Treasury reviews the August economic indicators; expects dairy prices to recover, labour markets to tighten, and stabilisation in the housing markets

Content from NZ Treasury*

Demand in household sector robust, supported by labour market

Data releases over August pointed to robust demand in the household sector in the June quarter, in line with an expected bounce-back in consumer spending.

Labour market surveys also pointed to strength in household demand with solid growth in jobs and employment income.

However, a further reduction in labour market spare capacity, as evidenced by a declining unemployment rate, will place upward pressure on wages over time.

Although consumer confidence has eased recently, early indicators for the September quarter suggest that the gains in household spending will be sustained, reinforced by the ongoing increase in net external migration inflows. Other activity indicators continue to point to a more moderate pace of expansion than in recent quarters, in line with rising interest rates.

Readings from business surveys indicated further expansion, but remain below the peaks achieved earlier this year.

With spare capacity exhausted and above-trend growth forecast over coming years, inflationary pressures are likely to gradually build despite pressures being largely in check outside of the construction sector currently.

Data outturns remain broadly consistent with the forecasts presented in the recently released Pre- election Economic and Fiscal Update (PREFU), although a mix of upside (net migration) and downside risks (dairy prices) persist.

Retail spending bounces back in June quarter...

The Retail Trade Survey for the June 2014 quarter signalled a bounce-back in consumer spending which is expected to be a key contributor to GDP growth in the quarter. After adjusting for seasonal effects, total retail sales volumes rose 1.2%, following a 0.8% gain in the March quarter, to be up 3.6% from a year ago (Figure 1).

Sales volumes rose in 10 of the 15 industry groups with motor vehicle sales up 3.6%, supported by the strong NZD/JPY exchange rate. Food and beverage services and accommodation sales were up a solid 2.7% and 6.0% respectively, likely resulting from the close proximity of Easter and ANZAC Day in April, which encouraged households to take extended holidays. The seasonally-adjusted value of total retail sales increased by a lesser extent in the quarter (1.0%), indicating a decline in prices in the retail sector. Although household consumption appears to be lifting, rising interest rates are having an offsetting impact, most noticeably on credit growth.

While household credit lifted 5.3% annually in the three months to June, the rate of increase has slowed from 5.6% in the three months to March.

With household disposable income growing at a comparatively higher rate of around 7.0% annually in recent quarters, this pace of credit growth is helping to keep the debt-to-income ratio stable, reflecting a degree of caution from households as their debt levels remain high.

...supported by sustained jobs growth...

Labour market data continued to show robust demand as jobs growth was sustained in the June quarter. According to the Household Labour Force Survey (HLFS), the number of people employed rose by 10,000 (0.4%) in the June 2014 quarter, following strong increases in the previous three quarters, to be 82,000 higher (3.7%) for the year.

Underlying the annual gain in employment has been a large increase in full-time employment and increased employment of people from prime working-age groups (25-54 years) (Figure 2). The corresponding survey of businesses (Quarterly Employment Survey (QES)) saw filled jobs rise at a similar pace of 0.4% in the quarter. Annual growth in filled jobs (2.3%) was lower than the annual increase in HLFS employment (3.7%).

...as the labour market tightens further...

The unemployment rate declined 0.3% points to 5.6% in the June quarter – the lowest level since the March 2009 quarter, falling below the Australian unemployment rate, which increased to 6.4% in July.

The decline was helped by a fall in the participation rate which meant labour demand was met from the existing pool of unemployed, which fell by 9,000. The participation rate eased 0.3% points to 68.9% in the June quarter owing to a sharp 0.6% fall in the participation rate of females. It should be noted that the participation rate was at a record high in the March quarter and remains well up on the same quarter last year (68.1%).

The ongoing net inflow of external migrants will further add to the working-age population in the near term, which should continue to partially offset labour demand pressures. Although the participation rate is expected to remain high, cyclical factors that have likely contributed to its rapid pick-up over the past year (namely the encouraged worker effect) could begin to ease as economic growth moderates.

...and employment incomes grow solidly

Labour incomes continued to lift as annual wage growth was stable and the number of hours worked rose. Annual growth in QES ordinary time hourly wages was steady at 2.5% in the June quarter, largely supported by private sector wage growth, up a solid 3.1% annually.

Hours paid rose a robust 3.6% in the year, and as a result, total weekly earnings increased 6.3%.

This solid annual growth in total gross earnings will be positive for consumption growth and PAYE source deductions. The Labour Cost Index, which measures wage inflation, painted a similar picture, rising 0.5% in the quarter, taking annual growth to a still-subdued 1.6% from 1.5% previously. The modest wage growth is reflective of the response of labour supply to date as activity has picked up and CPI inflation has remained moderate.

However, the fall in the unemployment rate over recent quarters suggests that the labour market is tightening.

Household spending appears robust going into Q3...

The momentum in household spending looks to have continued into July, pointing to a solid start to household consumption growth in the September quarter. Electronic card transactions in core industries (excluding fuel and vehicles) rose a seasonally-adjusted 0.5% in July – a 5.7% increase on last year, with the apparel industry rebounding somewhat as temperatures cooled. The seasonally-adjusted number of new car registrations also increased 1.7% in July to 19,100 – their highest level since late 2005.

...but confidence indicators signal a more moderate pace of expansion...

Consumer confidence has continued to ease from its peak earlier this year, consistent with monetary tightening and slower rates of house price appreciation. The ANZ-Roy Morgan consumer confidence index fell 8.5 points in August to 125.4, reaching its lowest level in 10 months. The decline was driven by a change in households’ perceptions of future financial conditions, possibly reflecting a reaction to interest rate hikes. Both the BNZ-Business NZ manufacturing PMI and services PSI continued to indicate expansion in activity, but are also down from the high levels recorded earlier this year. In the three months to July, the PMI and PSI were down to 53.0 and 56.0 respectively from 57.0 and 56.4 in the March quarter, suggesting a slower pace of expansion, albeit above trend. Likewise, hiring intentions were pared back with ANZ reporting a 3.6% fall in total job advertisements in the three months to July, indicating weaker employment growth ahead.

...supported by construction activity

The construction sector is set to provide ongoing support to economic activity as dwelling consents lifted 3.6% in the June quarter, following a 3.8% increase in the March quarter. This indicates solid growth in residential construction over the September quarter.

The number of new dwelling consents continued to surge in Canterbury, up 9.9% in the quarter (seasonally-adjusted) and 41% in the year, indicating further acceleration in earthquake reconstruction later this year.

Unsurprisingly, there were further signs that resource pressures intensified in the construction sector.

Prices for residential and non-residential buildings increased 1.3% and 1.1% respectively in the quarter, driving a 0.7% increase in the Capital Goods Price Index to take it 2.2% higher in the year.

Some signs of stabilisation in housing market...

Housing market data from REINZ indicated some stabilisation in sales volumes which rose 4.7% in July, the third consecutive monthly increase following an extended period of decline since loan-to-value restrictions were implemented. However, sales were still down 13% on July last year and annual housing credit growth slowed further to 5.3% in the June quarter, compared with 5.9% in late 2013. Nonetheless, recent outturns for sales suggest that the slowdown in house price appreciation could stabilise late this year (Figure 3).

The REINZ house price index increased 0.1% in July, with the annual pace slowing to 5.9% from 6.3% previously.

We expect annual house price growth to ease further in the September quarter, reflecting the drop in sales earlier this year, before lifting modestly in the December quarter as net migration and competitive fixed interest rates continue to support housing demand.

...while net migrant inflows climb higher...

The net inflow of external migrants increased further in July, with a seasonally-adjusted net gain of 4,500 migrants – the second highest on record. Annual net migration climbed to 41,000 as a result, just 1,500 short of the largest annual gain recorded in May 2003 (Figure 4).

The turnaround over the past two years has primarily been driven by trans-Tasman migration flows (particularly fewer departures to Australia) as labour market prospects between the two economies have diverged.

More recently, the contribution of arrivals from other countries such as India, China and Britain has been increasing and now explains around 26% of the annual turnaround (compared with 18% at the beginning of this year).

The ongoing net inflow of migrants will likely continue to support the demand for housing, particularly in Auckland and Christchurch, in addition to providing support for domestic consumption growth.

Migration outturns have been stronger than anticipated since the PREFU forecasts were finalised on 18 July. It is now likely that annual net migration will peak above the forecast 42,500, although the cycle is still expected to begin moderating later this year.

Commodity prices continue to slide...

The ANZ world commodity price index eased further in July – its fifth consecutive decline – down 2.4% in the month and 8.9% since its peak in February.

The drop was driven by a 7.9% fall in the dairy products index which is now 24.8% below its peak recorded in February. Forestry prices also eased 1.9% in the month (down 6.7% since February) reflecting a decline in Chinese demand.

On the other hand, meat, skin and wool prices continue to provide a partial offset, increasing 3.6%, to be up 20.7% on last year. The decline in overall commodity prices is set to continue over August, although some stabilisation in global dairy prices was evident.

The GlobalDairyTrade price index fell 13% over August, following an 8.7% fall in July and is now down 40% from its peak in February this year. Positively, the price index for whole milk powder rose 3.4% at the second auction in August, its largest increase since December 2013, providing tentative signs of stabilisation.

It was assumed in PREFU that prices will stabilise and recover later this year as seasonal factors (dip in Chinese demand and supply increases in New Zealand) reverse and Chinese stocks decline. Fonterra’s forecast payout of $6.00 per kg of milk solids for the 2014/15 season also assumes some recovery in global dairy prices and/or a fall in the NZD.

The NZD TWI has eased around 4% since mid-July, reflecting developments in the US, combined with further falls in commodity prices and softer indicators domestically.

...affecting merchandise export values

The impact of dairy price falls since February is beginning to flow through to the export data. Seasonally-adjusted merchandise exports were down 7.5% in July and 3.3% lower than July 2013.

The decline in export values was led by dairy which fell 8.7% from June, while dairy volumes fell by a lesser extent (4.0%) indicating that prices decreased. Import values on the other hand, were only down 1.8% in July and 4.8% in the year, owing to sizeable offsetting increases in oil, machinery and equipment, and textiles.

A $314m merchandise trade deficit was recorded for July as a result, while the annual trade surplus widened to $1.3b from $1.2b in the year to June.

An unbalanced global recovery amidst risks

Growth in the major economies was uneven in the June quarter: GDP expanded strongly in the US, but stalled in the euro area and contracted in Japan, and Chinese activity appeared weaker going into the September quarter.

Meanwhile, financial markets were affected by geopolitical risks.

Uneven growth in advanced economies...

The recovery continued in some advanced economies. The solid expansion in US activity is evidenced by strong ISM PMIs in July and a rebound in housing market data: house starts and new permits recovered, while house sales showed some stabilisation.

Rising activity supported jobs growth: non-farm payrolls rose 209,000 in July and the unemployment rate increased to 6.2% with a higher participation rate.

The UK’s cyclical upswing continued, with PMIs indicating strong growth in activity, notably in construction, supported by higher house prices. Some UK data were softer: employment fell slightly in the June quarter, although the unemployment rate declined to 6.4% with a lower participation rate.

Elsewhere, the recovery has stalled. Euro area GDP was flat in the June quarter, as the German and Italian economies contracted 0.2% and French GDP was unchanged. Euro area PMIs showed only a modest expansion in business activity in August, while country PMIs continue to indicate stronger activity in Germany and softness in the peripheral economies.

The Japanese economy contracted 1.7% in the June quarter, as domestic demand fell owing to the sales tax increase on 1 April and the frontloading of demand into the March quarter.

Growth appears weak in Australia, as the decline in household confidence and low wage growth weigh on consumption, and weak Chinese demand affects hard commodity exports. Reflecting soft activity, employment eased in July and contributed to a rise in the unemployment rate to 6.4%.

...led to a more supportive policy stance from some central banks...

Weak activity and low inflation led to more supportive policy stances from many central banks.

President Draghi reiterated that the European Central Bank will use all available tools to address low inflation (0.4% in July), leading analysts to expect further policy easing in coming quarters, including a possible asset purchase programme.

UK inflation fell to 1.6% in July and the Bank of England (BoE) reduced its forecasts of wage growth, suggesting weak price pressures despite the UK’s cyclical upturn. Consequently, expectations of the initial BoE rate rise were pushed back to January 2015 from November 2014.

It is uncertain whether the Bank of Japan will ease policy further, but the weak Q2 GDP may convince the Japanese government to increase fiscal stimulus and/or postpone the second rise in the sales tax scheduled for October 2015.

...but Federal Reserve tone is less supportive and NZD may continue to depreciate

As the US recovery becomes more entrenched, the Federal Reserve’s (Fed) policy tone is becoming less accommodative. The Fed’s July meeting minutes noted greater-than-expected improvements in the labour market and that inflation (2.0% in July) was more consistent with its target, while Fed Chair Yellen reiterated that an early rate rise is possible.

Despite the Fed statements, US yields fell in the month owing to increased geopolitical risks and pressure from low euro area yields, while strong data led US equity prices to rise to a new high.

The fall in US yields pushed NZ long-term interest rates lower, with the NZ 10-year government bond yields down 14 bps to 4.14%. Two-year swap rates have also fallen, allowing some local banks to offer lower 2-year fixed mortgage rates. The USD TWI appreciated strongly in the second half of August, as investors adjusted to stronger growth and lower risks in the US economy.

Consequently, the NZD/USD ended the month around 5% lower than in mid July, leading the NZD TWI to decline about 4% over the period (Figure 5).

Chinese activity eases and risks increase...

Growth in Chinese activity slowed in July: year- on-year growth in industrial production, retail sales and fixed investment declined from June, and a fall in the HSBC manufacturing PMI in August suggests that the softness has continued. New lending fell sharply in July and was attributed by the People’s Bank of China to the housing market slowdown.

Weak activity and credit growth, and low inflation (2.3% in July) may lead to further fiscal and monetary policy easing. Housing demand continues to weaken: new home prices fell in July and annual price growth slowed to 2.5% from 9% in early 2014.

The effectiveness of local government measures to boost the housing market appears to be limited so far.

...but growth rises in the rest of emerging Asia

Growth in New Zealand’s other emerging Asian trading partners was stronger in the June quarter.

The Taiwanese economy expanded 1.5%, Indonesia’s GDP grew 1.3% and output in Malaysia rose 1.8%, owing to strong private sector demand and net exports.

Thailand’s GDP grew 0.9% on the back of a domestic demand rebound, as the military coup in May led to greater political stability.

However, growth in the South Korean economy eased to 0.6%, as private consumption contracted following a major maritime disaster in April, while Singapore’s GDP growth on a year ago was soft at 2.1%.

Geopolitical risks continue to concern markets

Global markets were volatile in the middle of the month, affected by political tension in Ukraine and the Middle East.

European investor sentiment was particularly fragile owing to both geopolitical risks and weak data; the Stoxx600 fell to its lowest level since February, but recovered later in the month.

Russia has banned agricultural imports from the EU, the US and some other nations, and this is expected to lead to volatility in global commodity prices.

The impact on the NZ economy is uncertain, although NZ products are not included in the ban.