtr, providing only a partial valuation offset, so we forecast a 7.0%qtr fall in the XPI. With the import TWI down 0.6%, we expect a 0.3% rise in core import prices. However, petroleum prices fell around 4.6%, enough to tip our total MPI forecast to -0.3%qtr.

NZ Feb retail sales

Apr 14, Last: -1.1%, WBC f/c: -0.6%

• Total retail sales are expected to contract in February relative to January, as a weak auto sector offsets a small rise in ex-auto sales.
• Auto sector indicators are mixed, but overall point to further weakness. Vehicle registrations fell a further 15% in Feb, following a 14% decline in January, suggesting another large decline in auto sales. Meanwhile, fuel prices rose 16% m/m, which is expected to provide a partial offset as the higher price boosts nominal sales (assuming no change in volumes).
• Credit card and electronic transactions data suggest a small lift in ex-auto spending, with both lifting 0.5% in the month. We note though that electronic transactions in core retail sectors were down 0.4%.

NZ Q1 CPI

Apr 17, Last: -0.5%, WBC f/c: 0.3%

• We expect a 0.3% increase in the CPI for Q1, bringing the annual inflation rate down from 3.4% to 3.0%. The largest positive contributions will come from food (up 1.1% for the quarter), electricity, and the annual increases in tobacco excise and education fees.
• Lower fuel prices on average through Q1, and a fall in international airfares beyond the usual seasonal decline, are expected to drive a 0.3% quarterly fall in tradeable prices. Annual non-tradeable inflation is expected to slow from 4.3% to 3.9%, as housing-related inflation starts to ease.
• The economy has been in recession for more than a year now, creating significant slack that will leave annual inflation at the lower end of the 1-3% target band over the next year. This outlook, much more so than the moderation in current inflation, gives the RBNZ licence to cut the OCR further.

NZ Q1 CPI

Apr 17, Last: -0.5%, WBC f/c: 0.3%

• We expect a 0.3% increase in the CPI for Q1, bringing the annual inflation rate down from 3.4% to 3.0%. The largest positive contributions will come from food (up 1.1% for the quarter), electricity, and the annual increases in tobacco excise and education fees.
• Lower fuel prices on average through Q1, and a fall in international airfares beyond the usual seasonal decline, are expected to drive a 0.3% quarterly fall in tradeable prices. Annual non-tradeable inflation is expected to slow from 4.3% to 3.9%, as housing-related inflation starts to ease.
• The economy has been in recession for more than a year now, creating significant slack that will leave annual inflation at the lower end of the 1-3% target band over the next year. This outlook, much more so than the moderation in current inflation, gives the RBNZ licence to cut the OCR further.

US Mar inflation indicators

Apr 14, PPI headline Last: 0.1%, WBC f/c: -0.1%

Apr 15, CPI headline Last: 0.4%, WBC f/c: 0.1%

Apr 15, CPI core %yr Last: 1.8%, WBC f/c: 1.7%

• Headline inflation was sharply negative in the last quarter of 2008 as petrol prices tumbled from $3.80 per gallon to $1.60. Petrol has since risen towards $2.00, dragging monthly inflation into positive territory. However, for March the rise in petrol prices could be rendered a negative after seasonal adjustment, leaving headline CPI barely in positive territory
• Apart from energy we expect small positives across the board, leaving monthly core CPI around its recent 0.15% range. Core CPI was influenced by energy prices over 2008. Base effects will see annual core CPI fall over the next six months.
• PPI, both headline and core, is due a downward correction after an outsized jump in apparel prices in January.

US Apr regional Fed factory surveys

Apr 15, NY Fed index Last: -38.2, WBC f/c: -30.0

Apr 16, Philly Fed index Last: -35.0, WBC f/c: -32.0

• Most regional Fed surveys were a little less negative in March, and the national ISM factory index gained ground for a second consecutive month. In particular, new orders were stronger in most surveys. But the NY Fed survey bucked these trends by falling in March. We expect a rebound in April.
• The Philly Fed survey has been more in line with others from around the country. Realistically, forecasting these surveys of 100 or so regional factory bosses is impossible without agents on the ground. But to be consistent with the notion of a gradual recovery in H2 2009, this survey might be expected to improve a little at some point in Q2, maybe as soon as April.
• That said, renewed weakness in either survey is a risk and could generate an outsized market reaction.

US Mar industrial production to fall again

Apr 15, Last: -1.5%, WBC f/c: -0.8%

• Industrial production has declined sharply every month since November 2008. However, the rate of decline reached its nadir in December and has been moderating since.
• The regional Fed factory surveys and the national ISM all remained in deeply negative territory in March, but mostly suggested a less severe rate of decline relative to February. Aggregate manufacturing hours worked was similar, declining less severely than in February. And February factory orders saw positive growth for the first time in seven months.
• We expect another month of decline for industrial production, but the rate of decline to moderate for the third month running.

US Mar housing starts & permits to consolidate

Apr 16, starts Last: 583k, WBC f/c: 565k

Apr 16, permits Last: 564k, WBC f/c: 575k

• Building permits halved in the second half of 2008, but the pace of decline slowed around New Year. Permits posted a solid 6.2% increase in February, lead by a 16.1% increase in the single-family component. Multiples were down 10.8%. We expect a further small gain in March, led by a rebound in multiples and partially offset by a fall in singles. The US must clear its massive overhang of unused houses by building fewer new ones, but construction cannot stay this low forever.
• Housing starts jumped in Feb, mostly on a massive increase in the volatile multiples component and probably flattered by good weather in the North East. We expect multiples to fall sharply while singles to post another small gain. This combination would see total housing starts down slightly.

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