Thursday, May 21, 2015

New Zealand Budget 2015


  • The 2015 Budget sees a continuation of fiscal restraint with new initiatives being funded out of the new allocation allowance along with some re-prioritisation of other spending.
  • Revenue forecasts have been lowered again as a result of lower nominal GDP growth but it is still forecast to rise as a proportion of GDP over the projection period.
  • As has been well flagged the achievement of an operating surplus has been delayed to 2015/16.  However the trend improvement in the operating balance remains in place which is important for markets and rating agencies.
  • Economic assumptions underpinning the Budget are broadly in line with our own and therefore appear reasonable.  Key judgments about the risks to the outlook also appear reasonable.
  • Key policy initiatives include a package of measures to support children in hardship in return for greater work obligations as well as the earlier announced reduction in ACC levies and measures to tighten the tax treatment of housing.
  • As expected the bond program remains largely unchanged and the fiscal impulse remains negative on average over the projection period.  This Budget should hold no surprises for financial markets.

For full coverage see our Insights Paper here.

Friday, May 15, 2015

RBNZ: To cut or not to cut and what to keep a close eye on

Interest rate markets have priced in the increasing likelihood of cuts in the official cash rate (OCR) this year.   That follows continued low inflation outcomes and the shift to an easing bias by the RBNZ at its April OCR review.  Further impetus was provided by a generally weaker than expected March quarter labour market report and this weeks tweaking of LVR restrictions.  While the odds on a rate cut this year have risen, I’m still not convinced we will see lower interest rates this year and even less convinced that rate cuts are imminent.

I’ve written many times about the reasons behind New Zealand’s recent low inflation experience.  In short, low global inflation, the sharp drop in oil prices and an unsustainably high exchange rate has contributed to deflation in traded goods.  At the same time non-tradeable sector inflation has been kept well under control despite strong growth in the economy by strong growth in the economy’s capacity to grow without generating inflation.  That is best exemplified by recent growth in employment that has coincided with increased supply of labour via net migration inflows and an increasing participation rate.  This has resulted in continued benign wage inflation.


In its April OCR statement the RBNZ was pretty clear about the things that matter in determining whether rate cuts are on the way:  “It would be appropriate to lower the OCR if demand weakens, and wage and price-setting outcomes settle at levels lower than is consistent with the inflation target.”

Growth looks set to retain a solid 3% pace for a while yet, primarily supported by construction activity and consumer spending. Yesterday’s strong retail sales report supported the consumer spending story but also highlighted the inflation challenge with prices falling.  The biggest risk to the growth outlook is dairy prices.  My assumption has been dairy farmers will cope with one year of soft prices, but a second year would present more of a challenge. 

I expect growth will be begin to slow from later next year as we pass the peak in the Canterbury rebuild and as population growth slows.  But population growth slowing means that as GDP growth slows, potential growth will be slowing too.

Wage growth is certainly lower than I expected it would be at this stage of the cycle.  Even so, the private sector ordinary time Labour Cost Index (LCI) is at 1.8%.  Remember the LCI is effectively a measure of unit labour costs.  That says to me that wage inflation isn’t far off being consistent with CPI inflation of 2% over the medium term.  I’m expecting the LCI to continue to head modestly higher this year and into next year.

And then there’s the exchange rate.  The RBNZ’s shift to an easing bias and the expectation in the market of lower interest rates has had a significant impact on the Trade Weighted Exchange Rate Index (TWI).  The TWI has fallen around 4.5% since mid-April, helped most of all by a near 7% decline in the NZD/AUD as monetary policy expectations have shifted on both sides of the Tasman.  That follows an earlier adjustment against the USD as markets started to anticipate higher US interest rates.  The lower TWI is a positive development although I acknowledge at least part of this is predicated on the expectation of lower interest rate.

So where does this leave things?  I’m not yet ready to accept the economy needs further stimulus.  It is not yet clear that we can get through the cyclical peak in growth and capacity utilisation without that putting upward pressure on inflation.  I’m certainly not expecting the RBNZ to cut rates in June:  I don’t see why they would risk firing a rocket under the Auckland property market, at least before their LVR tweaks are in place.  So I still think interest rates are on hold for the foreseeable future, but the outlook is quite uncertain.  Things to keep a close eye on are dairy prices, the TWI and wages.

Monday, May 11, 2015

US unemployment rate continues trend lower

The steady trend improvement in the US labour market is such that the US unemployment rate is now firmly lower than that of Australia...and New Zealand.  What does that tell us about monetary policy in each of these countries?  

U.S. jobs growth recovered in April to +223k after the disruptions of the first quarter that saw a weak GDP out-turn and a soft jobs gain in the March month that was revised down to just +86k, showing disruptions in that month were greater than initially thought.

With the outlook for monetary policy, in particular the timing of “lift off” for US interest rates the topic de jour interest in this report wasn’t just centred on the degree of jobs growth bounce-back from March but also signals on spare capacity (the unemployment rate) and wages, especially given the recent acceleration in the employment cost index.

The unemployment rate dipped lower again to 5.4% reflecting a stronger employment gain in the household survey and came despite a tick higher in the participation rate to 62.8%.  The participation rate appears to have stabilised in recent months despite structural headwinds. 

Furthermore while full-time employment fell over the month and part-time rose, the recent trend has been towards growth in full-time jobs.  That has seen a big drop in the number of people working part-time for economic reasons (i.e. they would prefer to work more hours if they were available).  That has seen a steady decline in the broader measure of under-employment (U6) which now stands at 10.8%.

The stabilisation in the participation rate and the lower U6 “underemployment” rate are both indicative of the structural improvement underway in the labour market.

Wages as measured by average hourly earnings were up only 0.1% in the month and 2.2% over the year.   That's lower and a still flatter trend than the recent sharp move higher shown in the Employment Cost Index.  That’s largely explained by the fact that the ECI is a broader measure of employment costs.  

So there was really no new news for this for the FOMC other than supporting their view that March quarter weakness will prove transitory.  Furthermore wage growth seems consistent with higher inflation in time.  Remember the FOMC won’t wait for inflation to be consistent with their mandate before raising rates – they just need to be confident it’s going to get there.  That said June “lift-off” seems unlikely with September the likely earliest timing of the first rate hike.

The steady trend lower in the US unemployment rate is in stark contrast with recent developments in Australia and New Zealand.  Last week’s April employment report out of Australia showed weak employment growth (although that followed two stronger months of employment gains) and an unemployment rate at 6.2%.  The unemployment rate has been stuck in a 6.1% to 6.3% for a year.  And after showing a more modest trend improvement, the New Zealand unemployment rate is now appears stuck at 5.8%.

Of course the underlying labour market dynamics are quite different between Australia and New Zealand.  Australia’s elevated unemployment rate is a reflection of an economy that is running below trend with weak demand for labour.  Annual employment growth was only +1.5% in Australia in the year to April.

By contrast New Zealand’s employment growth in the year to March was +3.2%.  Our stubborn unemployment rate is a reflection of strong growth in the supply of labour with growth in the working age population being driven by strong net migration and a high participation rate which, as with the US, is the sign of a healthy well-functioning labour market.

Nevertheless high unemployment, regardless of the underlying dynamic, signals spare capacity in the labour market and likely subdued wage growth and low inflation pressure emanating from the labour market.  That’s part of the reason why the Reserve Bank of Australia has been easing monetary conditions recently and part of the reason why the Reserve Bank of New Zealand has shifted to an easing bias.

In moving to an easing bias last month the RBNZ highlighted wage setting behaviour as one of the factors they are watching closely.  The question is the extent to which the economy and the labour market can continue to expand without putting extra pressure on wages at a time when the Labour Cost Index (effectively unit labour costs) is at +1.8% and therefore already not far off being consistent with a return to 2% inflation.  It’s the outlook for labour market supply and demand that holds the key to the timing of the RBNZ’s next move. More on all the factors the RBNZ is weighing later this week.

Friday, May 8, 2015

Around the world by central bank (Part II)

Following on from the previous post on developed economies, this post looks at monetary policy in some of the key emerging economies.

People’s Bank of China

GDP growth in China came in at a better-than-expected 7% in the year to March, though that result seemed at odds with the sharper slowdown in the partial activity indicators including retail sales, fixed asset investment and industrial production.  More recent forward looking indicators suggest the down-trend has not stabilised yet.  The HSBC manufacturing PMI fell to 49.2 in April and while the official index remained unchanged at 50.1 over the same period, the employment index dropped to 48.0. 

While the Government has become more flexible about meeting its growth target recently, we’ve always thought protecting the job market from the adverse effects of a sharper than desired slowdown was a firmer bottom line.  That suggests the recent more aggressive steps to ease monetary conditions and lower the cost of capital will continue for a while yet.  We expect further interest rate cuts and reductions in the required reserve ratio in the period ahead.  These are likely to continue until the property market forms a firm base.

Reserve Bank of India

The key to the improved growth outlook in India has been the supply-side reform progress being made by the new Modi government.  This has seen the “unblocking” of the infrastructure investment pipeline, land and tax (likely introduction of a GST) reforms and the “Make in India” program.  Lower oil prices are also a net benefit to India.  It’s not all rosy however – a poor rainy season will impact on agricultural production and still soft global growth is still weighing on exports.

It’s the improved inflation outlook and the reform initiatives that will make lower inflation more likely to be sustained that have afforded the RBI scope to lower interest rates twice this year.  We think another 2-3 cuts in the repo rate are likely in the months ahead.

Banco Central do Brasil

COPOM (the monetary policy committee of the Brazilian central bank) raised the benchmark Selic rate a further 50 bps to 13.25% last week.  That’s despite the fact the economy being in recession on the back of both tighter monetary and fiscal conditions.  We are forecasting GDP growth of -0.5% in calendar 2015.

Inflation remains problematic with the CPI up 8.13% in the year to March 2015.  That is now well outside COPOM’s target range of 2.5% to 6.5%.  We think inflation is probably close to its peak, although the annual rate seems likely to remain elevated in the months ahead. That means we may also be close to the peak in interest rate although I won't completely dismiss the possibility of a final push higher at the June meeting.  Given the weak growth environment there will probably be scope to start easing monetary conditions again later this year or in early 2016.