Australian & New Zealand Weekly: RBA on Hold - Terms of Trade Boost Noted

Australian & New Zealand Weekly

Week beginning 30 June 2008

* Australia: RBA on hold - terms of trade boost noted.
* Aus data: credit, inflation gauge, retail, dwelling approvals & trade.
* New Zealand data: building consents, business & jobs confidence.
* ECB: President Trichet has signalled a rate rise.
* Eur CPI expected to approach 4% annual.
* US data: ISM's and payrolls the main focus.
* Key economic & financial forecasts.

Australia: RBA on Hold - Terms of Trade Boost Noted

The Reserve Bank Board meets on Tuesday July 1, with the result of their deliberations to be announced at 2:30 pm. We expect the Board will decide to leave rates unchanged.

Since the last Board meeting, when rates were also kept on hold, there have been a number of significant developments. The June Board Minutes which were released on June 17 were more "soothing" than the May Board Minutes. There was no reference in June to "members spent considerable time discussing the case for a further rise in the cash rate". In addition the Minutes referred to the Federal Budget as "mildly contractionary"; talked of business credit "slowing sharply" and anticipated that "a moderation in employment growth could be expected soon".

Of course that observation could be interpreted as prophetic since the June 12 employment report showed that there had actually been a contraction in jobs for the first time in 19 months, with job numbers falling by 19,700 in May.

However eleven days after the Board Meeting the Governor spoke of the economic outlook and allocated around 15 lines to evidence of the slowing economy and 55 lines to his concerns with the potential expansionary impact of the near 20% boost to the terms of trade, which has still to impact the income data.

This can be expected to work through the export numbers from April. The sharp leap in coal export prices has only just started to impact export data for March and April (27% increase in coal export prices assessed so far) and we are advised that the near 100% increase in iron ore prices will start impacting export values in the May data.

It is clear that the Bank is highly uncertain as to exactly how that stimulus will affect domestic spending. Recall that the RBA has forecast a slowdown in domestic spending growth from 6% in 2007 to around 2.5% in 2008 and holding there in 2009. That sequence of a sharp slowdown followed by a period of weak growth is assessed as necessary to reduce inflation from its current 4.25% to 2.75% by end 2010. The terms of trade will boost national incomes by 3% over this period.

We expect that the stimulus to spending and demand from this new income boost will be slow to come through and be much more muted than in previous stages of this commodity cycle. That is because firstly the government which collects one third of the surplus profits through taxes is unlikely to grant further tax cuts in the style of Howard/Costello as it fears "stoking" further inflation pressures. Another important channel is through an employment stimulus but we assess that labour shortages in the resources sector and its regions will mute the flexibility of resource companies to ratchet up hiring. In short, the spillover to spending and demand that the Reserve Bank fears is likely to be lagged and muted precluding the pressure to raise rates in 2008.

Further, we expect that the slowdown in global growth is likely to see a stalling of the terms of trade boom in 2009 (see figure). That would see a reversal of the income stimulus and may partly offset the lagged stimulus from 2008. Scrutiny of the impact on demand in 2004 following the initial follow through boost to the terms of trade shows that if domestic forces are sufficiently powerful (as we saw in 2004 when an abrupt reversal in the housing market slowed consumer spending) then the stimulatory impact on demand from a terms of trade boost may be limited.

We expect that in 2009 the lagged demand boost from the terms of trade rise will be offset by the downward momentum of domestic forces. However such a boost should be sufficient to limit the Bank's flexibility to cut rates in 2009.

The near term test for policy will come on July 23 when the June quarter CPI will be released. We believe that such is the Bank's desire not to tighten that it will be prepared to accept a higher starting point for inflation than the 4.2% it currently faces. For that starting point to increase we will need to see quarterly underlying inflation print above 0.9%. The last four reads have been: 0.9%; 0.9%; 1.1%; and 1.3%. With 0.9% dropping out, and given the recent sequence, it seems likely that annual inflation will rise.

Our early estimate for underlying inflation is in the 1.0-1.2% range, indicating that in annual terms underlying inflation will rise for the June quarter. However we expect that as long as the next quarterly read is below 1.3% the Bank can avoid another hike and argue that in a quarterly sense inflation has peaked.

Recall that all the Bank needs to do to avoid another rate hike in August is to argue that while its inflation task may have increased (needing to bring inflation down from say, 4.4% / 4.5% to 2.75% rather than 4.2% to 2.75%) the growth outlook has surprised on the downside since it last produced its inflation forecast.

Apart from the surprise reduction in jobs in May there has been other evidence to justify a weaker growth outlook than in May. Certainly business credit growth has stalled. In the three months to April business credit growth showed a 5% (annualised growth pace). That compared with a 25% annualised growth pace for the previous 3 months. Some of our customers have commented on how quickly activity appears to have slowed down. Credit market conditions have also deteriorated. Borrowing costs of AA banks are back close to the peaks of the recent crisis.

No doubt the Reserve Bank is receiving comparable anecdotal evidence from its surveys as indicated in the June Minutes. Despite persistent market pricing to the contrary we continue to stand by our view that rates have peaked in this cycle .

Australia: Data Wrap

Q2 job vacancies

• The quarterly ABS survey of job vacancies is less timely and more volatile than other measures of labour demand. The businesses included in the survey sample vary from quarter to quarter, and the data is only sampled on one day in the quarter, leaving results vulnerable to distortion from survey composition and timing. In fact, the May quarter is the final release of this series, with the survey not being conducted during 2008-09, although the Statistician said it may be reinstated for 2009-10.
• For what it's worth, the Q2 job vacancies report concurs with our other preferred leading indicators of employment in suggesting jobs growth resilience over 2008H2. Total job vacancies rose 3.4%qtr sa in Q2 after a 2.7% fall previously. This left their uptrend intact, although trend growth has slowed to 1.1%qtr (from 1.5%qtr prev), the weakest since 2005Q4. Annual trend growth slowed to 9.0%yr from 11.4%yr previously, down from a peak pace of 15.7%yr in 2006Q4 to its weakest since 2006Q2. Private sector vacancies rose 3.6% after a 3.0% fall previously, slowing trend growth to 1.1%qtr and 8.9%yr. Public sector vacancies rose 1.1% after a flat result previously, slowing trend growth to 1.1%qtr and 9.7%yr.
• With the slowing uptrend in vacancies, the trend vacancy rate edged up marginally to 1.69 from 1.68 previously, a new high. Historically, turning points in the vacancy rate have led turning points in annual jobs growth by around 6 months. The flattening of the uptrend in the vacancy rate is another pointer to resilience in jobs growth through 2008H2, concurring with our other preferred leading indicators of labour demand. For example, the Q2 read of our Westpac-ACCI Labour Market Composite Index remained consistent with only a gradual slowing in jobs growth through 2008H2 to a 2%yr pace.

Round-up of local data released last week

Date	Release	Previous	Latest	Mkt f/c
Thu 26	Q2 job vacancies		3.4%	-

New Zealand: The Week ahead & Economic Wrap

Stairway to recession

It was a week of data best forgotten. Q1 GDP was as just as dismal as expected, but there was little to cheer about elsewhere.

The week began with the RBNZ reporting a 1.1% fall in credit card transactions for May - in contrast to the official figures for electronic cards transactions, which recorded a 0.6% gain for the same month. These figures add to the uncertainty around retail sales - a sector that is already facing harsh times.

The Westpac Consumer Confidence survey hammered home this point, with a jaw-dropping decline in Q2. The index fell 15 points to 81.7 in June - the lowest level since the 1991 recession. The pressure on consumers has intensified over the past few months as sharply higher prices for everyday items such as food, fuel, and shelter have continued to eat into disposable incomes. Of these, the highly publicised rise in fuel prices is likely to be the main culprit. For the average household, the latest round of price increases since March translates into an extra $430 per year (assuming no volume response and prices remaining at current levels for the rest of the year). To that we can add a further 2% increase in food prices, a 5% decline in the currency which is putting upward pressure on import prices, falling house prices, rising unemployment, and increased debt servicing costs as people on fixed mortgages roll off onto markedly higher rates. It's no wonder consumers are feeling grumpy.

The current account deficit improved to 7.8% of GDP for the year to March 2008, but was significantly larger than we or the market were expecting. The trade balance slid back to a deficit of $127m, as the peak of the dairy bonanza and exports from the Tui oil field were outweighed by a sharp rise in both the price and volume of oil imports, and a sizeable jump in imports of plant and machinery. The other surprise was a fall in income earned by overseas subsidiaries of New Zealand companies. This would have to be a small and fairly idiosyncratic group, so reported earnings can be lumpy. We expect the trend improvement in the deficit to continue, but a whopping 40% increase in world oil prices in Q2 must take a toll in the near term.

Friday brought the keenly awaited GDP figures for Q1, which were widely seen as providing the first step towards recession. They didn't disappoint, printing at -0.3%, in line with market forecasts. Drought slammed agriculture output down by 5.6%, even larger than the sharp decline we had factored in. Dairy output fell by more than 12%, with declines also in lamb and beef production. This weakness flowed through to the manufacturing sector, with reduced primary processing, which is likely to be repeated in Q2.

Domestic demand has slowed abruptly. Household spending (private consumption) fell 0.4% in the quarter, as rising fuel and food prices, high interest rates and a slump in the housing market put a strain on consumer finances. While this was in line with our forecasts, it will be of concern to the RBNZ - we estimate that they had consumer spending rising in a range of 0.5% to 0.8% in their June forecasts. Again, household spending was likely even weaker in Q2, given the decline in consumer confidence. The slump in the housing market, due to high interest rates and slower net migration, saw residential construction fall 5.5%. Softer building activity pulled down GDP in the construction sector by 5.2%. The real estate and business services sector also contracted as house sales fell sharply.

Merchandise trade, which had the misfortune to be released at the same time as GDP, was weaker than expected at -$198m, and very weak for a May month. Exports were softer than expected, mainly due to an extremely low volume of dairy exports, down 29.7% on a year ago. Although the data have been volatile over the past few months, the overall effect of drought on export volumes is becoming clear, and has probably been more important than we initially thought.

Next week is much quieter on the data front, but no more promising. May building consents follow a mind-boggling 82% increase in April, as developers scrambled to beat an increase in fees on 1 May. We expect a 44% decline this time, but the risk is to the downside. Business confidence levelled out last month, but remains at levels consistent with recession. The clearer prospect of interest rate cuts may boost morale, but profits are still being squeezed from both sides. Finally, Q2 employment confidence is likely to remain gloomy - the economic news has deteriorated further since March, we have had confirmation than employment contracted unexpectedly in Q1, and there have been highly publicized layoffs by some key NZ firms. Overall, the evidence so far points to GDP growth in Q2 being even more negative than Q1, thereby meeting the technical definition of a recession.

Round-up of local data released last week

Date	Release	Previous	Latest
Mon 23 Jun	May credit card transactions	4.4%	-1.1%
Wed 25 Jun	Q2 consumer confidence	96.5	81.7
Thu 26 Jun	Q1 current account NZDmn s.a.	-3,117	-3,527
Fri 27 Jun	Q1 GDP %qtr	0.8%	-0.3%
	May merchandise trade NZDmn	-296	-196

Data previews

Aus May private credit

Jun 30, Last: 0.4%, WBC f/c: 0.6%

Mkt f/c: 0.6%, Range: 0.4% to 0.9%

• Credit growth has slowed appreciably as the RBA's aggressive tightening of monetary policy bites and in the wake of unsettled global financial markets.
• Credit expanded by just 0.4% in April, the weakest result since 2001 and followed gains of 0.6% in Feb and 0.8% in March. That is well off the avg. monthly pace of 1.2% over 20071.
• We're forecasting credit to increase by 0.6% in May.
• Housing credit growth, which was 0.75% in April, will continue to grind lower in the near-term given that new lending contracted sharply over the three months to April.
• Business credit hit a brick wall over the last three months, increasing by just 0.1% in April. This most likely overstates the underlying slow down. We expect a 0.7% rise in May.

Credit: business an abrupt correction

Aus RBA policy announcement

Jul 1, Last: 7.25%, WBC f/c: 7.25%

Mkt f/c: 7.25%

• The RBA left interest rates unchanged at 7.25% at their last three meetings and is almost certain to do so again in July.
• The RBA's aggressive tightening of monetary policy has already had a substantial impact on domestic demand. Accordingly, the Bank has moved to the sidelines to assess the full impact of past rate rises - compounded by the dampening effect of unsettled global markets.
• The June quarter CPI data, to be published on July 23, is the next major focus. This may show that quarterly core inflation has moderated in this environment of softer demand.
• However, the RBA remains uncertain about the outlook beyond that, with the concern that demand will get a second wind as the terms of trade jump boosts national income. This suggests that the risks to rates remains skewed to the high side.

RBA now on hold as prior hikes bite

Aus May retail sales

Jul 2, Last: -0.2%, WBC f/c: 0.1%

Mkt f/c: 0.1%, Range: -0.3% to 0.7%

• Retail sales continued to weaken in April, falling 0.2%. This followed a 0.2% rise in March and 0.1% declines in Jan and Feb. Consumers are tightening spending in response to higher interest rates and rising fuel prices.
• May should see a slight firming of +0.1%. Fuel prices continued to rise in May (+2.6%) but official rates were unchanged and there were no market-led moves either. Retailers also brought forward winter sales. While the response has reportedly been muted, the last time this happened, in 2005, sales rose 1.4%.
• The overall backdrop for consumers remains negative though. Sentiment posted a slight rise in May (+2.7%) and equity markets bounced (+4.2%) but both were still well down on year ago levels and saw renewed falls in June. Employment also fell 0.2% in May suggesting slower income gains.

Retail sales stall

Aus May dwelling approvals

Jul 2, Last: 7.8%, WBC f/c: -5.0%

Mkt f/c: -3.0%, Range: -7.0% to 5.0%

• Dwelling approvals jumped 7.8% in April led by a sharp spike in apartment approvals. The gain followed a 5.5% fall in March and substantial declines in the previous four months.
• Clearly the spike in apartments will reverse in May. The private houses component should also decline after a somewhat surprising 1.3% gain in April. With mortgage interest rates up 140bps since August, housing markets are coming under intense pressure with finance approvals down 17% since their January peak. That said, an acute shortage of housing should prevent a sharp post-GST style slump. Indeed, finance approvals for the construction of new dwellings have been relatively steady compared to total finance approvals.
• Overall we expect a 5.0% decline in dwelling approvals in May with risks to the downside.

Dwelling approvals

Aus May international trade balance, AUDbn

Jul 3, Last: -$0.957bn, WBC f/c: -$1.4bn

Mkt f/c: -$0.95bn, Range: -$1.6bn to $0.4bn

• The deficit fell $1591mn in Apr to $0.957bn, the lowest since Feb-07. Exports surged 5.8% led by a 7.4% jump in non-rural as the terms of trade boost began to flow through to coal prices and volumes built upon March's gains. Imports fell 2.2%.
• The May data will include the new iron ore contract prices (Rio's up 85% v last yr) and revise April's data also. We assume that 50% of iron ore is sold at a price 85% above a year ago, and the rest at spot prices. Combined with other non-rural volume gains, we expect a 6.5% non-rural X rise from the originally published Apr level, but with rural X down 4% and near flat services, we expect a 4% rise (from originally reported April level) for total X.
• X rise will be swamped by a 6% imports jump (goods 7.4%), lifting the deficit to $1.4bn (risks of a lower deficit from higher % of iron ore at contract price & Apr deficit will be revised lower).

Deficit up: NR led X rise swamped by M jump

NZ May building consents s.a.

Jun 30, Last: 82%, WBC f/c: -45%

• April dwelling consents surged by a mind-boggling 82% m/m as Easter timing issues were exacerbated by lumpy apartments as developers brought forward applications in order to avoid an increase in fees from 1 May.
• We expect almost half of that increase to unwind in May, with total consents down 45% in the month. But the risk is on the downside. Housing turnover provides a good 3-month lead on monthly building consents, and at current levels, they suggest consents should only be around 1400 per month rather than the 2800 reported in April.
• Continued weakness in non-residential consents is expected given poor confidence, weak economic growth and tight credit conditions.

Housing activity monthly, seasonally adjusted

NZ Jun NBNZ business confidence

Jun 30, Last: -49.7%

• General business confidence and own activity expectations levelled out last month, but remain at levels consistent with recession.
• The recovery looks to be some way away yet, though the RBNZ's clear signal for lower interest rates later this year may help to boost morale.
• Soaring fuel prices have put paid to any chance of a moderation in inflation expectations and pricing intentions.

NBNZ business confidence

NZ Q2 employment confidence index

Jul 1, Last: 128.8

• T he Westpac McDermott Miller employment confidence index fell 4.7 points to 128.8 in the March 2008 quarter, the biggest quarterly decline since the survey began in 2004.
• In March, talk of recession, rising business pessimism, and a sharp correction in the housing market (implying a contraction in the residential construction industry), all pointed to a moderation in the demand for labour, resulting in reduced job security and lower confidence.
• Since then, the economic news has deteriorated further. Employment contracted unexpectedly in Q1, and there have been highly publicized layoffs by some key NZ firms.
• All of these factors are expected to weigh heavily on employment confidence in Q2.

NZ Employment Confidence Indices

US Jun ISM factory and non-manufacturing surveys

Jul 1, Factory Last: 49.6, WBC f/c: 49.0

Jul 3, Non-man Last: 52.0, WBC f/c: 49.0

• The factory ISM headline has been in contractionary territory for the past four months although in May the headline was the highest since January and the production measure rose back above 50. But signals from the regional Fed factory surveys out of New York, Philadelphia and Richmond Fed were all weaker in June, and orders of capital equipment fell 0.8% in May. We sense that the economy is slowing again heading into Q3 so a renewed dip in the ISM headline to 49 or below is expected.
• The non-manufacturing ISM was below 50 right through Q1 but rose back into positive territory in April and May. The only evidence re June services activity we have to date is a weak Richmond Fed (not a reliable signal), but given our view that the economy is slipping again, this indicator should also soon head back below 50. Our June forecast is 49.0.

US ISM surveys

European Central Bank to tighten, just once

Jul 3, ECB Last: 4.0%, WBC f/c: 4.25%

• The ECB left rates on hold at 4.0% after the June 5 Council meeting but President Trichet said the risks to price stability had "further increased" and the Council was now "in a state of heightened alertness" - comments he repeated on June 25. He explained that the on hold decision was not unanimous; some wanted to lift rates; and it was "not excluded" that rates might be lifted by a "small amount" next month.
• With May CPI revised to a record high of 3.7% and 4% possible in June, other Council members echoing Trichet's sentiments and none offering a dovish perspective, we have to accept that a rate rise is now more likely than not. But Trichet himself has stressed he is not hinting at a "series of increases". Indeed recent survey evidence points to renewed economic weakness in H2 2008, which should prevent the ECB from hiking yet again and may allow for modest ECB easing in 2009.

ECB & BoE official interest rates

US Jun non-farm payrolls

Jul 3, Payrolls ch' Last: -49k, WBC f/c: -70k

Jul 3, Unemployment rate % Last: 5.5%, WBC f/c: 5.3%

• Payroll employment has averaged declines of around 65k per month so far this year, and the jobless rate has been trending higher, although teenage school-leavers hitting the numbers earlier than usual exaggerated May's 0.5 ppt rate jump to 5.5%.
• US GDP has barely grown since the end of Q3 last year. Confidence in the job market collapsed in June. The numbers receiving unemployment insurance payments rose to the highest in more than 4 years in the payrolls survey week. These factors point to ongoing payrolls job losses - perhaps a little steeper than trend this month given the recent extra weakness in most partial data since mid June.
• We see unemployment at 6% later this year but June may see a temporary dip back to 5.3% as the May teenager factor reverses.

US jobs market

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