Sunday, June 28, 2009

Australian & New Zealand Weekly : We Have Revised Our RBA View - Low Point Now 2.5%

Week beginning 29 June 2009

  • Australia: We have revised our RBA view - low point now 2.5%.
  • Australian data: May private credit, retail sales, building approvals and trade balance previewed.
  • NZ data: merchandise trade, building consents, business and employment confidence previewed.
  • US employment report: larger payrolls fall expected in June.
  • Other US data: house prices, Chicago PMI, consumer confidence and manufacturing ISM.
  • ECB to leave repo rate unchanged while assessing impact of QE.
  • Key economic & financial forecasts.
We have revised our forecast for the employment profile and accordingly slightly adjusted our interest rate view. While we still expect that the RBA will keep rates on hold through 2010 we no longer expect that 2% will be the low point in the cycle for the cash rate. We have raised that low point to 2.5%, now expecting the RBA to limit its rate cuts to 2 x 25 bp's cuts over the course of the remainder of 2009. These cuts are likely to be spaced with 2/3 month gaps.

Reasons for these changes are:

1. We now expect that the point beyond which the unemployment rate will stop rising quickly will be much earlier in 2010 than previously expected. That is because our lead indicators of employment growth have bottomed out 3-6 months earlier than originally expected (detailed research report to follow). Previously, we expected that the unemployment rate could be rising by around 1ppt in the first half of 2010 whereas we now expect that the increase will be limited to around 0.5% with minimal increase in the second half of 2010. We have lowered the expected peak in the unemployment rate to 8.1% compared to 8.6% previously.

The period of sharpest increase in the unemployment rate (around 2ppt's) will be concentrated in the second half of 2009 and it will be at that time that we expect the Bank will recognise the need to restore some confidence with some further monetary easing. If it decides not to move around that time then it is likely that we will have seen the end of the cycle.

We expect that pressure on the Bank to cut more extensively in the earlier months of 2009 was resisted since the Bank planned to retain some flexibility to be seen to be acting when the unemployment rate is rising quickly. That period is likely to be centred around the second half of 2009.

With unemployment not increasing as rapidly through 2010 as previously expected, the risk of an earlier than previously expected beginning to the rate hike cycle has increased but on balance we expect that other factors including continuing weak global economic conditions and sluggish domestic spending (growth rate in 2010 expected to be 1%) will contain the need to raise rates. While not increasing the unemployment rate will be hovering around 8%; business investment will still be contracting and the output gap will therefore remain wide allowing plenty of scope for an acceleration in growth in 2011 to be required just to close the output gap let alone pressure inflation.

We would only see the unemployment rate remaining around that 8% level in the first half of 2011.

2. We had expected that, given the muted response by the banks to the RBA's 0.25% rate cut in April, (only passed on 10 bp's to variable mortgage rates) the RBA may have decided that traction could only be achieved by a larger rate cut. We had pencilled in a 50 bp cut around September. However, the strong response of finance approvals to the rate cuts (up 30%) and some precautionary comments from the Governor in a recent speech warning against excesses in the First Home Buyer segment (an extraordinary 70% of the growth in finance approvals) makes it likely that the urgency to further stimulate the housing markets has passed for now.

The concern is that whereas the overall response of approvals to the rate cuts has been stronger than in previous rate cut cycles (hardly surprising given the extent of the cuts) the larger more stable components - upgraders and investors - have lagged in this cycle. It has been largely driven, at this stage, by FHB's who are likely to be dropping off as prices in their price brackets rise and the increased Grant is phased out from September.

Our recent survey showed that those respondents in higher age brackets and higher incomes remain deeply concerned about the outlook for house prices which may constrain their preparedness to participate in the housing recovery.

Not so for business. The RBA should be worried about the expected sharp contraction in business investment as the credit crisis and excess capacity weigh on investment plans.

In a recent report, the RBA points out that small business borrowing rates have been reduced by 230bp's compared to 385bp's for standard variable mortgage rates. Further, given that the markets have not priced in future rate cuts, any rate cut from the RBA would be largely priced into the bank bill rate. That would immediately help variable rate business borrowers and lower the funding costs of banks where wholesale funding costs and some retail deposit rates are directly linked to the bank bill rate or the cash rate.

3. We expect that the pace of consumer spending will slow to a trickle in the second half of 2009. The fading of the fiscal stimulus package; a contraction in labour incomes as unemployment rises and hours worked contracts; and reduction in consumer confidence (as the unemployment rate rises) will all weigh heavily on consumer spending. Concerns with the tractability of the recovery which to date has been supported by the fiscal stimulus and record rate cuts may also result in further rate cuts.

New Zealand: Week ahead & Data Wrap

Through the worst

New Zealand remained deep in the grips of recession in the first quarter of this year. However, more recent indicators suggest that the economy may be entering a bottoming-out phase.

GDP fell by 1% in the March quarter, following the same-sized contraction in the December 2008 quarter (revised down from -0.9%). That makes it five straight quarters of decline in the current recession, something that hasn't been observed since the official statistics began in 1977. The fall was close to our expectation of -0.9% and in line with the RBNZ's most recent forecast.

The tough economic conditions internationally in late 2008 spooked domestic consumers and businesses. Consumers cut spending by 1.4%, with spending on durable items taking the biggest hit. This was despite a recent income tax cut and anticipation of another in April, lower petrol prices, and a succession of interest rate cuts. House price declines, job insecurity and the international fear factor outweighed the positives. The decline in consumer spending in Q1 was the largest drop since 1991. Businesses felt no better, and slashed investment by 7.3% over the quarter.

Manufacturers, especially makers of durable goods, were slammed by the lack of demand. We estimate that the 7.2% drop in output was the biggest quarterly fall since 1977. While New Zealand manufacturers have fared better than in some regions (Germany and Japan spring to mind), few will have escaped the fallout of the global credit crunch, as purchases of durable goods are delayed or cancelled.

Retailers, wholesalers and transport providers also felt the ill-wind of weaker demand. In fact, retailers posted their worst quarter since September 1989, when the rate of GST was increased. Retail and wholesale trade both posted their fifth consecutive quarterly declines.

On a more positive note, the real estate and business sectors provided the strongest contribution to growth, partly due to a pickup in house sales. Government spending also supported growth both directly and indirectly through more infrastructure spending, helping the construction sector post a modest rise in the quarter. And oil flowing from the new Maari field boosted mining output.

At face value, the net export position added a whopping 4% to GDP. However, this was made up of a modest increase in exports and extremely weak imports, both of which detracted from other areas: exports were boosted by a rundown of stocks of dairy products, while weaker imports were the product of the sharp fall in consumption and capital investment. Import volumes have fallen by around 20% in the last three quarters - again, a run of declines not seen before in the official statistics.

Weakness in demand also drove the improvement in the current account deficit, which narrowed from 9.0% to 8.5% of GDP in Q1. As well as the import-driven shift in the goods balance, income from services exports was stronger than expected, reflected higher average spending by overseas visitors.

The narrowing in the current account deficit was less than we expected, due to persistent strength in investment income outflows. The quarterly figures suggest an increase in profits for overseasowned firms in New Zealand, and a sharp rise in interest payments on debt instruments held offshore. Quite frankly we find both of these implausible in the current environment. Company profits have demonstrably fallen in recent times, and notwithstanding the higher premium paid for borrowing offshore, the absolute level of interest rates fell as the RBNZ continued to slash the cash rate. However, we'll grant that these series are very difficult to measure from quarter to the next (they're no piece of cake to forecast either), and we remain of the view that they will trend lower over this year.

We expect the annual deficit to narrow significantly over the rest of the year, partly due to the oil price spike in the first half of 2008 dropping out of the equation, and partly due to ongoing weakness in import demand. Beyond this, though, the hope for a sustained decline in the deficit will depend on how households and businesses respond as the economy recovers. Little has changed in terms of the incentives that drove borrowing and spending prior to the credit crunch, so it may come down to whether New Zealanders have been sufficiently chastened by this recession to change their ways voluntarily. The RBNZ is giving the benefit of the doubt so far, but they are sufficiently worried about a return to lopsided growth to highlight it as a risk in the March Monetary Policy Statement.

Recent data indicates that June quarter GDP will be less weak than in the previous two quarters, although we're not forecasting a return to growth just yet. The Westpac-McDermott Miller consumer confidence survey rose from 96 to 106 in Q2, the highest reading since December 2007 but still below the long-run average. We suspect that consumers are responding more to what hasn't happened in recent months: back in March, fears of global depression, loss of access to credit, and widespread job losses were rampant. Today, the economy still faces significant challenges, but the fear of something much worse has diminished.

Finally, net migration continued to surge in May, reaching an annual inflow of 11,200. While the make-up of net flows differs from the 2003-03 migration boom - so far it's entirely driven by more New Zealanders staying home or, more recently, coming back from overseas - it is still a major positive for the labour force, consumer spending, housing - and interest rates.

Round-up of local data released last week

Date Release Previous Latest
Mon 22 Jun May external migration ann. 9,200 11,200
May credit card transactions 2.4% -0.4%
Wed 24 Jun Q2 consumer confidence 96.0 106.0
Thu 25 Jun Q1 current account deficit NZDm s.a. -3,724 -2,682
Fri 26 Jun Q1 GDP %qtr -1.0% -1.0%

Data Previews

Aus May private credit

Jun 30, Last: 0.1%, WBC f/c: 0.1%

Mkt f/c: 0.2%, Range: 0.0% to 0.5%

  • Private credit rose by just 0.1% in each of the last three months. A similar outcome is likely in May. That would lower annual growth to 4%, down from 16% at the start of 2008.
  • The positive is that housing credit growth is strengthening, as new lending (housing finance) rebounds in response to a 41 year low in variable mortgage rates and the enhanced First Home Buyer scheme. Housing credit growth is now running at around an 8% annualised pace, after briefly dipping to less than 6½% annualised last August.
  • However, business credit (representing a little less than 40% of total credit) is contracting, declining by 1.6% over the last three months. The downturn has some way to run with firms reducing expenditure in response to the recession.

Aus May retail trade

Jul 1, Last: 0.3% (sa, trend series suspended), WBC f/c: 0.5%

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

  • Retail sales rose 0.3% in April after a 2.2% rise in March. Sales are up 6.8%yr and are 4.8% higher than their November level last year (i.e. prior to fiscal stimulus payments).
  • Uncertainty over the impact of the Govt's second round of fiscal payments and the flow through to spending continues to make forecasting extremely difficult. Govt spending figures show the bulk of the payments were disbursed by April, implying a sharp wind-down through May-June. However, we suspect the payments made in March-April would have continued to support retail sales in May - a view corroborated by anecdotal reports of strong sales. A steady rally in consumer sentiment would also have helped.
  • Overall we expect a 0.5% rise in sales but the risks around this clearly remain large, with a big wind-down looming from June

Aus May dwelling approvals

Jul 1, Last: 5.1%, WBC f/c: 2.0%

Mkt f/c: 3.3%, Range: -2.5% to 7.0%

  • Dwelling approvals rose strongly by 5.1% in April with significant upward revisions to previous months. The gain brings approvals more in line with the strong increases signalled by other indicators.
  • However, there is still a way to go. Housing finance approvals for the construction & purchase of newly built dwellings for example are up well over 40% from their mid-2008 lows. Dwelling approvals by comparison are up just 21%. There is unlikely to be a one-for-one mapping between the two, but something a little closer is to be expected.
  • We are forecasting a solid 2% rise in approvals for May. However, there has been a tendency over the last six months for gains in approvals to appear in revised figures rather than original estimates (due to late survey returns).

Aus May international trade balance, AUDbn

Jul 2, Last: -$0.09bn, WBC f/c: -$0.7bn

Mkt f/c: -$0.125bn, Range: -$1.0bn to +$1.0bn

  • The trade balance returned to deficit in April for the first time since July 2008, falling from a $2.302bn surplus to a $0.091bn deficit. Exports saw a price-led 11.3% collapse, with the ABS incorporating a 20% estimate for the iron ore price fall from March to April. The hit to bulk export prices has driven total exports into a downtrend at -2.5%mth, with the non-rural trend at -3.8%mth, despite recent gains in volumes. Imports fell 1.7% (5th straight fall) as a 7.3% higher AUD hit prices, leaving them in a downtrend (-2.0%mth led by capital goods).
  • While better China demand argues for higher non-rural volumes, further significant price weakness (RBA NR index fell 10.7%) and a large SAdj drag gives a 10% non-rural export fall, and -6.6% for total exports. Merchandise import data implies a partially offsetting 4.7% price-led fall in goods, with total imports -3.8%, widening the deficit to $700mn.

NZ May merchandise trade NZDm

Jun 29, Last: 276, WBC f/c: 490

  • The trade balance has moved well into surplus territory over recent months. Imports have crashed as consumers spend less, especially on big-ticket imports like cars, and as firms invest less. Meanwhile, export receipts have held up as commodity prices have stabilised at around trend levels.
  • May is typically the strongest month for trade surpluses, as exports peak but imports are at their lowest. Our forecast reflects both the trend toward strong trade surpluses and the normal seasonal pattern.
  • Car imports have recovered, but remain very weak compared to a year ago, so the import bill will still be low. On the export side, another new oil field coming online, combined with improved commodity prices, should lead to a strong month.

NZ May building consents s.a.

Jun 29, Last: 11.2%, WBC f/c: 3.0%

  • Dwelling consents rose strongly in April, but this followed a prolonged period of weakness. And with just over 1,100 consents being issued per month, the number of new homes being built is below that required to keep pace with population growth, especially with net migration surging in recent months.
  • Combined with historically low mortgage rates and the marked increase in home sales in recent months, there is a clear signal new home construction needs to pick up the pace. As such, another lift in consents is expected in May.
  • The trend in non-residential consents continued lower in April, producing the seventh consecutive decline. While recent business confidence surveys have painted a horrendous picture for the non-residential market, the latest NBNZ business survey recorded a strong rise in confidence in commercial construction, although it remains net negative.

NZ Jun NBNZ business confidence

Jun 30, Last: 1.9%

  • Headline confidence rose sharply again in May, reaching positive territory for only the second time in the last seven years. However, while most of the details of the survey improved, they remained weaker than in previous recessions.
  • Some recent negative factors could see confidence ease back slightly this month. House sales eased in May in seasonally adjusted terms as long-term mortgage rates continued to rise, and Fonterra's first estimate of the payout for the 2009/10 season was at the low end of expectations at $4.55/kg. On the other hand, the 1 April tax cuts and surging net migration have provided some support to consumer spending.
  • The survey results in April and May were broadly consistent with a 0.5% decline in Q2 GDP, compared to the RBNZ's most recent forecast of -0.3%. We are likely to revise up our current forecast of -1.0%.

NZ Q2 employment confidence index

Jul 1, Last: 93.2

  • Employment confidence took a hammering in Q1, as concerns around current employment conditions reached fever pitch, and expectations of future conditions worsened.
  • Since March, the news on the employment front hasn't worsened but neither has it improved. Business surveys suggest layoffs will continue to rise, and evidence suggests that wage growth is slowing fast.
  • That said, employment confidence has already collapsed in the past six months. Moreover, the recent lift in consumer confidence suggests a stabilisation in views around the labour market may have occurred.

US Jun ISM factory index

Jul 1, Last: 42.8, WBC f/c: 44.5

  • Over the past few months, all the US business surveys have shown varying degrees of improvement, as fears of economic Armageddon around the turn of the year have been replaced by concerns about a more 'normal' recession. The ISM factory index bottomed at 32.9 in Dec but steadily recovered to 42.8 in May (still consistent with significant industrial contraction).
  • The regional surveys available so far for June have mostly continued this trend: Philly Fed was less negative and Richmond Fed indicated industrial expansion for the second month running. The exception was a modest pull-back in the NY Fed after May's steep jump. These signals, and back to back durable orders growth in April-May, point to a further rise in the national ISM factory index for Jun, though we expect it to remain in negative (sub 50) territory for some time yet.

European Central Bank rate decision

Jul 2, ECB Last: 1.0%, WBC f/c: 1.0%

  • Unlike in the US and the UK, European economic data do not yet make a convincing case that the pace of economic contraction has moderated substantially from the 1.8% & 2.5% slumps recorded in Q4 and Q1 respectively. While some business surveys show less pessimistic growth expectations, most measures of current activity remain around historic lows.
  • The ECB has not ruled out further cuts in its repo rate, but recent policy action has been on different fronts. It is about to embark on its €60bn covered bond purchase program, and its so-called "stealth easing" on June 24 represented its biggest ever single day market operation where €442bn of 1 year funding was provided to all bidders at the official repo rate of 1.0%. We suspect the ECB will wait to assess the impact of these measures before contemplating a further repo rate cut.

US June non-farm payrolls to fall by 400k

Jul 2, Payrolls Last: -345k, WBC f/c: -400k

Jul 2, Unemployment Last: 9.4%, WBC f/c: 9.6%

  • The monthly payrolls decline reached 741k in January, but losses have moderated since then, and in May the decline was 345k.
  • However that outcome looked a little out of line with other labour market indicators, which have shown some improvement since the start of this year, but perhaps not as much as the payrolls report found. Initial jobless claims peaked at 674k in late March but by late June were still holding well above 600k. Business surveys were reporting a rapid pace of job shedding late in Q2, consistent with ~400k payrolls losses. The ADP payrolls estimate found 532k private sector job losses in May compared to 338k in BLS report.
  • For these reasons we expect June payrolls to fall by a somewhat larger 400k, with a further rise in the jobless rate to 9.6%.

Westpac Institutional Bank


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