Friday, October 31, 2014

Solid Q3 growth in America

September quarter US GDP growth came in in at a respectable annualised rate 3.5%.  That was slightly higher than average market expectations.  Furthermore, the detail of the result was suggestive of solid momentum in the US economy.

Personal consumption growth was held back over the quarter by soft growth in services.  That appears to have been the result of a mild summer and the resultant impact on utilities spending however consumption of durable goods posted a robust 7.2% annualised increase.

Private investment growth was held back by a negative contribution from inventories.  Residential investment looked soft with an annualised increase of 1.8% but disappointment needs to be tempered by observing that followed an 8.8% increase in the prior quarter. But growth in investment equipment came in at 7.2%.  All good.

Net exports was due a positive bounce after two negative quarters and didn’t disappoint with a 1.3% percentage point contribution to the overall result.  Expect that to revert to a negative contribution next quarter.

To look through the noise in any GDP result the best number to focus on is real final sales.  That came in at an annualized 4.2% in the quarter, up from 3.2% in the June quarter and the strongest result since the increase of the same magnitude in fourth quarter of 2010.  To me that’s indicative of an economy that’s building growth momentum.  This result lifts our annual average GDP growth forecast for 2014 slightly to 2.3% (from 2.2%) and supports our expectation of around 3.0% growth in 2015 and 2016.

There are no monetary policy implications in this result other than to give the FOMC increased confidence that growth in the economy is on a firm footing and that further normalisation of monetary conditions will be appropriate in time.

Thursday, October 30, 2014

The RBNZ and the Fed

The Reserve Bank of New Zealand and the US Federal Reserve both announced their latest monetary policy decisions this morning with the RBNZ’s statement best described as surprising on the dovish side, with the Fed a tad more hawkish than expected.

It was no surprise the RBNZ left the OCR unchanged at 3.5% today.  What was a surprise was the removal of any reference to further rate hikes.  Even during the “period of assessment” since July the RBNZ has continued to indicate that further rate hikes would be necessary – until today.

The critical paragraph from today’s statement is as follows:

“CPI inflation is currently at a low level despite above-trend growth.  However, inflation is expected to increase as the expansion continues.  A period of assessment remains appropriate before considering further policy adjustment.”


It’s clear the RBNZ believes they have done enough for now, and that “for now” is likely to be a long time.  As a notorious hawk it pains me to concede that the probability of further rate hikes has diminished recently but I expect that, like us, the RBNZ will most likely still think the next move in interest rates will be up rather than down.

But recent low inflation outcomes means they have considerable time on their side.  You will recall that following last week’s lower-than-expected September quarter CPI data we shifted or next rate hike expectation from March next year to September (see post below).  We will know more about the RBNZ’s interest rate expectations when we get the December Monetary Policy Statement.

There were no other surprises in the press release.  The RBNZ acknowledged recent softening in the data out of some of the major economies apart from the US.  With respect to New Zealand, the RBNZ acknowledges the economy has been growing above trend, but is expected to moderate towards a more sustainable rate over coming years.

On the exchange rate the RBNZ repeated its line that the level of the NZD remains “unjustified and unsustainable” and that they expect a “further significant depreciation”.  Agreed.

A key catalyst for a lower NZD remains our expectation of a stronger USD over time.  We saw that in action today with a somewhat more hawkish than expected statement from the US Federal Open Market Committee (FOMC).

As anticipated the FOMC announced the end of quantitative easing effective from the start of November. However, the statement was generally more upbeat than expected on the economy, especially with respect to the labour market where the committee now sees “gradually diminishing” rather than “significant” underutilization.

With respect to inflation the Committee acknowledged that near term inflation would be held down by lower energy prices but that the risk of persistent lower than target inflation has “diminished somewhat since early this year”.

The “considerable time” forward guidance was unchanged but the Committee reiterated that the policy outlook remains data dependent.  I’m still comfortable a view that the FOMC starts to raise interest rates from mid next year, although the risks to that right now are biased to later rather than earlier.

Friday, October 24, 2014

Where's inflation gone?

Inflation is low nearly everywhere.  In most countries that’s no surprise - think about the Euro zone where growth is insufficiently robust to make any significant dent in the huge amount of spare capacity that exists across the region.  Even in America where growth is stronger, a large negative output gap means inflationary pressures remains benign.

The surprise, at least for me, is persistently low inflation outcomes in New Zealand where we have recently enjoyed a period of growth that is the fastest in a decade, the strongest in the developed world and has led to a closing of the output gap.  Yet the only sustained inflation pressure in the New Zealand economy at the moment is in the housing sector.  Everywhere else inflation remains largely non-existent.

So why is inflation now back to the bottom-end of the Reserve Bank’s 1-3% target band?  I can point to a number of reasons.  Firstly, and perhaps most obviously, the recent strength in the exchange rate is still flowing through to lower prices of tradeable goods.


Secondly we have recently seen a period of strong business investment that has added to the economy’s non-inflationary potential growth rate.  That is helping keep non-tradeable inflation pressures in check.

The third factor is recently strong net inward migration.  When we think of the impact of strong net migration we think of the added pressure that puts on the housing market.  But the other side of the story is that much of the recent growth in employment has been met by rising participation – with net migration a key contributor to that.  That is helping keep wage inflation at bay.

So where to from here?  At the start of this year we published a paper “The New Zealand Tightening Cycle”.   That paper discussed the added uncertainties in this first post-Global Financial Crisis monetary policy cycle, including uncertainty about the level of the neutral cash rate, the level and future trajectory of potential GDP growth, how households would respond to higher interest rates, the balance between hiring and investing by firms as they resourced themselves for increased demand for their goods and services and the impact of LVR restrictions on the housing market.

We know a bit more about some of those things but not all of them.  In particular with the exchange rate now lower we expect a positive contribution to inflation from non-tradeables prices over the next few quarters.  But in general there is still more than the usual degree of uncertainty about the future direction for domestic interest rates.


It’s my expectation that we will still need higher interest rates from current levels.  Growth, while off its peak is still expected to remain ahead of potential which will ultimately lead to upward pressure on prices.  We are not prepared to write inflation’s obituary just yet!!

But given the persistence of lower than expected inflation outcomes, the Reserve Bank has time on their side.  I am shifting my expected next rate hike from March 2015 to September 2015 with a forecast peak in the Official Cash Rate of 4.5% by mid-2016.

Wednesday, October 22, 2014

China GDP - lower but better than expected

The slowdown in China GDP growth continued into the third quarter of 2014 but came in slightly better than expected.  Growth slowed from 7.5% in the year to June to 7.3% in September.  Average market expectations were for growth of 7.2%.

The monthly partial indicators showed industrial production recovering over the month from 6.9% yoy in August to 8.0% yoy in September, although down in the September quarter relative to June.  Production related to external demand is relatively strong while production related to the property market remains weak.  Fixed asset investment slowed further over the month, again largely related to the property sector however retail sales continue to hold up well in real terms with the year on year growth improving from 10.6% in August to 10.8% in September.

Weakness over the quarter was clearly centered in the domestic economy.  Net exports provided a significant positive offset to the domestic weakness, contributing 2.5% percentage points to the result.  We don’t expect the external sector will be able to continue to provide such a significant positive offset to further domestic weakness going forward.

The Government will be keen to limit any further deterioration in growth into the end of the year.  That will see then continuing to deploy targeted easing measures to support domestic demand, especially in the housing market.  No further growth deterioration into year end would still see them miss the growth target of 7.5% this year, although the Government seems comfortable with a small miss.

The chance of broader easing measures such as cuts to the benchmark interest rate have increased recently, especially given recent low inflation outcomes.  However I think the Government would be keen to avoid that step if they can.  The good news is that while China remains in the midst of a managed slowdown and rebalancing, the Government  has plenty of ammunition to throw at the economy should conditions look to deteriorate more sharply.