Monthly Economic Indicators January 2016

Executive Summary#

Analysis#

Data released over December and January point to stronger economic growth over the second half of 2015 than in the first. Real GDP growth of 0.9% in the September quarter was stronger than anticipated in the Half Year Update (HYEFU) and partial indicators suggest growth momentum will persist into the December quarter. Improved business and consumer sentiment, reduced drought risk, and ongoing increases in migration, tourism and construction activity suggest growth over 2016 may accelerate to around 2.5%, a little higher than expected in the HYEFU. However, subdued pricing pressures, as evidenced by the lowest annual CPI inflation outturn since 1999, and low prices for key exports, notably dairy, suggest some downside risks to nominal GDP growth.

Solid economic growth in September quarter#

Real production GDP rose 0.9% in the September quarter, taking growth in the year to September to 2.9% (Figure 1). Growth in the quarter was chiefly driven by services industries (+0.9%). The outturn was above the 2.7% annual average growth anticipated in HYEFU, although some of the difference was owing to the incorporation of annual benchmarks which raised the level of real GDP.

Figure 1: Real production GDP growth

Source:  Statistics NZ

Real expenditure GDP growth was somewhat higher, at 1.2% in the September quarter and 3.4% in the year to September. Nominal GDP growth was lower, at 0.6% in the quarter, as the weaker terms of trade (down 3.8%) offset some of the strength in real GDP.

Business activity picked up in the December quarter. . .#

Results from the Quarterly Survey of Business Opinion (QSBO) suggest that growth momentum has continued into the December quarter. A net 18% of firms experienced an increase in domestic trading activity in the quarter, up from 12% in the previous quarter. The trading activity measure, which is usually a reliable indicator of GDP growth, suggests that there is some upside risk to the HYEFU forecast of 0.6% growth in the December quarter.

The business confidence measure rebounded strongly, with a net 13% of firms expecting the general business environment to improve over the next 6 months, from -10% in the previous quarter (Figure 2). This is consistent with developments in the ANZ Business Outlook survey, which also pointed to a recovery in confidence. However, the headline measure masks some important regional disparities. While the QSBO does not measure farmers directly, confidence remained negative in rural regions hit hardest by falling dairy prices and dry weather, including Northland, Bay of Plenty and Taranaki.

Figure 2: Business confidence

Source:  ANZ, NZIER

A net 15% of firms reported an increase in employees and employment intentions, while little changed, remained positive. This is consistent with our expectations of modest employment growth in the December quarter and over the first half of 2016. An increase in the difficulty of finding both skilled and unskilled labour may be indicative of a slight tightening in the labour market. Investment intentions eased slightly but remain on par with their five-year average.

. . .but pricing pressures remain subdued#

The QSBO also pointed to pricing pressures remaining subdued. A net 3% of firms reported an increase in selling prices over the three months to December, while a net 9% expect to increase prices in the coming three months.

Subdued pricing pressures were evident in the Consumers Price Index (CPI), which fell 0.5% in the December quarter, chiefly as a result of lower prices for food and petrol (Figure 3). Although tradables prices, which fell 1.8%, were the main driver of the decline in the quarter, non-tradables inflation was fairly low at 0.5%.

Figure 3: Consumers Price Index Inflation

Source:  Statistics NZ

The quarterly outturn saw annual CPI inflation fall to 0.1%, its slowest pace since 1999. Although annual non-tradables inflation picked up from the previous quarter to 1.8%, it remains close to a 14-year low.

Tradables inflation is expected to face ongoing headwinds in the near term, chiefly owing to recent declines in oil prices. That said, the exchange rate depreciation which occurred in mid 2015 is expected to provide some offset. As oil prices stabilise, tradables inflation should begin to pick up from late 2016. Non-tradables inflation is expected to remain subdued in the near term, given our estimate of spare capacity in the economy. Overall, annual headline inflation is expected to gradually pick up over 2016, in line with the Half Year Update. However, the annual rate will be lower given the weaker December result.

After reducing the Official Cash Rate (OCR) to 2.5% in December, the Reserve Bank remained on hold in January but stated that “some further policy easing may be required over the coming year”. The inflation outturns have raised market expectations of further reductions in the OCR this year, with some analysts calling for cuts as early as March.

Consumers remain confident. . .#

Private consumption expanded by 0.6% in the September quarter, with annual average growth easing to 2.4%. Growth in household services was particularly sluggish, although from a statistical standpoint this may partly reflect an increased proportion of total services expenditure being allocated to foreign tourists (i.e. travel service exports).

The total value of electronic cards transactions increased by 0.6% in the quarter (seasonally adjusted), in line with expectations for nominal private consumption in the Half Year Update. The weak CPI outturn suggests that the increase in card transaction values was driven by greater levels of activity rather than higher prices, which in turn indicates solid growth in real private consumption in the December quarter. This view is supported by continuing strength in consumer confidence, which increased in January according to the ANZ survey (after accounting for the usual holiday-season boost).

Total consumption is being bolstered by high net migration. Annual net migration reached a new record high of 63,700 in November. The annual growth continues to be driven by low levels of departures and increasing arrivals (Figure 4). For the eighth month in a row there was a positive net monthly gain from Australia, which appears slightly at odds with the relative labour market situation - Australian unemployment at 5.8% in December compared to New Zealand’s 6.0% in September.

Figure 4: Annual migration

Source:  Statistics NZ

. . .and residential investment continues to pick up#

Residential investment activity increased by 0.9% in the September quarter, a more subdued pace of expansion than anticipated in the Half Year Update. However, building consents and sales transaction data point to stronger residential investment growth in the December and March quarters of around 3% and 2% respectively. The seasonally adjusted number of new residential building consents rose 1.8% in November, taking growth in the year to November to 9.1%.

Growth in recent months has been driven by Auckland and, to a lesser extent, other North Island regions, as high levels of house price growth continue to signal a supply and demand imbalance. Consents were stable in Canterbury, consistent with the plateauing of the Canterbury residential rebuild. Solid growth in consents for apartments and townhouses, flats and units suggests rapid growth in urban land and house prices (particularly in Auckland) are encouraging increased residential intensification (Figure 5).

Figure 5: Residential consents

Source:  Statistics NZ

The national median house price rose 1.6% in December (seasonally adjusted), chiefly owing to a 1.8% increase in Auckland median prices. After a brief hiatus while regulatory changes were digested, sales volumes in Auckland rebounded in December, although they remain lower than a year ago. The relaxation of LVR restrictions and greater relative affordability outside of Auckland supported housing demand in the rest of the North Island, particularly in Waikato where sales volumes were 30% higher than a year ago.

The current account deficit narrowed. . .#

The annual current account deficit narrowed to 3.3% of GDP in September, from 3.4% in June. The narrowing of the current account deficit was driven by a widening of the services surplus to 1.4% of GDP (from 1.1%), which was only partly offset by further deterioration in the goods balance to -0.8% of GDP (from -0.6%). The primary and secondary income balances were little changed.

Most of the increase in the services surplus was owing to the ongoing strength of other personal travel services exports (chiefly tourism), which were 37% higher in the year to September. This strength appears to have continued into the December quarter. Short term visitor arrivals were 11.1% higher in November compared to a year ago, with annual visitor arrivals up 8.9% to 3.09 million, a new record (Figure 6). The visitor arrival data suggest some upside risk to the forecast for services exports in the Half Year Update. Travel services exports are expected to remain buoyant over coming quarters, reflecting the continuing growth in Chinese visitors as well as the competitiveness boost from a lower New Zealand dollar. This is expected to keep the services surplus at high levels in coming quarters.

Figure 6: Short term visitor arrivals

Source:  Statistics NZ

. . .despite renewed falls in the terms of trade#

New Zealand’s total terms of trade renewed its downward trajectory, falling 3.8% in the September quarter. Export commodity prices have remained weak, with the ANZ commodity price index indicating further falls in the terms of trade are likely in coming quarters, in line with our forecast (Figure 6). However, the sharp falls in oil prices since late 2015 (see next page for further details) may provide some offset in the terms of trade, both through their direct impact on mineral fuel import prices and indirectly through the impact on other goods prices and transport costs.

Although the terms of trade declined, net exports increased in the September quarter, making an overall large positive contribution to real expenditure GDP growth and the narrowing of the current account deficit. Import volumes fell by 2.8% in the quarter, making the largest positive contribution to expenditure GDP growth of any major component. Lower volumes of intermediate goods, fuel and services drove the decline, partly offset by increases in capital and consumption goods. The fall in services imports likely reflects the effect of the lower exchange rate, with values broadly flat in the quarter. Lower intermediate goods volumes may be partly attributable to reduced demand for dairy feed. Real exports increased by 1.9% in the quarter, chiefly owing to large increases in dairy and meat export volumes, although these appear to have been at least partly met from inventories, and steady growth in services exports.

Figure 7: Terms of trade and commodity prices

Source:  Statistics NZ, ANZ

Dairy prices have remained fairly flat, with modest increases at the December GDT auctions mostly offset by modest declines in the January auctions. Although domestic milk production is down 2.6% season to date, global milk production continues to grow and demand remains tepid, weighing on prices. In response to the dairy price outlook, Fonterra reduced its milk price forecast from $4.60/kg MS to $4.15/kg MS, slightly lower than analysts’ expectations. Open Country, New Zealand’s second largest dairy processor, cut its milk price payout to a similar level of $4.00 - 4.30/kg MS earlier in January.

Dry weather conditions at the end of 2015 were adding further pressure on dairy farmers and the agricultural sector more generally. January has seen good rainfall across much of the country, helping to alleviate soil moisture deficits. While the threat of drought has diminished recently, it remains a significant risk. Precautionary measures by farmers (such as an earlier pattern of livestock slaughter) still appear to be prudent and will have led to reductions in total output for the season already.

Overseas merchandise trade data for the December quarter point to further widening of the goods deficit. The annual merchandise trade deficit widened to $3.5 billion in December, from $3.2 billion in September. While the goods deficit continues to widen as expected in the Half Year Update, the strength of services exports and a potentially lower fuel import bill suggest that the current account deficit may peak at a lower level than the 6.0% we were anticipating.

Overall, domestic economic growth looks to have picked up over the second half of 2015#

After growing at just 0.5% in the first half of 2015, quarterly growth picked up to 0.9% in September quarter and partial indicators of the December quarter suggest growth of 0.6 - 0.8%. As such, the Half Year Update forecast of 0.6% growth in December quarter remains appropriate but subject to some upside risk. Economic growth is expected to continue at around this quarterly pace throughout 2016, as domestic demand growth remains moderate and net export growth is likely to slow. Although the threat of drought has recently receded, it remains a risk to the economic outlook over the first half of 2016.

Rocky start to 2016 for global economy#

It has been a shaky start to 2016 as renewed concerns over China‘s economy led to heightened volatility in financial markets. Global equity markets have declined and demand for safe-haven assets increased. From early December, the Shanghai Composite is down around 24%, the S&P 500 is down around 8%, and US 10-year yields are down more than 25 basis points, although there was some stabilisation in markets at the end of January.

Economic data continue to point to ongoing recovery in the US (although the outlook has been revised lower) as the Federal Reserve (Fed) increased its policy rate in early December for the first time in almost a decade. Growth has continued to slow in China as the economy rebalances from investment to consumption. Muted global demand has kept downward pressure on commodity prices, particularly oil which has also been affected by increased supply. The price of Brent oil fell below US $30/bbl (a 12-year low), from around $44/bbl in early December, and in late January was just above $30/bbl.

Reflecting these developments, the IMF lowered its outlook for global growth in 2016 and 2017 by 0.2% points each to 3.4% and 3.6% respectively, as a result of more gradual growth in developing economies, particularly Brazil, where recession is likely to persist for longer than expected, and a steadying of growth in the US as the stronger US dollar constrains manufacturing activity and lower oil prices affect mining investment.

Fed tightens as US recovery continues. . .#

The US recovery continues, but data have been mixed with ongoing momentum in the labour market and soft headline inflation. The labour market strengthened in December, with non-farm payrolls growth of 292,000, well above expectations for 200,000. Hourly earnings rose 2.5% annually in December and the unemployment rate was unchanged at 5.0%.That said, December CPI inflation was below expectations, falling 0.1% point, to be up 0.7% in the year, reflecting low oil prices. Annual core inflation (which excludes food and energy) was 2.1%, up 0.1% point from November.

Figure 8: US inflation and Federal funds rate

Source:  Haver

As expected, the Fed increased its policy rate 25 basis points to 0.25% - 0.50% in December and held in January (Figure 8). The Committee noted that ongoing accommodative monetary policy and improved labour market conditions are expected to return personal consumption expenditure inflation (the Fed’s preferred measure) to the 2% target over the medium term. In the lead-up to the increase, there was concern among analysts that markets may respond adversely. However, because the increase was widely anticipated, the reaction was relatively muted. Market pricing is for only one further increase in 2016, much less than the Fed’s December projections which showed four 25 basis point increases.

. . .and China’s growth continues to slow#

China’s economy expanded 6.8% in the year to December, below expectations and the weakest growth rate since 2009. That said, the data continue to show the economy is rebalancing from investment to consumption, with tertiary industry (services) growth of 8.1% continuing to be the key driver of growth, but it has slowed from 8.6% in September. Growth in secondary industry (chiefly construction and manufacturing) remained low at 5.9% (Figure 9).

Figure 9: China's GDP

Source:  Haver

Evidence of rebalancing can also be seen in other data as manufacturing growth slows more than consumption. Annual industrial production growth fell to 5.9% in December from 6.2% in November, and fixed asset investment growth fell to 10.0%, its slowest rate since 2000. Retail sales grew 11.1%, down from 11.2% in November but above the 2015 average.

Reflecting slowing growth, inflationary pressures have remained muted, with annual inflation increasing 0.1% points from November to 1.6% in December, well below the government’s 3% target. Core inflation was 1.5%, unchanged from October. Analysts expect further stimulus by authorities in the first half of the year.

Australian labour market strengthens#

Continuing strength in Australia’s labour market suggests the transition from mining investment to consumption remains on track. Employment increased 2.6% from a year ago in December 2015 and the unemployment rate fell to 5.8%. However, there is some scepticism that employment growth is as strong as the official figures suggest as economic growth remains below trend. Consumer confidence fell in December, and retail sales in November increased 4.3% from a year ago, below the 2014 average. CPI inflation picked up slightly in the December quarter but remained relatively low. Annual headline inflation was 1.7% and core inflation was 2.0%, at the bottom of the RBA’s target band of 2% - 3%. A rate cut by the RBA is now considered less likely, but markets are still pricing in a single 25 basis point cut by September.

Euro area outlook deteriorates#

In December the ECB extended its asset purchase programme until at least March 2017 and cut its deposit rate 10 basis points to -0.3%. However, these moves disappointed markets and the euro strengthened slightly. Despite recent economic data being reasonably positive, the outlook for growth and inflation has weakened in early 2015 as growth slows in emerging economies (an important export market, particularly for Germany), confidence is affected by financial market volatility and geopolitical risks, and falling commodity prices will keep inflation low. In a recent speech, ECB President Draghi indicated that further monetary support was likely, possibly as soon as March. This announcement brought some stability to financial markets.

UK recovery continues, but slowing#

The UK recovery continues but at a slower pace, with little inflationary pressures emerging. Labour market data were mixed with the unemployment rate declining to 5.1% in the three months to November and strong employment growth of 1.9% from a year ago. However, annual earnings growth remained soft at 2.1%. Headline and core inflation were at their highest since the beginning of 2015 (0.2% and 1.4% respectively), but remain well below the post-2009 average. The Bank of England kept its policy rate unchanged at 0.5% in January and markets expect the Bank to remain on hold over 2016 as the Governor commented that “now is not the time to raise rates”.

The overall global economic outlook is weaker#

Overall, the outlook for the global economy has weakened significantly since late 2015 as growth in emerging economies (particularly Brazil, Russia and China) slows and the recovery in the developed economies (notably the US and UK) steadies rather than accelerates. So far, lower oil prices have not provided a boost to consumer demand, the scope for further monetary stimulus is limited (and there are doubts about its impact), and weaker trade growth and lower commodity prices are reinforcing the weaker outlook.

Special Topic: Decomposing New Zealand's Terms of Trade#

New Zealand is a small open economy that relies on its external sector as a source of economic growth and development. As a result, New Zealand’s terms of trade, the ratio of export prices to import prices, are a key economic measure. An increase in the terms of trade allows a country to purchase more imports for a given quantity of exports. Changes in the terms of trade can have substantial impacts on the economy as a whole, directly through the impact on export revenues and indirectly through the impact of imported goods and services prices on domestic costs and prices. As a result, the terms of trade are a significant driver of changes in nominal GDP and, consequently, tax revenues.

A recent Treasury Working Paper develops a technique to decompose New Zealand’s terms of trade into the contributions from different components of the export and import baskets. [1] The first part of this special topic examines how New Zealand’s terms of trade have evolved over time. The second part decomposes the terms of trade forecast from the Half Year Update.

New Zealand’s terms of trade have risen substantially since the mid 2000s#

New Zealand’s total terms of trade were relatively stable throughout the 1990s and into the early 2000s (Figure 10). Since the mid 2000s, the terms of trade have trended higher although with a much wider cyclical range. Nonetheless, volatility is still much lower than in the 1960s and 1970s. In the March 2014 quarter the terms of trade reached a 41-year high.

Figure 10: Goods terms of trade

Source:  Statistics New Zealand

Decomposition methodology#

The decomposition technique described in the paper decomposes the percentage change in the terms of trade into the contributions from different export and import components, e.g. the contribution from dairy exports, the contribution from mineral fuel imports etc. [2] These contributions can then be further split into the contribution owing to a change in deflators (prices) and the contribution from a change in that component’s share of the export or import basket, i.e. the component’s relative weighting in the terms of trade. The decomposition can be undertaken for both adjacent periods (i.e. year-on-year or quarter-on-quarter) and for non-adjacent periods (e.g. the change from 1995 to 2015).

Rising export prices have made the largest positive contribution to the terms of trade over the past two decades...#

Figure 11 shows the decomposition of the terms of trade to the year to March 2015. [3] Each column refers to a non-adjacent decomposition of the terms of trade, i.e. 1991 shows the decomposition between 1991 and 2015, 1992 shows the decomposition between 1992 and 2015, and so on. The crosses show the actual change in the terms of trade between the start and end point. The contributions by each component have been partially aggregated to show high-level trends.

Figure 11: Terms of trade decomposition

Source:  Statistics New Zealand, the Treasury

Increases in export prices have made the largest contribution to the terms of trade over the past two decades (dark blue bars). Dairy prices have been one of the larger contributors, although there have been price gains across all export components for most of the longer term decompositions.

While export prices have contributed to gains in the terms of trade, the composition of exports has not had a material impact (green bars). In particular, the shift in the weighting of the export basket from meat towards dairy had a relatively neutral impact in terms of contribution to changes in the terms of trade. This is because prices for both have increased over time, so the positive “weighting effect” for dairy (positive price change x increase in weighting) was offset by a negative effect for meat (positive price change x decrease in weighting).

. . .although the changing composition of imports has also made a significant positive contribution#

In contrast, the change in the composition of imports has had a material impact (light grey bars). Capital goods and, to a lesser extent, consumer goods have steadily increased as a share of imports in real terms as their prices have generally declined, while intermediate goods and mineral fuels have decreased as their prices increased. The positive compositional effects have acted to partially offset the overall negative contribution to the terms of trade that increasing import prices have made. Most of the adjustment in import composition took place in the period up to the early 2000s.

Overall, the adjustment in import composition appears to be consistent with the aggregation of rational responses by firms and households to changing relative prices. That is, as consumer and capital goods have fallen in price, consumers and firms have demanded relatively more of them, while the economy has become more fuel-efficient in response to higher fuel prices. Since the GFC the compositional effect has faded but import prices have been in overall decline, making a positive contribution to the terms of trade (light blue bars).

Decomposition of the Half Year Update terms of trade forecast#

The decomposition technique was initially developed to better understand Treasury’s terms of trade forecast. Figure 12 shows the year-on-year decomposition of the Half Year Update terms of trade forecast.

The large influence dairy prices have on the terms of trade in recent years is apparent in the chart. In the year to March 2015, dairy prices reduced the terms of trade by 3.6 percentage points (pps). A similar negative contribution of 3.0 pps is expected in the March 2016 year. As dairy prices recover, they are expected to make a positive contribution to the terms of trade in the 2017, 2018 and 2019 March years. Export prices excluding dairy are expected to make positive contributions throughout the forecast period, particularly non-commodity and export services. The forecast depreciation of the New Zealand dollar in 2016 and 2017 partly drives these positive contributions.

Figure 12: Terms of trade forecast decomposition (March years)

Source:  Statistics New Zealand, the Treasury

Falling mineral fuel prices (chiefly as a result of falling crude oil prices) provided a sizeable offset to falling dairy prices in the March 2015 year (+1.8 pps) and are forecast to continue to do so in the March 2016 year (+2.6 pps). Import prices more generally made positive contributions to the terms of trade in the March 2015 year. However, import prices excluding oil are expected to make negative contributions to the terms of trade over 2016 and 2017, partly as a result of the depreciating dollar. [4]

The lower terms of trade forecast over 2016 and 2017 March years are a significant driver of the slower growth in nominal GDP forecast in the Half Year Update, and consequently slower growth in tax revenues.

New Zealand Key Economic Data#

1 February 2016

Quarterly Indicators#

Monthly Indicators#