Thursday, May 5, 2011

NZ Labour Market: Careful Interpretation Warranted

The plethora of labour market data released this week needs to be interpreted with considerable caution. Importantly, none of the data captures the impact of the February 22nd Christchurch earthquake. The Quarterly Employment Survey (QES) and the Labour Cost Index (LCI) released yesterday were finalised before the earthquake. The Household labour Force Survey (HLFS) released today is surveyed on an ongoing basis through the quarter, but Statistics New Zealand made the understandable decision to discontinue surveying in Christchurch after the quake.

There are, however, some important messages in the data. The better than expected employment growth (1.4% in the quarter) and resulting lower than expected unemployment rate (6.6%) tell us the labour market was improving into the early part of 2011 – with much of that growth coming from full-time employment. That’s consistent with our view of a gradual pick-up in economic activity, at least before the earthquake. Hours work data counts against that to some extent, but I’m still happy with Q1 2011 GDP increase of 0.4%.

Yesterdays LCI wage data also had an important message. You will recall our view that given the structural nature of the GFC recession, potential growth in many developed countries is mostly likely lower than it was previously, including here in New Zealand. That means that capacity constraints would get hit earlier in the cycle. Furthermore, those constraints would most likely be evident in the labour market first.

Indeed nominal wages have risen at a reasonable clip over the past 12-months, up 3.9% using the unadjusted LCI data. Some have made the erroneous assumption that given the 4.5% increase in the CPI over the same period that purchasing power is now lower. That’s not the case. Roughly half the increase in the CPI was due to the increase in GST and the increase in nominal wages is gross of tax. Wage earners were compensated for the increase in GST with income tax reductions i.e. increase in after-tax income.

The more important message in the LCI data is that unit labour costs are also on the rise. The 0.4% increase in the private sector LCI increase over the quarter took the annual rate of increase to 2% - bang on the mid-point of the Reserve Bank’s inflation target. While that’s not a reason to panic, it’s an important consideration in the context of ultra-loose monetary conditions.

So, if it wasn’t for the earthquake, the message for the RBNZ would have been: “Start getting ye to neutral!” But the February earthquake was a game-changer. With the scale of the immediate disruption unknown, the RBNZ chose to take out “insurance” by lowering the OCR by 50bps to 2.5% in March.

Following the initial earthquake in September 2010, we had assumed some GDP growth impetus from the rebuild late this year. Following the second earthquake, we shifted that out to 2012. The RBNZ therefore has a bit of monetary policy wriggle-room – but not as much as a cursory glance of the indicators would suggest. We still expect a 50bp tightening in December this year, with the OCR up to 4.5% by Q3 2012.