Saturday, May 2, 2009

Australian & New Zealand Weekly : Limited Fiscal Flexibility Puts Emphasis back onto Monetary Policy

Week beginning 4 May 2009

  • Australia: limited fiscal flexibility, emphasis back onto monetary policy.
  • RBA to pause this month & to downgrade growth forecasts in SMP.
  • Australian data: house prices, dwelling approvals, labour force, retail, international trade.
  • New Zealand data: wages, labour force.
  • ECB, one last cut. BoE focus on quantitative easing.
  • US: Bernanke, payrolls, ISM non-manufacturing.
  • Key economic & financial forecasts.

The Reserve Bank Board meets on May 5 next week. We expect the Board will decide to hold rates steady at this meeting although we do not believe that the easing cycle is over. We retain our long held view that the RBA will be cutting rates in the second half of 2009 to a low of 2%, with downside risks.

The pause in May will purely be in recognition that the Bank assesses that it has limited further scope to cut and that scope will be better used when the employment data in particular starts to deteriorate more rapidly during the second half of 2009.

RBA decisions in 2009 will be about tactics rather than pure economics. If economics alone dominated policy then we would have already seen bigger cuts than the zero (March) and 25bp's (April). Economics would dictate that rates should be cut as far and as quickly as possible to put maximum stimulus into the economy. That has not happened so far this year and we expect that will continue to be the preferred policy approach. Certainly there can be no argument that rates should continue to fall in Australia.

Indeed the pressure on monetary policy is beginning to intensify further as the flexibility of fiscal policy is diminishing. In our detailed Budget Preview, which we will release next week prior to the May 12 Budget, we estimate that the "starting position" of the Budget in 2009/10 will be for a deficit of around $50bn (4.3% of GDP) with a similar "staring point" for 2010/2011 blowing out to $62bn (5.1% of GDP). The "starting position" is defined as the likely budget position if there are no new initiatives in the Budget or if any initiatives are funded by offsetting savings.

We expect that there will of course be a range of new initiatives covering pensioners; unemployment benefits and infrastructure. The net effect of these initiatives could be to add, say, $5bn to the deficit each year after "savings" are achieved through some revenue measures possibly associated with middle class welfare and business subsidies. That would see the deficit expand to 4.7% of GDP in 2009/10 and 5.5% of GDP in 2010/2011.

Already the fiscal stimulus in this recession is much larger than we have seen in previous recessions. In the 1983 recession the deficit peaked at 3.3% of GDP in 1983/84 and in the 1991 recession the deficit peaked at 4.1% of GDP. The fiscal stimulus over the 1980's recession period peaked at 3.5% of GDP; 5.6% of GDP in the 1990's recession and already looks like 7.2% of GDP assuming "only" $5bn of net new initiatives in 2009/10 and zero net impact of new initiatives on Budget night in May 2010. As the May 2010 budget is a potential "election budget" this assumption seems to be rather conservative.

Certainly the starting point in terms of net debt is much more favourable for the Federal authorities than in those earlier recessions. In June 2008 the federal authorities had negative net debt of $42.9bn (-3.8% of GDP) compared to net debt of 3.4%% of GDP in June 1982 and net debt of 4.1% of GDP in June 1990. However, the situation for the federal authorities has become more complicated due to the global financial crisis. Whilst not direct Commonwealth government securities the Commonwealth government has acquired a range of contingent liabilities through its guarantees for banks' wholesale bond issues and the likely guarantees associated with the semi government authorities. A Commonwealth guarantee is now attached to $89bn (7.6% of GDP) of bank securities with up to a further $20bn to be issued in 2009. It is probable that the semi government authorities will accept the Commonwealth authorities' offer of guarantees for $111bn of outstanding securities and potentially $50bn of new issuance over 2009/10 (another 14% of GDP).

If we accumulate a further, say, $100bn of new bank issuance in 2010 (possibly less as banks' balance sheets grow much more slowly in 2010) with the stated semi government program and the likely combined Commonwealth deficits over 2008/9 to 2010/2011 of around $160bn (or 14% of GDP) we start to see a picture where the Commonwealth liabilities and contingent liabilities grow from a net debt position of negative 3.8% of GDP to 14% (Commonwealth) plus 18% (banks) plus 14% (semis) totalling 46% of GDP.

Now this number still compares well with the 2008 starting points of the majors - Europe (42%), UK (41%), US (40%) and Japan (87%). Further these starting points have also blown out substantially as the majors deal with their own fiscal stimuluses - IMF estimates that the budget deficits of the major economies will increase from 2% of GDP in 2007 to10.5% of GDP in 2010. These countries are also providing guarantees for their banks although Australia's banks have been relatively larger users of the guarantee facility than other countries due to the much greater reliance which Australia has put on its banking system to fund its foreign liabilities.

The purpose of this analysis is to highlight how quickly Australia's staggeringly strong Commonwealth fiscal position has deteriorated as a result of the global financial crisis. The likely result of this is that the Federal authorities will assess that they have limited flexibility to continue with aggressive discretionary fiscal stimulus particularly in such hostile global capital markets.

Less flexibility on discretionary fiscal policy highlights the need for monetary policy to do more. In fact we emphasise that our 2% target has downside risks. It is unlikely that the banks will be able to pass much on to retail borrowers (given the need to offer reasonable deposit rates to savers) if the RBA decided to push rates below 2%. However lower bill rates would certainly assist corporates and overall bank funding costs.

Australia: Data Wrap

Mar private credit

  • Credit to the private sector was little changed in March, inching 0.1% higher after a flat result in February.
  • A contraction in business credit is the source of weakness, with a 0.6% fall in March after a 0.5% decline in February. The outlook is for further declines in this segment as firms cut back on investment.
  • Housing credit growth is improving, albeit gradually, as owneroccupier demand for housing finance recovers. Housing credit increased by 0.65% in the month.
  • Going forward, while the RBA's recent sharp cuts to interest rates are a positive, we expect credit growth to be constrained by the weak economic environment - in particular, by business cutting back on spending and credit.

Round-up of local data released last week

Date Release Previous Latest Mkt f/c
Thu 30 Mar private credit flat 0.1% 0.3%
Fri 1 Q1 NAB business survey - - -
Apr AiG PMI 33.2 30.1 -

New Zealand: Week ahead & Data Wrap

Signal processing

The RBNZ delivered the 50 basis point rate cut that we expected this week, and gave a surprisingly clear signal about the path for interest rates in the foreseeable future.

The main motivation for a large cut was the deterioration in the outlook for the global economy since the March Monetary Policy Statement. Despite talk of 'green shoots' in some regions (which mostly consist of activity falling at a slower pace), hopes for a near-term recovery are rapidly fading. The latest Consensus growth forecasts for New Zealand's major trading partners were revised down to -2.2% for this year and +2.0% for next year; plugging in the recent forecasts by the IMF, whose relative gloominess on the Asia- Pacific region seems to be more in line with the RBNZ's thinking, gives a 2.8% fall this year and a miserly 0.8% rebound next year.

The RBNZ also stated that financial conditions were tighter than was warranted, repeating the warning they gave in an unscheduled statement in early April. Long-term interest rates rose sharply in March, as borrowers read the MPS as a signal that rates had bottomed, and rushed to lock in long-term fixed rates. RBNZ data released on Thursday showed that as much as $9bn of mortgages were switched into fixed terms of longer than a year in March - that's about 7% of all home loans outstanding. No wonder the wholesale funding market clogged up at the time.

We had noted before that the RBNZ's signals on the outlook for rates would be at least as important as the OCR decision itself. This week's statement provided an interesting twist: “we expect to keep the OCR at or below the current level through until the latter part of 2010”. It's unusual for a central bank to commit to keeping interest rates unchanged for a specific period, but in this case they're not alone. The central banks of Canada and Sweden have gone down this avenue in recent weeks, having already reduced their policy rates to near-zero, and one ECB official has discussed taking this approach.

Arguably, it isn't as much of a departure for the RBNZ as for other central banks, as they already publish a projected path for 90-day rates in the MPS each quarter. The March projection suggested no tightening until mid-2010, and there's no doubt that the worsening global outlook since then would justify pushing the timing of hikes further out. So in a way, this week's statement simply put into words what they would normally express in chart form.

But naming a specific date helps to make the RBNZ's signal crystalclear: rates are not going up for a long time. The benefits of this are twofold: it keeps a lid on longer-term interest rates; and it gives borrowers more confidence to remain on floating or short-term fixed rates, where they will receive more of the benefit of recent (and any future) OCR cuts.

The risk in this approach - of which the RBNZ will be well aware - is that they could end up making a rod for their own backs, if they find themselves having to change that date. Projections for monetary policy are always highly conditional on events, and in this extremely uncertain environment it's tough to make a firm commitment one way or another. The RBNZ may need to keep interest rates low for even longer if the economy remains mired in recession; or they could find themselves hiking much earlier if inflation comes roaring back faster than expected.

Nevertheless, the RBNZ has obviously decided that the benefits outweigh the risks this time. We'd certainly regard it as a major improvement over the March MPS, where they signalled that rates would remain low for an extended period, then garbled the message by focusing on why they felt that rates couldn't go much lower.

We expect some further easing this year, consistent with the RBNZ's statement that “the OCR could still move modestly lower over the coming quarters”. However, with the RBNZ already anticipating a lot of bad news to come on the world economy, the hurdle for large cuts is getting higher. We are sticking with our pick of 25bp cuts at each of the June and July reviews, taking the OCR to a low of 2%.

There were mixed messages from this week's economic data. New Zealand recorded a solid $324m trade surplus in March that benefited from sagging import demand, and building consents remained mired near record lows. However, business confidence rose sharply in April, albeit from near-record lows. The details were still weak enough to suggest another negative read for GDP in Q2, but we will be watching how this survey develops.

Next week the focus is on the labour market in Q1. Wage growth is expected to slow, reflecting the easing in labour demand and reduced inflation expectations. We expect employment to fall by 1.2%, though much of this is payback for the surprise 0.9% gain in Q4 last year. Recent labour indicators suggest the risks are to the downside: the latest Quarterly Survey of Business Opinion showed that a net 35% of firms intend to shed staff over the next three months, and the Westpac-McDermott Miller employment confidence index fell significantly. Our forecast for employment, along with an expected dip in the participation rate, implies to a hefty rise in the unemployment rate from 4.7% to 5.3%. We expect unemployment to peak at 7.7% by mid-2010.

Round-up of local data released last week

Date Release Previous Latest
Wed 29 Apr Mar merchandise trade NZDmn 487 324
Apr NBNZ business confidence -39.3% -14.5%
Thu 30 Apr RBNZ OCR review 3.00% 2.50%
Mar building consents s.a. 11.7% -4.6%

Data Previews

Aus Q1 house price index

May 4, Last: -0.8%, WBC f/c: flat

Mkt f/c: flat, Range: -0.5% to 1.0%

  • House prices edged another 0.8% lower in Q4 with Q3's decline revised down from -1.8% to -2.4% and through the year price growth dropping to -3.3%yr, the first negative since 1996 and the biggest annual fall on records back to 1987-88. Despite this and the risk of further downward revisions, the Q4 result did contain some hints of improvement with the pace of decline moderating across all major capital cities.
  • Private sector measures show house prices continued to firm in Q1, with some pointing to slight monthly gains in Feb/March. The RBA's aggressive interest rate cuts and the Govt's boost to the first home buyers' grant would have given more substantial support to prices in early 2009 with a strong rise in auction clearance rates also suggesting firmer prices. Overall we expect a flat result, with previous declines dragging annual growth down to -4%yr. Risks around this are evenly balanced.

Aus Mar dwelling approvals

May 5, Last: 7.8%, WBC f/c: 3.0%

Mkt f/c: 2.3%, Range: -2.0% to 7.0%

  • The long awaited up-tick in dwelling approvals finally materialised in Feb with a solid 7.8% rise. That said, it wasn't quite in the expected form with the bounce concentrated in apartments and private houses still essentially flat. The previous six months had seen apartments lead a 27% slide in monthly dwelling approvals as the credit crunch hit this segment hard. Houses were expected to lead any upturn.
  • March should show a more convincing improvement. Housing finance approvals for the construction & purchase of new dwellings have continued to surge (now up 23% from their Aug low with industry figs pointing to another strong rise in March). New home sales are also posting solid gains (up 22% in Q1). First home buyers are driving the up-tick to date. While the upturn in other segments has been more restrained, we expect to see a solid 3% follow-on rise in approvals in March.

Aus RBA policy announcement

May 5, Last: 3.00%, WBC f/c: 3.00%

May 8, Statement on Monetary Policy

  • The RBA will be in focus this week, first on Tuesday and then again on Friday, with the Statement on Monetary Policy.
  • With the cash rate at 3.0%, down from a high of 7.25%, the majority of the easing cycle has occurred. Interest rates, particularly variable mortgage rates, are now at very low levels.
  • The timing of additional monetary policy easing is, in part, a tactical decision. We anticipate that the Bank will pause in May, as they did in March. We see 2.0% as the low point.
  • The Statement on Monetary Policy will see the Bank lower their economic growth forecasts to reflect the reality of the current economic recession. The Bank was expecting no growth in the non-farm economy in the year to June 2009.

Aus Mar retail sales

May 6, Last: -2.0% (sa, trend series suspended), WBC f/c: -0.5%

Mkt f/c: 0.5%, Range: -1.5% to 2.0%

  • Retail sales fell 2.0% in Feb as the boost from the Govt's $8.4bn fiscal bonus payments in Dec started to wind down. Despite the drop, Feb retail sales were still 2.3% higher than the Nov level that preceded the fiscal package, and 4.1% higher than Feb 2007.
  • Policy influences will continue to complicate the picture in March. The first of the second round of fiscal payments ($12.2bn) started to flow to consumers early in the month. However, this stimulus is more of a drip-feed than Dec's one- off hit, with payments spread out over the five months to July. As such there is likely to be a less dramatic impact on sales. Indeed, we expect the unwind from the December's boost to dominate in March with monthly sales forecast to dip a further 0.5%. However, the risks around this are large, especially when survey volatility and redesign issues are thrown into the mix.

Aus Q1 real retail sales

May 6, Last: 0.8%, WBC f/c: 0.2%

Mkt f/c: 0.8%, Range: 0.2% to 2.4%

  • Real retail sales rose 0.8% in Q4 after basically flat spending volumes over the previous three quarters.
  • The timing of the fiscal boost means the impact on spending is spread fairly evenly over Q4 and Q1. Monthly retail sales spiked 3.8% in Dec, rose a further 0.5% in Jan then fell back 2% in Feb and by a further 0.5% (expected) in March. All up, nominal sales are forecast to be up 1.2% for Q1 as a whole, building on the strong 1.8% nominal gain in Q4. However, CPI data points to another solid 1% rise in retail prices in Q1 as per Q4, implying just a 0.2%qtr gain in Q1 real retail sales.
  • Overall, the data continues to point to an insipid response to the massive policy injection from rate cuts and fiscal payments - real disposable incomes surged an extraordinary 9.2%yr in 2008 but real retail sales have barely risen 1%yr.

Aus Mar international trade balance, AUDbn

May 6, Last: +$2.1bn, WBC f/c: +$1.7bn

Mkt f/c: $1.85bn, Range: $0.25bn to $3.0bn

  • The trade surplus surged $1.2bn in Feb to $2.1bn. A narrowly based export rebound (led by re-exports of non-monetary gold) of 4.4% failed to prevent their downtrend steepening (-1.7%mth for total exports with non-rural trend -2.7%mth). Indeed, ex-non-monetary gold, non-rural exports trend growth slumped to a record low of -3.8%mth. Imports fell 0.6% (third consecutive fall) taking trend growth to -2.4%mth (weakest since 1975), led by weak consumer goods.
  • Anecdotes suggest some recovery in China demand supporting some rebound in non-rural export volumes. But with weaker prices, a large seasonal adjustment drag and fall back in gold, we expect non-rural exports to drop 7%. With stronger rural export volumes, total exports should fall 4.6%. Merchandise import data implies a partially offsetting 4% fall in goods, with total imports -3.2%, narrowing the surplus to $1.7bn.

Aus Apr employment

May 7, Last: -34.7k, WBC f/c: -18k

Mkt f/c: -25k, Range: -50k to -10k

  • After several months of resilience, jobs capitulated in March to the persistent weakness in leading indicators of labour demand, with a 34.7k fall. This saw the deterioration in the underlying trends gather pace. Total employment trend growth fell to 0.42%yr (lowest since Jul-93) and with revisions, the monthly trend (-5k) has been in decline for four months.
  • We expect last month's acceleration in the labour market deterioration to continue in April, but with seasonally adjusted data volatile month to month, we look for a lesser jobs fall this time. Our composite of business survey employment indexes has provided an accurate short term lead in recent months, and points to a fall in 3m MA jobs growth to around -17k from the current -11k pace, implying an April result of -18k. This would take monthly trend growth to -10.7k and slow annual trend growth to +0.08%yr (weakest since May-93).

Aus Apr unemployment rate

May 7, Last: 5.7%, WBC f/c: 5.8%

Mkt f/c: 5.9%, Range: 5.7% to 6.1%

  • In contrast to past recessions (when months of jobs weakness have been accompanied by falls in the participation rate), recent months have seen the participation rate remain high, a likely function of increased participation from those who would usually be considering retirement but for the plunge in superannuation wealth. This has seen the unemployment rate spike 1.2ppts in three months to 5.7%.
  • The ASX200 recovered 10% through March, which may see a more typical participation reaction in April. Still, we look for a relatively small pullback to 65.4% from 65.5%. This would see a relative consolidation in the unemployment rate this time, rising to 5.8%. However, given the recent behaviour of participation (and our unrounded forecast is 5.84%), risks must lie to the upside.

NZ Q1 wage growth

May 4, QES pvt ord time - Last: 0.8%, WBC f/c: 0.7%

May 6, LCI pvt ord time - Last: 0.7%, WBC f/c: 0.5%

  • Wage growth has been strong in the past year, but we expect it to slow in earnest through 2009 in line with easing labour demand and reduced inflation expectations.
  • The most important wage data is the LCI private sector all salary and wage rates (this is the series the RBNZ watch). Last quarter this series registered an increase of 0.7%, to be up 3.2% on a year ago. We expect growth of 0.6% this quarter, bringing the annual rate to a 2-year low of 3.1%.
  • The QES is the more volatile series, as it is impacted by compositional shifts in the workforce. As such, it is hard to read much into a single quarterly outturn. The better indicators to watch in the QES are filled jobs and hours paid. We expect to see substantial negatives on both.

NZ Q1 employment and unemployment

May 7, Employment - Last: 0.9%, WBC f/c: -1.2%

Unemployment - Last: 4.7%, WBC f/c: 5.3%

  • Employment indicators have been horrendous in the past couple of quarters, but we have yet to see that in the official labour statistics. We expect the 2009Q1 HLFS data to correct that.
  • After a 0.9% increase in employment in 2008Q4, our forecast is for a 1.2% decline in Q1.
  • Assuming participation also unwinds from the record high 69.2% reached in 2008Q4, we expect the unemployment rate to hit 5.3%, from 4.7% currently.
  • V olatility in the employment and participation data means the unemployment rate is the best gauge of the state of the labour market. Our fear is that the outcome is worse than 5.3%.

Bank of England and European Central Bank

May 7, BoE Last: 0.5%, WBC f/c: 0.5%

May 7, ECB Last: 1.25%, WBC f/c: 1.0%

  • The BoE policy committee unanimously voted to maintain the 0.50% bank rate in April, and to continue with its £75bn program of asset purchases (quantitative easing). Since then, GDP growth was reported as down almost 2% in Q1, and the Chancellor's budget will require substantial bond issuance to fund a deficit of £175bn this fiscal year. The growth outlook will keep rates on hold and the upward pressure on yields from supply will keep the QE program rolling along.
  • The ECB cut rates 25bp at the April meeting and ECB chief Trichet didn't exclude a further move. With Germany slashing its own GDP forecast from -2.25% to -6% this year, the growth/inflation outlook favours further immediate easing. Also, Trichet committed to provide more detail on "non- standard measures", its version of quantitative easing, in May.

US non-farm payrolls to fall by 650k

May 8 , Last: -663k, WBC f/c: -650k

  • After shedding 1.8mn payroll jobs in the first year or so of the recession, since Nov last year a further 3.3mn jobs were lost, for an average monthly decline of 666k. With the economy contracting at faster than a 6% annualised pace in both Q4 and Q1, that pace of jobs decline looks like being maintained.
  • Initial unemployment insurance claims, layoff announcements, consumer job market expectations, and employment indicators from the regional Fed indices all indicate that job losses have continued at that pace. We are forecasting a 650k drop in April and expect upward revisions to the size of Feb-Mar's job losses.
  • If that pace of employment decline is reflected in the separate household survey, then assuming an upward correction in the labour force size (it fell in March) then the jobless rate should jump from 8.5% to 8.8% in April.

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