Thursday, December 18, 2014

NZ GDP stronger...and weaker...than expected

New Zealand September quarter GDP came in stronger than expect at +1.0% qoq, but the major news of the day was the downward revision to earlier growth estimates.  The biggest issue we have been grappling with recently has been persistently low inflation in the face of growth that has been, until now, well above potential.  At least part of that is now explained by the fact that growth hasn’t been as strong as we thought it was.

Dealing with the quarter first, growth at +1.0% was stronger than expected by us (+0.8%), the consensus (+0.7%) and the Reserve Bank (+0.9%).  Growth was strongest in the primary and goods-producing sectors.  Strongest contributions came from agriculture, mining and manufacturing.  Construction activity was down slightly over the quarter, but remains at a high level.

Despite the stronger than expected growth in the quarter annual growth came in at +3.2% yoy versus the expected +3.3%.  Annual growth in the year to June was revised down from +3.9% to +3.2%.  Annual average growth was +2.9% in the September year versus the expected +3.1%.

Lower than previously reported growth tells us productivity has not been as strong as we previously thought but also that output gap measures will now also be revised lower.  This helps explain recent inflation incomes that have continued to surprise on the downside.

Looking ahead I’m keeping my forecasts unchanged at this point which means I’m continuing to expect a period of above trend growth and that it will be appropriate for the RBNZ to resume interest rate hikes in the second half of next year.     

A "patient" FOMC

The Federal Open Market Committee (FOMC) today changed its forward guidance to indicate it can be patient in continuing to normalise monetary policy.  While it’s a shift in language they were at pains to insist that this is not a change in policy with the Committee seeing the change in language as consistent with its previous guidance and therefore not indicating an earlier than previously communicated increase in interest rates.

It was always going to be the case that at some point the Committee would be closer to rate hikes than the continued use of “considerable time” warranted.  Recent data has certainly been supportive of further progress towards policy normalisation being appropriate including jobs growth (payrolls), average hourly earnings and consumer spending.

The potential fly in the ointment for the Committee today was recent offshore developments including financial instability in Russia and sharply lower oil prices.  The Committee, rightly in my opinion, chose to stay focused on domestic growth and inflation considerations.

But in a nod to the lower oil prices the language around inflation was tweaked.  Out from the October statement was “the Committee judges that the likelihood of inflation running persistently below 2% has diminished somewhat since early this year” while included was “the Committee continues to monitor inflation developments closely”.

In the press conference Janet Yellen agreed with us (and, to be fair, the consensus view) that oil price falls will be a net positive for the US economy and that the inflation impact, while acknowledging the possibility of some spillover into core inflation, will prove to be transitory.  I agree, although I still think a significant spillover into core inflation may buy the Committee some time before hiking.  The Summary of Economic Projections shows lower than expected headline inflation in 2015 while core inflation is only slightly lower.

The statement also acknowledges further falls in inflation expectations, but point out that longer-term inflation expectations have remained stable.  Inflation expectations are important in determining the appropriate stance of monetary conditions but why expectations shift is just as important – they can also be due to factors that ultimately prove to be transitory.

The crux of the matter remains that underutilisation of labour resources continues to diminish and the Committee therefore expects inflation to rise gradually toward 2% as the labour market improves further.   Interest rate increases are coming.  I still think mid next year for the start of rate hikes with recent (domestic US) data suggesting risks around that timing are back to evenly balanced (rather than biased to later).

Thursday, December 11, 2014

RBNZ December Monetary Policy Statement

There was the proverbial “no surprises” from the Reserve Bank of New Zealand (RBNZ) this morning.  They left the Official Cash Rate (OCR) unchanged at 3.5%, pushed out the next rate hike to the back end of next year, reduced the total quantum of tightening and acknowledged both upside and downside risks.

The key point is that despite recent low inflation outcomes it is the RBNZ’s judgment that continued strong growth and the recent decline in the exchange rate will likely see inflation move higher next year and that in order to keep inflation and inflation expectations contained near the 2 percent target midpoint “some further modest tightening is likely to be required”.  I concur.

The RBNZ is expecting continued robust 3.0%-plus growth in the period ahead.  Near term forecasts are broadly the same as ours but we have growth coming off a bit faster in the back end of the projection period.

The Bank also see’s potential growth holding up better than I do.  It’s certainly the case that potential growth is strong right now at around the 3.0% level for all the reasons I’ve written about before.  The RBNZ sees this level being sustained through the projection period.  I’m not convinced.

But the key questions for today are when will the RBNZ start hiking rates again and how high will they have to go?  This tightening cycle was always going to carry more than the usual degree of uncertainties.  Key questions for the post-Global Financial Crisis environment  were, and to a large extent still are, where the neutral cash rate is, the level of potential growth and how households would responding to higher interest rates and new Loan to Value Ratio (LVR) restrictions.

In the Monetary Policy Statement today the RBNZ flagged three important considerations in determining how quickly and how far rates would need to rise: how actual pricing decisions interact with measures of capacity pressure and inflation expectations; how house price inflation develops in the face of still-low interest rates, strong net migration, restrictions on high loan to value ratio mortgage lending, and supply shortages; and how reduced dairy farm incomes affect spending.

The upside risk from housing and the downside risk to rural incomes and spending was reinforced this week with strong REINZ housing data out this weeks and the downward revision to the Fonterra payout.  And of course oil prices are lower since the RBNZ finalised their forecasts.

The RBNZs interest rate projections show interest rate increases beginning again from December next year.  The projected track has the 90-day bank bill rate rising gradually over the projection period to 4.5% at the end of 2017, a level that’s 30 bps lower than their September projections.  And of course with both upside and downside risks to the outlook, the RBNZ states that further policy adjustments will depend on data emerging over the assessment period.

For our take on the outlook for the New Zealand economy and monetary policy, have a look at our December edition of New Zealand Insights which you can find here.

Tuesday, December 2, 2014

The economics of lower oil prices

The price of oil has moved sharply lower over the last 5 months.  This has been the combined result of softening global demand and increased supply (from the US).  One factor that can normally be relied upon to lead to some stabilisation in times of price weakness is production cuts.  However, at its most recent meeting last month, OPEC left production levels unchanged.  This led to a further decline in prices towards the end of the month.  Prices (WTI, USD/bl) are now down close to 40% on the 2014 peak of US$107 per barrel seen in July.

The implications for oil producers are clear.  Lower exports revenues, lower growth and weaker current account balances – although lower currencies are assisting to varying extents.  And of course lower prices makes investment in new production capacity uneconomical.  Indeed some industry commentators are suggesting OPECs decision not to cut production is aimed at making further expansion of US shale oil production uneconomic.

At the global level there are a couple of important economic impacts.  Lower oil prices leaves more income in the hands of consumers to spend on other things – so it’s good for consumption and GDP growth.  And of course lower oil prices means lower inflation and reduced inflation expectations.  Sure many central banks focus on underlying or “core” measures of inflation but persistently low oil prices will also have an impact on core inflation in time.  All else being that means easier monetary conditions than would otherwise be the case.

In the United States, both an important consumer and increasingly important producer of oil, the impact of lower oil prices will be a net positive for the economy as the lower oil revenues and lower capital expenditure. But it also reinforces our view that the risks around a mid-2015 interest rate hike from the Fed is biased to later rather than earlier.

In Japan our concern this year is that the reduction in real incomes on the back of the recent tax hike.  Lower oil prices will provide a welcome offset to that.  But it also makes the Bank of Japan’s 2% inflation target even more challenging that it was already.  Similarly in the Euro zone the problem of already low inflation is exacerbated and makes the intended expansion of the ECB’s balance sheet more urgent.