New Zealand Weekly
Bigger Nut, Bigger Hammer
We expect the Reserve Bank to keep the OCR on hold at 7.50% on Thursday. However, inflation pressure is building, so we expect a hike in June and another later in the year.
New Zealand's economic upturn is gaining momentum fast, boosted by stratospheric commodity prices and expansionary fiscal policy. Data has shown that house price inflation has returned to double digits, retail sales are booming, and inflation pressure is mounting. Last week's CPI data was the biggest shock. Although headline inflation was a moderate 2.5%, nontradables inflation accelerated to 4.1%. This suggests that the low growth last year did nothing to alleviate inflationary pressure in New Zealand. As our recent work suggests, the potential growth rate of New Zealand has slowed, meaning it takes ever-lower growth rates to alleviate inflation. The inflation nut is much bigger than previously thought, and will be much harder to crack.
But it has not been all bad news for the RBNZ - they have been delivered a much bigger hammer to crack the inflation nut with. Markets have pushed longterm interest rates up by more than the OCR, fixed mortgage rates have risen even more, and the NZD has hit a new post-float high.
The challenge for the Reserve Bank, and for us, is to weigh up the opposing forces of a stronger economy on one hand, and tighter monetary conditions on the other. We have come down on the side of the strong economy. We now expect not one, but two hikes in the OCR this year. The key to our view is the persistence of the current upturn, with drivers such as commodity prices and fiscal policy that are not about to moderate any time soon. Households are confident with the labour market at virtually full employment. Now that the economy has gained momentum, it will take a lot to cool it down. When a truck starts rolling a small rock under the tyre will be enough to stop it, but once it gathers momentum it needs a big boulder in its path.
Of course, stopping a runaway truck with a boulder makes a big mess. The RBNZ has let things get away again, and that just makes the inevitable economic downturn sharper. New Zealand is in a vulnerable and unsustainable position due to the excessive current account deficit and high debt levels. At some point the final 25 basis points of monetary tightening is going to send the housing market over a tipping point. When house prices stop rising, the correction for the rest of the economy will be sharp.
Dr Bollard has always been conscious of the risk of sending the economy over a tipping point. That is why he will take a measured, slow and steady approach to the renewed monetary tightening cycle he embarked on last month. The RBNZ will approach the peak of the interest rate cycle slowly and carefully, verifying the effect of each hike before delivering the next. This slow and steady approach implies that the OCR will remain on hold in April, with the next hike being delivered June.
No matter what the decision on rates, the accompanying press release will be extremely hawkish. If there is no hike, we would expect the statement to label further hikes as “likely”. If the decision is for an April hike, then the statement will be slightly more moderate, with language such as “a further incremental adjustment to rates may be necessary.” The market is positioned for a hike, but whether that hike comes in April or June is immaterial. Therefore an on-hold decision on Thursday would not see the currency fall much, so long as the statement is hawkish.
In other data this week, we expect business confidence to wane a little on the back of the interest rate hike in March. The merchandise trade balance is likely to reflect strong consumption, with very strong imports pushing the balance out to -$170m.
Fixed vs. floating: Buoyant economic indicators in early 2007, especially those related to housing and domestic spending, means that the RBNZ is likely to lift interest rates again - maybe twice. Even if rates are lifted once, they look like staying high for some time. Fixing for 2 years seems appropriate given this outlook. But with the possibility of interest rate cuts later in 2008, an 18-month term is seen as a better alternative to a longer term.
NZ Interest Rates*
Key Data Previews
NZ RBNZ OCR review
- The RBNZ is expected to pause in April, preferring to assess the impact of a sharp increase in mortgage rates and a post-float high in the NZD/USD.
- Inflation pressures have intensified.
- We expect two hikes by the end of the year.
NZ Official Cash Rate NZ Mar merchandise trade NZDmn
- The consumer resurgence will drive imports higher.
- Exports are also going well.
- The trade balance is expected to widen to -$170m.
NZ merchandise trade balance NZ Apr NBNZ business confidence
- Business confidence fell in March following the RBNZ hike and is expected to fall further in the April read as monetary conditions have tightened significantly.
- Firms' own activity has been buoyant in the first three months of 2007 with strong momentum in domestic demand. Watch for any downward impact from the tighter monetary conditions, although it is too soon for this to show up.
- Attention will also be on inflation expectations, still a concern for the RBNZ. We expect another mild easing, extending seven consecutive months of declines.
NBNZ Business Confidence Aus Q1 PPI
- The Q4 PPI rose 0.2%qtr and 3.5%yr. Non-core items saw a mild rise in food prices more than offset by a sharp fall in oil. The core PPI was constrained to a 0.8%qtr rise by falling core import prices, but domestic core prices ex-construction rose 1.1%qtr and 4.2%yr.
- In Q1 we expect a further fall in core imports (-1.0%) with a higher A$, lower petroleum (-5.1%) and a similar rise (0.9%) in building construction prices to Q4. But food prices accelerated (1.2%). The domestic core ex-construction pace is expected to ease slightly (f/c 1.0% vs 1.1% prev) helped by an easing exutilities pace after two strong quarters. This gives a total PPI of 0.6%qtr and 3.4%yr (vs 3.5%yr prev).
PPI: domestic core rising, imports falling Aus Q1 CPI
- Our Q1 headline CPI forecast is 0.7%qtr & 3.1%yr (vs 3.3% prev). Higher petrol adds 0.4ppts, a +0.6ppt swing from Q4's drag. Main pluses are in health (PBS effect), housing (rents), education, alcohol & tobacco (excise), transport, recreation (domestic hols), finance & insurance services (Nov rate hike), food (drought). Minuses include clothing & household goods (discount sales).
- The average RBA core CPI is also expected at 0.7%qtr, up from Q4's 'low' 0.5% result, taking the annual rate to 2.9% from 3.0%. This forecast is particularly sensitive to the house purchase item (which Monday's PPI gives guidance on). We assume another 'low' rise here (0.6%), leaving upside risk to our 0.7% RBA core forecast.
CPI inflation: headline and RBA core Aus Feb Westpac-MI Leading Index
- The annualised growth rate of the Westpac-MI Leading Index of economic activity, which indicates the likely pace of economic activity three to nine months into the future, was 4.8% in January, above its long term trend of 3.9%.
- For February, the monthly components of the index were positive. The share market added 1.0% during what was a volatile month. The money supply accelerated to increase by 1.5%. Dwelling approvals surged by 10.5%, boosted by a cluster of apartment approvals. On the international front, US industrial production rebounded to increase by 0.8%.
Westpac-MI Leading Index US Mar existing and new home sales
- Existing home sales posted solid gains in Jan and Feb, and indeed have not recorded a significant fall since September last year. However because sales are measured at closure, the colder weather from late Jan has not yet impacted the data. Pending home sales have been softer, so March existing home sales should post a steep - but weather-related - fall.
- In contrast, new sales, measured at signing, plunged nearly 20% in Jan-Feb due to the snow and the lack of sub-prime buyers. Stronger construction jobs and hours and higher starts in Mar suggest a decent sales bounce - and an upward revision would not surprise either.
US housing sales US Apr consumer confidence/sentiment
- The sentiment indicators we have seen thus far for April (including the prelim UoM report) all posted moderate falls, with the main driver being increased concern about the economy - hardly surprising given all the chatter about “recession”, since the sub-prime mortgage market woes hit the mainstream media.
- But as April progressed the economic news, led by the labour market, looked a little less dire, and the stock market hit a new record high. That means that the April CB confidence decline should not be steep, and we expect the final UoM read to be revised higher.
US consumer confidence US Mar durable goods orders
- Notwithstanding big swings in the civilian aircraft component, orders were very weak in Jan and failed to recover in Feb. Of particular concern, core capital goods orders (ex defence and aircraft) posted back to back declines in the first two months of this year, calling into question the sustainability of business investment spending as a driver of economic growth.
- The Mar orders headline will once again be boosted by aircraft with Boeing orders up sharply. Also, with business equipment output up 0.8% in Mar, and orders still growing in the ISM survey, we are optimistic that core capital goods orders will stage a recovery of sorts.
US durable goods orders US Q1 GDP growth to hold above 2%
- US GDP growth printed with a 2 handle in the last three quarters of 2006. Sharply weaker housing investment, and more recently softer business investment, have been major factors at play.
- We expect GDP growth of 2.2% in Q1. At the time of writing, that was a little above the consensus of below 2% annualised. That may be because we tweaked our forecast a little higher this week following solid retail and less weak housing data. We also expect business investment in structures to surprise to the upside.
- The core PCE deflator is forecast to accelerate from 1.8% annualised in Q4 to back above 2% in Q1.
US GDP growth US Q1 employment cost index
- The ECI showed signs of stirring in Q2 and Q3 last year, as the tightening labour market finally began to see wages and benefits bid higher. But in Q4 it rose a more modest 0.8%, due to slower wages and salaries growth.
- We expect a much stronger Q1 growth rate of 1.1%, which would be the fastest pace the ECI has seen early 2004. Recent payrolls data show decent earnings growth, suggesting a bounce in the wages and salaries component, while higher medical care costs (often front loaded into firms' dental/medical program costs at the start of the year) will boost the benefits component too.
US Employment Cost Index
Westpac Institutional Bank
