Thursday, January 31, 2013

RBNZ on hold, but for how long?

No-one will be surprised the Reserve Bank of New Zealand left the Official Cash Rate (OCR) unchanged today.  However, the tone of the press release was probably a tad more hawkish than the market was expecting, especially given the much weaker than expected December quarter CPI.  The Bank has made it abundantly clear (again) that the next move in interest rates is up.

It’s clear the Bank is firmly focussed on where growth and inflation are likely to head rather than where they have been.  That’s entirely appropriate.  The Bank sees global growth recovering in 2013 and they believe that domestic GDP growth is recovering from the “softness” seen in the middle of 2012.  They also acknowledge the weak labour market and fiscal consolidation are negatives for growth, so there are still headwinds.

The Bank notes that recent inflation has been subdued and that this is mostly due to the “overvalued” New Zealand dollar.  That’s been evident in the split between tradeable and non-tradeable inflation.  We also know the Bank believes there is not much they can do about the overvalued exchange rate.  We agree with that.  It’s wrong to assume that lower interest rates would lead to a lower New Zealand dollar – other factors are at play.

With respect to the housing market the Bank note the recent house price inflation and that they “are watching this and household credit growth closely”, as they should.  They also note that given the improving global financial market sentiment, bank funding costs have reduced leading to some reduction in interest rates faced by households (and firms) in New Zealand.  That’s clearly adding further impetus to the housing market.

The Bank does not want to see financial stability or inflation risks accentuated by demand in the housing market getting too far ahead of supply.  That reflects the Bank’s role in ensuring financial stability and its new requirement to monitor asset prices.

As I said the other day, we see the current housing market problem as being predominantly one of a shortage of supply rather than undesirable speculative demand, but if not dealt with, the former can quickly become the latter.  Dealing with supply needs a multi-faceted response.  I’ll have more to say on the NZ housing market next week.  I’m also looking forward to the Governors speech tomorrow for any clues on where the Bank is at with respect to the use of macro-prudential tools.

The Bank concludes that “Overall, we expect economic growth to strengthen over the coming year, reducing spare capacity and bringing inflation slowly back towards the 2 percent target midpoint.”   And of the course the Bank won’t wait for inflation to get to 2% before they start to remove the monetary stimulus.   I’m left feeling comfortable with my view that we will start to see higher interest rates from later this year.    

Monday, January 28, 2013

Musings on Davos

Comments out of The World Economic Forum which has just wrapped up in Davos were generally more upbeat this year.  Mind you, “up-beat” is a relative concept in the post-GFC world.

I’d characterise the mood of the Forum as one of cautious optimism.  There was general acknowledgment that a lot of good work had occurred during 2012 which has helped reduce finance sector tensions.  However, a lot still needs to be done if developed economies are to achieve a higher level of sustainable growth.

European Central Bank President Mario Draghi summed it up nicely.  He said that while conditions had improved considerably in financial markets, policymakers are still waiting for signs that the real economy has turned for the better.  “We haven’t seen an equal momentum on the real side of the economy.”

There was general acknowledgment that more needs to be done. The disappointment was that, apart from continued commitment to more active monetary policy and medium- term fiscal consolidation, there was a dearth of ideas about what to actually do.  The risk is that reduced financial tension will contribute to broader policy complacency.

That doesn’t change our view of a better global growth environment in 2013, however it makes me concerned that the key developed economies might remain stuck in a low growth high unemployment rut.  Our forecast for average developed economy growth for the next three years doesn’t get above 2% per annum.  Sure, some economies will do better than others but the overall picture is not one of robustness.

It remains the case that monetary and fiscal policy can only do so much.  The OECD’s Angel Gurria said countries should “go structural” and implement difficult reforms to boost long term growth.  Yep.  A learned colleague just asked me “What’s the point to Davos?”  I replied “The more politicians hear the same message, the more inclined they may be to do something about it.”

Wednesday, January 23, 2013

Japan steps up reflation efforts

The new Japanese Prime Minister Shinzo Abe’s call for more aggressive action from the Bank of Japan (BoJ) to combat low growth and deflation has been met with an increase in the inflation “goal” of 1.0% to a “target” of 2.0% and the adoption of open-ended quantitative easing.

This move from the BoJ follows the recent announcement from the Government of a fresh fiscal stimulus package of 10.3 trillion yen (US$110 billion) which will be focussed on infrastructure spending and greater disaster preparedness.  The Government’s aim is to boost GDP growth by 2% and create 600,000 new jobs.  We’ll see.
Combating Japan’s economic malaise is complex and the solution requires a multi-faceted approach.  But some areas are constrained.  Fiscal policy can only go so far when fiscal settings and the forward trajectory for public debt are already unsustainable.  But neither can monetary policy fill the void of lack of effort on structural reforms.   

I agree with the BoJs statement that inflation will only move towards a level consistent with price stability as “efforts by a wide range of entities towards strengthening competitiveness and growth potential of Japan’s economy make progress.”  In a joint statement with the BoJ, the Government has committed to formulate measures to boost competitiveness and Japan’s growth potential.  “Those measures include all possible decisive policy actions for reforming the economic structure, such as concentrating resources on innovative research and development, strengthening the foundation for innovation, carrying out bold regulatory and institutional reforms and better utilizing the tax system.”  That all sounds great but it remains to be seen what the Government is actually going to do.

While acknowledging that monetary and fiscal policy can’t do all the heavy lifting, the measures announced yesterday by the BoJ could have gone further.  I’ve previously expressed scepticism that quantitative easing can do much to improve economic growth and labour market outcomes but it can be a powerful tool in combating deflation.  I would have liked to see the BoJ step up the quantum of its asset purchase program.  I like the adoption of a 2% inflation target.  That will be helpful in raising inflation expectations, but that needs to be followed by aggressive action.

Recent developments in Japan are in the right direction, but there’s still a lot to be done. In the meantime I’m happy with my GDP forecasts for calendar 2013 of 1.0%.

Sunday, January 20, 2013

China turns the corner

At the end of last year we anointed 2012 as the year of the “crisis averted”.  One of the things markets were worried about as 2012 progressed was the possibility of a hard landing in China.  While the world’s second largest economy slowed further and for longer than we initially expected, December quarter GDP confirmed the turnaround evident in recent activity data that the economy reached the low point in the cycle the September 2012 quarter and posted a modest improvement in the year to December.

China GDP growth rose from 7.4% in the year to September to 7.9% in December.  Data for industrial production, retail sales and fixed asset investment all came in stronger than expected.  That’s on top of last week’s better-than-expected export data.  Exports can be volatile so we haven’t read too much into that result.  That’s why we tend to focus on three-month moving averages for the activity data.  But as you can see from the graph below, the turnaround is coming through most sectors to varying degrees.


Much of the improvement in GDP growth over the quarter was due to higher investment, most notably public works (railways).  That’s where much of the recent stimulus has been targeted and implementation was stepped up a notch in the second half of 2012.  The authorities have been cautious with stimulus with the current fiscal package well shy of that introduced during the Global Financial Crisis.  As it has turned out, much of the slowdown in GDP growth over the previous 7 quarters has been structural simply by virtue of the fact the authorities have been happy to see some of the recent excesses (residential property, local government) in the economy reduced.

With inflation now also appearing to have turned the quarter (year to December CPI inflation rose to 2.5%) albeit largely due to the impact of bad weather on food prices, authorities will be even more cautious about stimulus.  It seems a safe bet to assume that interest rates are now on hold.  The new leadership may well look to continue to boost fiscal spending, but we expect that will remain modest, at least compared to the post-GFC period.

That means we contine to see an only modest recovery in China growth in 2013.  Annual average growth came in at 7.8% last year.  We are currently forecasting 8.0% for 2013.  That might look a bit light now but I'm happy to leave it where it is at the moment.  But isnt it nice to be contemplating upside risk to GDP growth for a change?

China still faces a significant challenge to maintain reasonable growth and rebalance its economy in the face of structural challenges.  Data also released last week showed a decline in China’s working-age population for the first time.  That’s a result of population control policies such as the one-child policy.  That supports our view that despite the current cyclical rebound, China remains on a pathway to lower trend growth.

Also if consumption is to rise as a proportion of a growing economy, incomes must rise as well.  That makes reforms to boost productivity essential in order to keep inflation in check.  Otherwise efforts to rebalance the economy will ultimately prove to be unsustainable.

In the meantime, improving China GDP growth supports our view of a modestly improving global growth environment in 2013 which will see higher New Zealand trading partner growth.  That’s good for export volume growth (agriculture growing conditions permitting) and commodity prices.  Such a environment will, however, continue to lend support the New Zealand dollar.

Friday, January 18, 2013

New Zealand inflation lower than expected...again

New Zealand’s Q4 2012 Consumer Price Index was softer than expected, coming in at -0.2% for the quarter and +0.9% for the year.  The annual rate ticked up slightly by virtue of a slightly larger negative from the fourth quarter of 2011 falling out of the annual calculation. 

A low number for the quarter was not a surprise.  Market expectations were for an increase of 0.1% for the quarter, while our view was that something close to zero was probably about right, especially given heavy price discounting in the lead up to Christmas. 

The surprise for me was the split between tradeable and non-tradeable inflation.  Non-tradeable inflation came in at +0.3% for the quarter and +2.5% for the year while the outcome for tradeable inflation were -0.7% and -1.0% respectively.  Thus the key disinflationary factor in the New Zealand economy right now is the on-going strength of the New Zealand dollar, alongside weaker commodity prices last year.


This result will undoubtedly lead to further calls for cuts to interest rates.  Unfortunately those calls are missing the point.  The key factor driving the New Zealand dollar right now is the not interest rate differentials, it’s the fact that commodity prices are still relatively high, the global economy appears to be recovering and many of the countries whose exchange rates make up are Trade Weighted Exchange Rate Index (TWI) are undertaking quantitative easing.  Cuts to interest rates here will not, in my view, lead to a lower New Zealand dollar, at least not a sustained decline.

Furthermore, cuts to interest rates now will provide further heat to an increasingly stretched housing market.  The good thing about the current strength in the market, especially Auckland, is the problem is due to a shortage of supply rather than what would be the more worrisome problem of speculative demand, although one can soon become the other.

Of course house prices themselves do not feed into the CPI directly, but construction costs do.  Even then, that component of the CPI rose an only modest 0.6%.  I wouldn't have been surprised to see a higher number.  Nevertheless, the Reserve Bank will be watching closely.

Today’s result does not change my view, nor I expect the Reserve Bank’s, that the next move in interest rates is up; the only question is when?  Economic growth is picking up, largely driven by the construction sector.  Latest reads on both business and consumer confidence support that view, as does rising capacity utilisation. 

We think GDP qrowth will be around 2.8% in 2013, up from 2% this year.  With potential GDP at around 2% per annum (lower than it once was), I still think the time will be right in the second half of this year to start removing some of the monetary stimulus.

Tuesday, January 15, 2013

While I was away...

Yes, I had a great holiday.  Thanks for asking.  It was quite an action-packed three weeks with fiscal cliff negotiations, FOMC minutes sending shivers through bond markets and a raft of data out of China, supporting our suspicions that GDP activity recovered somewhat into the end of 2012.

The biggest news was the part-resolution of the “fiscal cliff” in America.  Politicians belatedly reached agreement on the tax aspects of the problem but as we suspected, expenditure (sequestration) was too hot to handle and that can got kicked down the road.  But not too far; expenditure will be discussed again shortly as part of the raising of the debt ceiling debate which needs to take place by end of February/early March.  More importantly, in the absence of a “Grand Bargain”, fiscal policy in America will continue to be a make-it-up-as-you-go process.  For more on the “fiscal cliff”, see the post below.

Recent activity data supports the view of the US economy finishing the year with modest growth, but improving fundamentals more generally.  December PMI data was good, though not spectacular, and housing data has continued to support the view of a recovery emerging in that market.   The labour market held up well into the end of the year with a 155k increase in non-farm payrolls in December.  If anecdotal evidence is correct, firms have been delaying hiring and investment decisions.   That could see some stronger employment gains in the months ahead and some recovery in capital spending.

Our working assumption has been that US fiscal drag in 2013 would be around twice that of 2012.  GDP growth looks set to come in around 2.3% (annual average) for calendar 2012.  With fiscal drag of around 0.7% over the year, growth would have been around 3.0% without the contractionary influence of fiscal policy.  In 2013, we think fiscal drag will be around 1.5%.  Our forecast for GDP growth for the year is 2.1% or around 3.5% without the fiscal drag.  That feels about right, especially given the modestly improving housing market.

The US bond market took fright with the release of the minutes of the December Federal Open Market Committee meeting, with concern that QE3 might end as early as the middle of this year.  These supposedly “hawkish” comments saw bond yields up sharply.  Isn’t it amazing what’s considered hawkish these days?  It’s too early to tell how long QE3 runs for, but given our view that US GDP growth will most likely demonstrate an accelerating profile over the course of 2013, I think it’s likely we will at least see a reduction in the quantum of QE (currently $85 billion per month) later in the year.  Anything beyond that will depend on the labour market and the path of inflation, particularly the personal consumption expenditure (PCE) deflator.

Economic activity remains weak in Europe.  Business sentiment remains soft and the labour market continues to weaken: Europe’s unemployment rate reached 11.8% in November.  Latest PMI data suggests that while the recession isn’t getting any deeper, but neither does there appear to be any chance of imminent recovery.  We think the earliest we will see a return to growth in Europe is late this year.  The ECB left interest rate unchanged last week.  I’m ok with that; any cut to interest rates now would be largely symbolic, rather than having any meaningful impact on economic activity.  Perhaps the biggest news of the last few weeks in Europe was, once again, politics with an election likely in Italy In February.  Mario Monti, the caretaker Prime Minister, will stand again.  That’s encouraging.

In Japan activity data remains weak and prices continue to fall.  That supports Prime Minister Abe’s call for more aggressive monetary policy action.  While in the past I have questioned the merits of quantitative easing for the purposes of influencing real activity in the economy, it is more effective with respect to combating deflation.   QE could and should have been used more aggressively in Japan.  Raising the Bank of Japan’s (recently introduced) inflation target from 1% to 2% would also help lift inflation expectations, but needs to be followed up with aggressive monetary policy action.  Last week the new Government announced a new fiscal stimulus package which should help see Japan out of the current recession later this year.

In China recent data has supported our view that GDP growth recovered into the end of 2012 but also that the recovery will likely remain modest overall.  Export growth was strong in December, although the data can be volatile.  Money supply and loans data is trending gradually higher.  We continue to expect a stronger recovery in industrial production as the inventory cycle turns.

Inflation in China nudged higher in December on the back of a weather-induced increase in food prices, but underlying inflation pressures appear well-contained.  Nevertheless, as inflation edges higher over the period ahead, authorities will remain constrained to monetary policy fine-tuning rather than anything more aggressive.  I will have more to say on China on Friday after the release of Q4 2012 GDP data.  We expect annual growth of 7.8%.

Wednesday, January 2, 2013

Musings on the "fiscal cliff", American politics and the near-term outlook for the US economy

Update:  Since posting the comment below, the US House of Representatives has also passed the American Taxpayer Relief Act.  House Republican attempts to attach spending cuts to the plan failed.  They know they will get to fight that battle over the next few weeks in the lead up to raising the debt ceiling.  An early 2013 outcome to go with our summary of 2012 as the year of the "crisis averted".


The US senate last night passed the American Taxpayer Relief Act to take the rough edges off the economic impact of the “fiscal cliff”.  The House of Representatives is still to vote, so it’s not a done deal yet. 

It seems we have spent much of the last two years waiting and hoping for politicians to do the blindingly obvious.  In the immediate aftermath of the GFC we mused that politicians would find it difficult to do what would be necessary to rein in large budget deficits.  That is certainly proving to be the case.

Markets were euphoric in the aftermath of the 2010 US mid-term elections when President Obama first lost the House of Representatives which delivered a divided congress.  The theory was it would curb the President’s regulatory inclinations.  What it did was weaken the decision making and legislative process.  Four more years...

After an arduous process, the deal extends the Bush-era tax cuts for individuals earning under $400k and couples under $450k, raise taxes on dividends and capital gains from 15% to 20%, and extends unemployment insurance for another twelve months (a not insignificant win for the President).  Payroll tax cuts expire as scheduled and will rise from 4.2% to 6.2%.

Tax was the area of greatest commonality as neither side wanted taxes to go up for everybody, so that where it was going to be easiest to get a deal done.  As we expected would be the case, the sequester of around $110 billion in expenditure was too complex an issue to deal with right now and will be left to the next session of Congress.  Legislators have given themselves another two months to work that bit out.

It’s certainly a relief that a deal appears close to being done it’s disappointing that it wasn’t a comprehensive package that dealt with all the components of the fiscal cliff.  They’ve had no shortage of time.  I am just a casual observer of American politics and its legislative process, but it seems to me that one side of the debate has become increasingly ideologically intransigent.  That makes timely pragmatic compromise a stretch target on every issue.

While the deal falls short of dealing with all aspects of the cliff, its light years away from the so-called "Grand Bargain" that was being contemplated just a few days ago.  At that point President Obama and House speaker John Boehner were boldly aspirational in talking of overhauls of the tax code and Medicare, as were possible wide-ranging changes to social security.   Right now progress on these complex longer term issues seems nigh on impossible.  That makes me worried about item 3 in my "Things to watch in 2013" post below.

This legislation doesn’t deal with the debt ceiling.  Treasury Secretary Tim Geithner earlier advised that the debt ceiling of $16.4 trillion was to be reached on December 31st 2012.  The Treasury is able to exercise what it calls “extraordinary measures” that will see them through until late February or early March before the ceiling needs to be formally raised.  That will coincide with negotiations on spending cuts.  So we get to do it all again soon folks.

As I mentioned before Christmas the good news is that at the bottom of a now reduced cliff is a gradually improving underlying economy.  In recent days we've seen good US housing market data and improved claims for unemployment benefits indicating the labour market held up relatively well as the fiscal cliff approached.  Only consumer confidence was disappointing, but that appeared directly related to fiscal cliff anxiety.  (An aside – we’ve also seen good PMI data out of China in the last couple of days supporting our view of modest recovery.)

Despite that better data, it still appears likely that December quarter economic growth will be the weakest of 2012.  I've got a 1.0% seasonally adjusted annual rate pencilled in, down from a recently upwardly-revised 3.1% in Q3.

The tax deal will stop the us economy plunging the full depth of the cliff, although the proposed tax increases will keep Q1 2013 growth similarly soft at around 1% (saar).  The expiry of the payroll tax cut will have the biggest impact on consumption as it affects everyone.  Tax increases for those on higher incomes will have some impact on consumption, but at those incomes level, I'm making the bold assumption they will have a bigger impact on the household savings rate.

Looking further out the housing market is improving and will become an increasingly important tailwind in 2013.  Also we know that firms have been delaying hiring and investment plans to some extent.  Hopefully they will soon feel confident to implement those plans.  We continue to see investment and exports as the key growth areas for the US.  We still see full year us growth coming in at around the "new normal" trend rate of 2% but for a change, and Congress willing, the risks appear evenly balanced.

Now back to the garden.....