Monday, October 26, 2009

Australian & New Zealand Weekly : Core CPI Trend May Unnerve RBA

Week beginning 26 October 2009

  • Core CPI trend may unnerve RBA.
  • Australian data: Q3 PPI & Q3 CPI, private credit.
  • New Zealand: RBNZ OCR review, trade, building consents, business survey.
  • BoJ meeting.
  • US data: Q3 GDP, durable goods, regional surveys.
  • Key economic & financial forecasts.
Next week we will see prints of the September quarter CPI. The Reserve Bank has recently indicated considerable nervousness about its inflation forecasts. The most recent RBA forecasts which were released on August 7 had underlying inflation slowing from 4.3% in 2008 to 3.25% in 2009 and 2% in 2010.

The October Board Minutes clearly indicate that the Bank is now likely to revise up its inflation forecasts: "while current forecasts suggested it (inflation) would fall in the coming year the expected trough in inflation was significantly higher than earlier thought" and "by 2011 inflation could be rising again."

A concern for the Bank is that underlying inflation built up much more rapidly through 2008 than in any period since the 1990/91 recession. This was at a time when the economy was operating near or at full-capacity, as evident from the unemployment rate which declined to just 4.0%, the lowest since 1974. Housing stock shortages were a compounding factor, with rents increasing strongly.

In the aftermath of the 1990/91 recession underlying inflation slowed from 6.1% in 1990 to 1.9% in 1992. Over the subsequent 15 years to September 2007 the highest print for annual underlying inflation was 3.3%. That was in December 2001, although even that read was indirectly affected by the introduction of the GST. By comparison, core inflation hit 4.3% in 2008 - clearly indicating that underlying inflation had stepped up to a higher peak in this cycle.

Turning to the September quarter 2009, our forecast for underlying inflation is 0.9%. That follows 1.2% (September quarter 2008); 0.7% (December quarter 2008); 1.1% (March quarter 2009); and 0.8% (June quarter 2009).

Disconcertingly, our forecast indicates an increase in the quarterly measure. This is at a time when the lagged effect of the slowdown in spending through 2008 (domestic demand growth slowed from 6% in 2007 to 3.5% in 2008) and 2009 (we estimate that domestic demand growth will slow further to -0.4% in 2009) should be indicating a fall in the quarterly measure as a clear beginning of a downward cycle in underlying inflation.

If the underlying CPI number does print at 0.9% it would be necessary for the December underlying CPI to print 0.45% to achieve the Bank's forecast of 3.25% for 2009. Given the run of quarterly underlying measures that seems particularly unlikely. Even a 0.7% read for the December quarter would be required to achieve a 3.5% result for 2009 - any evidence that quarterly underlying inflation has troughed in 2009 would be very disturbing for the RBA. However, it is still most likely that underlying inflation will bottom out in 2010.

With annual underlying inflation printing 4.3% in 2008; and forecast to print 3.5% in 2009 and the Bank forecasting that GDP growth would return to trend in 2010, "and subsequently to strengthen somewhat" the substantial risk is that the lowpoint in underlying inflation which can be expected in 2010 is much higher than the current 2% forecast and even substantially higher than the 2.5% which might now be on their radar screen. That would be considered absolutely the maximum acceptable lowpoint in any inflation cycle for a central bank targeting "2-3% on average through the cycle".

Given the growth outlook of both the Bank (at trend) and Westpac for 2010 (domestic demand growth in 2010 expected to be 4% up from -0.4% in 2009) inflation can be expected to be rising in 2011. The concern for the Bank should be that the starting point for the next upcycle in inflation is too high and more urgent action needs to be taken with monetary policy.

We expect that the Bank will be very anxious to see that quarterly underlying inflation has trended down in September. Clear evidence that it has started to pick up before the impact of the usual lags would be disturbing.

It would be very unlikely that a central bank would be comfortable running a highly stimulatory monetary policy when evidence was building that the lowpoint of inflation in the next cycle was too high, thereby risking the whole credibility of the "2-3% on average through the cycle" target. An associated consideration for the RBA is that there will be considerably less slack in the labour market following this downturn than after the last two recessions, with the unemployment rate now expected to peak in 2010 below 7%.

Concerns about an unacceptably high lowpoint for inflation in the next cycle would certainly expose a highly stimulatory policy stance.

With policy currently seen to be exceptionally stimulatory it is reasonable to expect the Bank to accelerate any plans to withdraw the stimulus - that would put a 50bp tightening right into the forefront in November.

Australia: Data Wrap

Aug Westpac-MI Leading Index

  • 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 1.7% in August just below its long term trend of 2.8%. The annualised growth rate of the Coincident Index was -0.1%, also below its long term trend of 2.8%.
  • The pace of recovery in the growth rate of the Leading Index has been remarkable. The annualised growth rate has moved from -6.9% in May to today's print of 1.7% in August - an increase of 8.6ppts.
  • The rate of recovery in the Index was not as rapid following the recessions of the early 1980's and 1990's. The current sharp improvement in the growth rate of the Leading Index strongly supports the view that the Australian economy is moving onto a much stronger growth trajectory in 2010.

Sep motor vehicle sales

  • Vehicle sales increased 2.9% in September, to be 2.0% lower than a year-ago. The rise suggests an underlying cyclical upturn is underway. Notably, passenger vehicle sales increased for the 6th consecutive month, rising by 1.6% to be up 12% from the March low.

Sep merchandise imports

  • Merchandise imports valued $17.6bn in September. The ABS advise that this represents a rise of 6% in seasonally adjusted terms, on a balance of payments basis.
  • Intermediate and other merchandise goods rose $656m (10%) with fuels and lubricants up $448m (25%), non-monetary gold rose $182m (33%), consumption goods rose $123m (2%) and capital goods rose $74m (2%).

Q3 trade price indexes

  • Export prices fell sharply again in Q3 by 9.6%qtr (weaker than expected) after a 20.6%qtr fall previously as a minor rise in USD commodity prices was more than offset by the valuation drag from a 9.6%qtr AUD/USD appreciation. The fall was led by coal, coke and briquettes (-34.2%) and metalliferous ores and metal scrap (-12.1%), with partially offsetting rises in non-ferrous metals (16.1%) and petroleum and related products (5.4%).
  • Import prices fell 3.0%qtr in Q3 (on our Westpac forecast after a 6.4% fall previously, led by broad valuation effects of the stronger AUD, as well as lower prices in general industrial machinery and equipment and machine parts (-7.4%). Food and beverage prices fell again (-5.3%), but mineral fuels jumped 15.1%. Abstracting from these non-core items, core import prices fell sharply by 5.4% as the import weighted AUD TWI jumped 6.6% in the quarter.
  • The data has no implications for our Q3 CPI forecast as the currency pass-through from imports to consumer prices is often largely absorbed or passed on with a longer lag - although the weakness in core import prices provides scope for Q4 discounting, if it is required by softer spending momentum from the drop out of fiscal stimulus, and rate hikes.

Round-up of local data released last week

Date Release Previous Latest Mkt f/c
Mon 19 RBA Assist.Gov. Lowe speech - - -
Tue 20 Sep merchandise imports, AUDbn (nsa) 15.5 17.6 -
Oct RBA meeting minutes - - -
Wed 21 Aug Westpac-MI Leading Index, ann'lsd -1.0% 1.7% -
Sep motor vehicle sales 0.1% 2.9% -
Fri 23 Q3 export price index -20.6% -9.6% -4.7%
Q3 import price index -6.4% -3.0% -2.8%

New Zealand: Week ahead & Data Wrap

On tenterhooks

Last week was a quiet one for NZ data, with all eyes on the RBNZ and their review of the official cash rate this Thursday. No one expects a change in rates, but the press statement will be keenly dissected for hints regarding when the first hike is likely to come.

This week saw another modest upwards revision to Consensus growth forecasts for New Zealand's trading partner for 2009 and 2010. This is the fifth consecutive upward revision. Growth next year is now expected to be only a little below average, though in context this is a fairly modest recovery considering it follows a record contraction in 2009. However, much worse was widely expected not very long ago, and the speed of recovery has taken the Reserve Bank of NZ by surprise, along with the associated recovery in NZ's commodity prices. Growth in 2009 and 2010 is now expected to be almost 1% higher cumulatively than the RBNZ expected just last month.

The other data release was net migration and visitor numbers. Monthly net migration surprised slightly on the downside, with arrivals of foreigners failing to bounce back as much as expected from a weak August. Monthly seasonally adjusted net migration is flattening out as the Australian economy outbids ours, but annual migration will still continue to pick up strongly over the rest of the year to a peak of around 23,000, stimulating the housing market and retail.

Visitor arrivals picked up strongly in the month, unexpectedly, to be 8.5% higher than a year ago. This was driven by a huge surge in the number of Australians arriving for holidays. Part of this will be the tail end of a very good NZ ski season, which has now done its dash, but it's nonetheless good news for a suffering tourism sector.

All eyes are on the RBNZ on Thursday for the six-weekly opportunity to reset the Official Cash Rate. Our view is that the RBNZ will take some time before acting to remove its stimulus - partly because they're not yet fully convinced that the recovery is secure, particularly given the spectacular rise in the exchange rate, and partly because they will want to signal a change in tack in a way that doesn't cause the market to react violently.

Since the September Monetary Policy Statement, we've seen evidence of a stronger global economy and commodity prices, a higher starting point for GDP, stronger NZ retail numbers, a rise in net migration, improved business and consumer confidence, and most notably, a marked pick-up in the housing market, where prices are now only 4.4% below their 2007 peak. This will be feeding the RBNZ's concerns about a return to unbalanced growth, and the only way for monetary policy to reverse the trend is to lift mortgage rates.

To top it off, the stronger than expected September quarter CPI will have given the RBNZ cause for concern. After five quarters of deep recession, annual inflation has bottomed out for now at 1.7% (only slightly below the midpoint of the 1-3% target band) and non-tradables inflation has eased only to 3.0%. We expect that the degree of spare capacity and the strength of the exchange rate, if sustained, will keep annual inflation well below 2% in 2010. It's the outlook for inflation in 2011 and beyond - which falls into the RBNZ's medium-term horizon - that looks more worrisome, as the recovery will start to add to inflation pressures that have only been tempered, rather than squashed, by the last recession.

But looking at the big picture, monetary conditions are once again a lot tighter than expected, due to the rise in long-term interest rates and the New Zealand dollar. The RBNZ toned down their rhetoric on the currency in the September statement, but at the very least they will see it as significantly reducing inflation pressures over the next year. (Indeed, we are getting to levels where renewed currency intervention is looking likely).

The challenge for the RBNZ is to lay the groundwork for eventual tightening in a way that doesn't scare the horses, and which gives them some flexibility around the timing. We expect that this statement will see a jettisoning of the last vestige of an easing bias and remove the expectation that rates will remain "at or below current levels through until the latter part of 2010". In its stead they will probably have a phrase akin to "the OCR can stay at a low level for a considerable period of time". The end goal is a gradual tightening cycle beginning in Q1 next year.

In other upcoming data, business confidence is likely to hold its ground after a sharp rise in the last six months to the highest level in more than 10 years. September merchandise trade is expected to be solidly in deficit as domestic spending recovers but the dairy season has yet to kick off; and building consents are expected to rebound as housing shortages start to bite. Apartment consents are the wild card. We are assuming recent extreme weakness will persist, but the risk is for a sudden rebound.

Round-up of local data released last week

Date Release Previous Latest
Wed 21 Oct Sep external migration ann. 15,642 17,043
Sep credit card transactions 1.6% -1.0%

Data Previews

Aus Q3 PPI

Oct 26, Last: -0.8%, WBC f/c: 0.2%

Mkt f/c: 0.3%, Range: -0.8% to 1.5%

  • The Q2 PPI was a weak -0.8%qtr, 2.1%yr. Non-core items subtracted 0.10ppts from the qtly rate (food -1.2%, petroleum +4.9%). Core import prices fell 6.2% as the AUD import weighted TWI rose 10.2%, driving a weak overall core PPI of -0.9%qtr (record low). The core PPI was also subdued by -0.5% for building construction prices, offsetting a domestic core ex-construction & utilities PPI of +0.7%qtr.
  • The core PPI is f/c to rebound slightly in Q3, despite further AUD strength cutting core import prices (f/c -5.1%), with building construction to stabilise (f/c flat), and a strong utilities led jump in the domestic core ex-construction (f/c 2.2%). This gives 0.2%qtr for the core PPI, slowing the annual rate to 1.6%yr from 3.4%yr. Food prices are f/c at -1.3%, petroleum +12.0%, giving a minor net addition, for a total PPI rise of 0.2%qtr (but cutting annual to 0.4%yr vs 2.1%yr prev).

Aus Q3 CPI

Oct 28, Last: 0.5%, WBC f/c: 1.1%

Mkt f/c: 0.9%, Range: 0.5% to 1.2%

  • Our Q3 headline CPI f/c allows a minor fall in the annual rate to 1.4%yr from 1.5%yr. Drivers of the higher qtly pace include utilities (9.2%) from big one-off jumps. Petrol rose 4.3%. Financial & insurance services are f/c up 1.3% with deposit & loan facilities +1.0% (greater rate rises in loan products vs depo products) & higher insurance premiums. Alcohol & tobacco rise 0.9% (excise up); rents are f/c to slow to a 1.1% pace; house purchase costs are f/c to repeat Q2's 0.8% rise. Other +ves include property rates, meals out, & holidays.
  • Our avg RBA underlying CPI f/c is 0.9%qtr, 3.6%yr (vs 0.8%qtr, 3.9%yr prev). 3 main factors give the higher qtly pace: a +ve for D&L facil. (vs -ves of Q1, Q2) pushes items with price falls out of the trimmed mean; much lesser dept store July discounting with lower stocks; strong utilities rises (even after SAdj) account for large share of top of distribution.

Aus Sep private credit

Oct 30, Last: 0.1%, WBC f/c: 0.2%

Mkt f/c: 0.2%, Range: 0.1% to 0.3%

  • Private credit growth may be at a turning point, reflecting improved economic conditions. We're forecasting a 0.2% increase in September. That follows a 0.1% rise in August and an average 0.06% increase over the six months prior to that.
  • Housing credit growth stepped up to 7½% annualised over the last three months, up from a low of 6.1% last August. New lending has been particularly strong. Moreover, credit to investors was stronger over the last two months.
  • Personal credit increased by 0.5% in August, after contracting by almost 8% since the end of 2007.
  • The question is when will business credit, which declined by 0.6% in August, show some improvement. While business credit typically lags the recovery, the rate of decline may begin to moderate given improving confidence and conditions.

NZ Oct NBNZ business confidence

Oct 28, Last: 49.1

  • General business confidence has risen sharply in the last six months, to reach its highest level in more than 10 years. We expect more moderate gains over coming months.
  • The similar BNZ survey at the start of this month was down slightly, with real estate confidence a little more subdued. Since then, we have seen that house sales and prices were stronger in September. We've also had another positive outcome from Fonterra's online milk powder auction, retail card transactions rose, and the manufacturing and services PMIs pointed to further growth in September.
  • More importantly, we will be looking for further improvement in the details of the survey. Employment intentions turned slightly positive in September and anecdotes suggest more businesses are now looking to hire. Improving profits would help to fund expansion plans.

NZ RBNZ OCR review

Oct 29, Last: 2.50%, WBC f/c: 2.50%, Mkt f/c: 2.50%

  • The New Zealand economy continues to recover at a faster pace than the RBNZ expected.
  • 'Emergency' monetary policy settings will need to be withdrawn earlier than previously thought.
  • A key issue for next week is the RBNZ's expectation that rates will remain "at or below current levels until the latter part of 2010". We think that this statement has served its purpose and can safely be removed.

NZ Sep merchandise trade NZDm

Oct 29, Last: -725, WBC f/c: -450

  • After a period in surplus early this year, the merchandise trade balance has been slipping steadily back into deficit. The prices of both imports and exports have been rising. But the consumer recovery has added extra punch to import volumes, while the volume growth in exports has been slower. We expect more of the same flavour this month. Our forecast deficit is larger than earlier this year, but still small by the standards of 2003 - 2008.
  • We expect September imports to be turbo-charged as importers restock following the surprise jump in retail spending in August.
  • We expect export receipts to begin reflecting the 64% increase in international dairy prices over the past three months, although with stocks running low and the new season not really up to speed the volume of exports will be low.

NZ Sep building consents s.a.

Oct 30, Last: 1.7%, WBC f/c: 4.0%

  • Dwelling consents have, to date, been reasonably slow to respond to the changing dynamics in the housing market. While consent issuance is 21% off the multi-decade lows reached in January this year, solid housing demand and weak supply suggest that growth should be even stronger if we are to avoid a housing shortage. Credit conditions and a lack of confidence have been dampening influences, but with both now more supportive, the pace of increase is set to pick up.
  • We expect a sturdy 4% increase in dwelling consents this month, driven by another strong gain in ex-apartment consents (7% m/m). Apartment consents remain the wildcard. Following last month's woeful issuance (just 30) we have factored in 50 apartment consents in Sept, but a return to average since the beginning of this year (around 150) risks a more spectacular increase in the monthly total (+10%).

US Sep durable goods orders to remain soft

Oct 28, Last: 1.8%, WBC f/c: -1.5%

  • Durable goods orders corrected lower in August, with a pullback in civilian aircraft orders and a second month of slippage in core capital goods orders. The contribution from autos was minimal, probably because orders were cut back sharply later in the month as the cash for clunkers scheme drew to a close.
  • September orders are expected to be just flat. Boeing orders were down again, and after two monthly gains, defence might correct lower. Also, auto orders should more clearly lose their recent upward momentum, and business equipment production growth stalled last month, suggesting orders there have fallen away.
  • Those developments would offset gains elsewhere: the Sep ISM factory index orders pulled back from 65 to 61, but that is still strong. Core capital goods orders are due to bounce (after Jul-Aug falls), a positive in an otherwise sluggish report.

US Q3 GDP advance: confirmation recession is over

Oct 29, Last: -0.7% annualised, WBC f/c: 2.3%

  • US GDP plunged at around a 6% annualised pace in Q4 and Q1, but the pace of contraction eased markedly in Q2, and partial data available for Q3 suggest the economy is expanding once again. This will focus attention on the question: is growth self sustaining (ie a genuine recovery) or entirely dependent on extensive fiscal, interest rate and quantitative easing?
  • Spending on autos received a temporary boost from cash for clunkers, so consumer spending should bounce after falling in Q2. We may also start to see the early signs of long-awaited inventory rebuilding, although that process may make a bigger contribution to Q4 than Q3. Business investment should fall at a slower pace than in Q2; ditto for housing, though a housing expansion is not yet apparent in the monthly construction underway figures. Net exports and public sending should be positive.

Westpac Institutional Bank


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