Wednesday, May 27, 2015

Tweaking global growth

With first estimates of March 2015 quarter GDP data for many of the world’s major economies it’s timely to take a fresh look at the outlook for global growth.  The biggest tweaks are as follows:
  1. US GDP barely expanded in the first quarter of 2015 and will likely be revised down to a negative number with the release of the second estimate later this week.  There were many reasons for the weakness with some (weather, port strike) likely to be transitory while others (higher dollar) are likely to be a continued drag on growth.  The surprise was sharp increase in inventories over the quarter which will have a negative impact on activity growth over the next few months.  Inventories appear likely to be revised down in this week’s second estimate but for now it’s prudent to knock my calendar 2015 annual average forecast back from 3.0% to 2.6%.
  2. Recent activity data out of Japan has been mixed.  Our view has been that growth will remain only modest at best though Q1 GDP growth came in stronger than expected.  However, in similar fashion to the US, there was strong inventory investment over the quarter which seems likely to have a negative impact on growth in the period ahead.  Final demand (consumption) will get a small boost over the next couple of quarters but we expect growth to remain modest overall.  Expect growth of 0.8% this year, down from the earlier estimate of 1.0%.
  3. Euro zone GDP growth was a better than expected 0.4% qoq in Q1 although there were some surprises in the mix with Germany weaker than expected while France and Italy came in stronger than expected.  While France and Italy still worry me I’ve “banked” the upside surprise and nudged growth up a bit for Q2 and Q3, largely on the back of improved credit growth.  That is now expected to deliver 1.4% growth this year, up from the earlier estimate of 1.2%.
  4. Russia is still expected to be in deep recession this year.  That said Q1 data was a bit stronger than expected and interest rates have come down a bit more quickly than expected.  The higher oil price will also help take the rough edges off but Russia will continue to struggle while sanctions remain in place.  I’m now picking a recession of -3.5% this year, up from the previous estimate of -4.0%.
  5. I haven’t changed the forecasts for China, India and Brazil but in all three cases risks are biased to the downside.  The trend decline in activity data in China continues and we expect GDP growth of around 6.7% for the year to June but then for policy easing and stabilisation in the property market to provide some upside to growth into year-end.  So I’m sticking with calendar year annual average growth of 6.8% for now.  In India signs aren’t good for the monsoon season so the risk to expected 2015 growth of 8.0% is to the downside.  In Brazil, risks to our forecast of a mild recession of -0.5% are also to the downside given contractionary monetary and fiscal policy.

Adding that all up still gives a picture of modestly higher developed economy growth this year compared with last year while emerging market growth is expected to be lower.  Global growth is expected at 3.3% this year, a fraction lower than the 3.4% achieved in 2014.  Global growth then picks up to 3.8% next year with faster growth in both developed and emerging economies.  The good news for markets is that in every case, central banks are responding appropriately to their own unique set of circumstances.

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.

Wednesday, May 6, 2015

Around the world by central bank (Part I)

One of our key themes for 2015 was the extent to which the monetary policy outlook amongst both the key developed and emerging economies would become divergent as growth and the inflation outlook diverged.  That remains the case although in some countries there have been shifts in the timing of next moves.  And in one important case, the central bank’s bias has recently shifted from tightening through neutral to an easing bias.    

This post covers developed economies, emerging economies tomorrow.

US Federal Reserve

The latest FOMC statement shed little new light on the timing of “lift off” in US interest rates.  However the tone of  the economic assessment was more cautious reflecting the poor Q1 GDP result (+0.2% saar) and the uncertainty about how much of the weakness will ultimately prove transitory.  Inflation measures remain mixed with core CPI and PPI ticking up recently but the Fed’s preferred measure of inflation, the core personal consumption expenditure deflator, remains low with the annual rate now at +1.3%. 

However, the recent move higher in the employment cost index to +2.6% yoy, the highest rate since 2008, will give the FOMC confidence that inflation will likely move higher in time and that zero interest rates will soon no longer be appropriate.  Given the weak Q1 GDP result a June start to the hiking cycle appears unlikely with September now the first likely opportunity for “lift-off”.  But that requires data between now and then to show a meaningful bounce back in growth.  The risk is lift-off occurs later still.

European Central Bank

Inflation and financial data out of the Euro zone data with credit growth improving and headline back up to zero following its brief flirtation with (technical) deflation.  However core inflation remains undesirably low at only +0.6% yoy.  Broader financial conditions continue their slow improvement with bank lending to the private sector recording its first annual increase in 3 years. For the past year to March, total credit has risen by +0.1%. Residential mortgage lending is mildly positive at +0.2% on an annual basis however corporate lending is still negative at -0.6% yoy.

We have recently revised up our growth forecast for this year to +1.4% but there is still a long way to go before the ECB can be confident of any sustained improvement in the inflation outlook.  Spare capacity remains significant, most evident in the labour market with the euro zone unemployment rate at 11.3%. 

We therefore expect inflation to remain low with little scope for the ECB to reduce its asset purchase program before September next year.  In fact the risk appears to me that the program gets extended.

Bank of Japan

It’s a similar story in Japan where the recovery from last year’s recession is, at best, patchy.  The latest disappointment was March industrial production which slipped again by -0.3% to be down by -1.2% for the past year.

The BoJ is maintaining a steady course with their aggressive monetary policy settings. April’s BoJ meeting reaffirmed the Yen 80 trillion annual asset purchase target.  The BoJ marginally tempered their GDP growth forecasts by -0.1% for the next 2 years with Fiscal Year 2015 now at 2% growth and FY 2016 at 1.5% growth. The Bank also lowered its inflation forecasts and pushed out the time by which they expect to achieve their 2% inflation target to “around the first half of FY2016”.

We believe the BoJ remains overly optimistic on the outlook for both growth and inflation.  As the data continues to undershoot their expectations, the BoJ appears likely to adopt additional easing measures. 

Bank of England

Like the US the UK economy also suffered a weak Q1 growth result (+0.3% qoq) which is also likely to prove temporary, at least in part.  Underlying momentum in the economy continues to look reasonably solid.  However the weaker start to the year means that growth for calendar 2015 is now likely to come in softer than expected earlier at 2.7%.

Even with that slightly softer growth performance we expect spare capacity to continue to be absorbed with the unemployment rate likely to be close to 5% by the end of the year.  While the BoE is on hold for the next few months, we expect an increase in interest rates in early 2016.

Reserve Bank of Australia

The Reserve Bank of Australia (RBA) lowered the official cash interest rate by 0.25% to 2.0% yesterday. This is the second interest rate cut this year with the cash rate now at a record low.  Recent cuts reflect below trend growth and significant spare capacity as evidenced by the high unemployment rate. 

However in its statement yesterday the RBA notably removed the previous comments indicating “a further easing of policy may be appropriate”.  Hence the RBA now has a neutral stance on monetary policy, implying no immediate prospect for a further interest rate cut. The AMP Capital team in Sydney expects the RBA is likely to keep interest rates on hold over coming months.

Reserve Bank of New Zealand

The RBNZ adopted an easing bias at the April OCR review.  More precisely the Bank says “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”.  So it’s a bias to ease with a set of conditions that seems unlikely to be (collectively) met – at least in the near term. 

That’s despite today’s labour market data coming in generally softer than expected.  Employment growth came in much as expected at +0.7% qoq reflecting solid growth in the economy, however the unemployment rate remained unchanged at 5.8% (a drop to 5.5% was expected) given another strong increase in the working age population.  The Labour Cost Index (unit labour costs) came in softer than expected too.

Looking ahead we expect GDP growth to remain relatively robust, though not as robust as the Bank, and for that to put pressure on resources in time, particularly in the labour market.  That said there are downside risks to growth from weaker dairy prices (down again overnight) and the strong New Zealand dollar.

So I’m not ready to join the growing chorus for interest rate cuts, at least not yet.  At this point I’m sticking to the view that interest rates are on hold for the foreseeable future and where interest rates go next is a story for next year.  For more on the outlook for the New Zealand economy and interest rates in the next issue of New Zealand Insights.