Wednesday, November 3, 2010

Westpac : Don’t rock the boat

Economic data has tended to be on the disappointing side in recent weeks, but not enough to warrant a change in the RBNZ’s forecasts over the crucial mediumterm horizon. While observed activity has been soft – in particular the weak 0.2% growth in June quarter GDP – near-term growth prospects look brighter, thanks
to the continued strength in commodity export prices and the expected reconstruction activity following the Canterbury earthquake.

The RBNZ’s international outlook is still dominated by a two-speed global recovery, with strong growth in Australia and Asia but weakness in the US and Europe. The RBNZ also commented that “it is unclear how further policy support would impact on the outlook for growth in our Western trading partners” – a jab at the effectiveness of another round of quantitative easing, which the Fed is expected to unveil this week.

It’s worth noting what wasn’t mentioned in the statement: the New Zealand dollar, which recently hit one-year highs against the beleaguered US dollar. This suggests the RBNZ is (rightly) more focused on the trade-weighted index, which is about where it was when the September forecasts were being finalised, and indeed has been effectively flat for the last year.

The last paragraph of the statement, which the market generally looks to as a guide to the next rate move, noted that “it remains likely that further removal of monetary policy support will be required at some stage.” That’s not substantially different from the wording of the September review, although the message that interest rates are still going higher was arguably given more prominence this time.

As we saw in September, the RBNZ has made some big assumptions as part of its central forecasts: that households will further increase their rates of saving; that inflation expectations will decline even as headline inflation rises above 4%; and that the rise in the terms of trade will only be temporary. It will take a lot of accumulated evidence to either prove or disprove these assumptions. We expect the next OCR hike to be in March 2011 at the earliest.

Last week’s data releases were a mixed bag. There was a tentative improvement in business confidence in October, with most of the major components recording their first rise since April/May. The biggest gains in confidence were in retailing and services – those sectors most exposed to the scaremongering ahead of the GST hike. In contrast, the construction sector remained downbeat, despite the opportunities presented by the

Canterbury earthquake – though this could be consistent with a small number of respondents receiving the lion’s share of the reconstruction work.

Excluding the volatile apartments segment, building consents fell 2.6% in September, leaving them down 17% over the last three months. There’s no doubt that some of the latest weakness can be pinned on the Canterbury earthquake, which saw the Christchurch consent processing centre closed for two weeks
(the impact on applications themselves is more likely to be a story for October and beyond). But there has been a clear downturn in all of the major centres in recent months, as higher interest rates and concerns over tax changes have weighed down the housing market. Were it not for the earthquake, it’s likely that national building activity would have contracted again through late 2010 and early into 2011.

The September trade deficit of $532m was broadly in line with forecasts, and lifted the annual surplus to a nine-year high of $921m. Exports, particularly meat, have softened in recent months despite high world prices; we estimate that seasonally adjusted volumes were down by 5% or more in the September quarter. However, we know that nature, rather than world demand, was responsible for this. Drought conditions led to a big hit to production in the June quarter, and export volumes were maintained by running down stocks.

But since GDP is a measure of current production rather than sales, the impact of the drought was already accounted for in the weak 0.2% growth in Q2 GDP. Imports continue to recover steadily. As we’ve been highlighting for several months, imports of capital equipment (ex transport) have shown a particularly strong rebound. The September figures saw a particularly large jump to $609m due to a large order of wind turbines, but the underlying trend has been one of consistent growth since the start of the year. Adjusting for seasonal factors and exchange rate effects, capital imports have risen 35% from their lows, and are just 7% below their pre-recession peaks.

The notion that businesses are reluctant to invest isn’t supported by their actions. Labour market indicators will dominate the headlines this week. Survey evidence suggests that the labour market continued its gradual improvement in Q3. We expect an uptick in average wage inflation as measured by the Labour Cost Index (Tues) – a product not of larger wage increases, but of a greater share of workers receiving any raise at all. The unemployment rate (Thurs) has shown some extreme volatility in the last few quarters, possibly due to recent changes in seasonal patterns, but hopefully Q3 will be a ‘clean’ read; if so, we expect a small decline to 6.7%.

Fixed vs. floating: The RBNZ’s more cautious stance suggests that floating rates will remain on hold for several more months. Fixed-term rates could rise in that time, but only if there is a substantial turnaround in sentiment on the global economy. As a result, there is no urgency to fix right now.

Full report: Westpac : Don’t rock the boat

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