A Weekly Outlook for New Zealand, Australia and US Markets

Fuelling Inflation

The first week of the year held no New Zealand data, but there was still important economic news, with the price of oil hitting US$100 for a brief period on Thursday.

Just a year ago the possibility of $100 per barrel oil was a classic 'what-if' scenario for economists, given credence as a possibility but not seriously considered likely. Today it is reality.

As a net oil importer, the NZ economy tends to suffer from high oil prices. The price of petrol has already risen to a record-equalling NZ$1.76 per litre of 91- Octane. The only reason petrol has not risen beyond the previous high is the strong NZD, which is insulating consumers from the worst of the oil price hikes. If the NZD was back at US$0.60, petrol prices would be over NZ$2 per litre.

With petrol at this price, the average household will spend $260 more in 2008 on petrol than in 2007. Across all households, that adds up to $415m less discretionary spending. Some parts of the economy could slow as consumers feel the petrol pinch. The silver lining is that expensive petrol encourages fuel efficiency and moderates carbon emissions. We may see less congestion and greater use of public transport, just as we did in 2006. Small car sales are booming, motor-cycle registrations are up 50% on a year ago, and sales of SUVs have collapsed.

Although high petrol prices will cool economic growth, they will also stoke the inflation fire. Expensive petrol boosts inflation directly, as well as pushing up other prices such as taxi fares and groceries. Rising prices for food and transport may fuel inflation expectations, generating higher wage demands and creating an ongoing headache for the Reserve Bank.

Normally the Reserve Bank would weigh the threat of higher inflation as equal to the threat of lower economic growth. However, the latest oil price shock could not have come at a worse time on the inflation front. The RBNZ was already forecasting inflation of 3.2% for the March 2008 quarter. It is now likely that inflation will go much higher, pushing the three-year average of inflation well above the top of the Reserve Bank's 1% - 3% target band, and making the Bank nervous. Under these circumstances, we think the Bank will fret more about inflation than about slower growth. Expensive oil will make the RBNZ more likely to hike the OCR this year.

In today's data, the monthly merchandise trade balance showed a bigger-than-expected deficit for November. Imports of plant and machinery goods were very strong, possibly indicating that investment is starting the take off. Conditions are ripe for investment, and we have been anticipating something of an investment boom in 2008: incomes are rising strongly thanks to huge dairy payouts, the economy is already running close to full capacity, infrastructure is in need of an upgrade, and the high NZD makes imported plant and machinery goods cheaper.

On Wednesday the December Westpac McDermott Miller Employment Confidence Index will be released. Confidence reached a record in September. Whether that level is sustained in December will be interesting - unemployment is extremely low but there has been a deluge of bad economic news from overseas. The December month commodity price index, also released on Wednesday, is expected to register a decline on the back of meat prices, which have fallen in recent weeks. The world price index could be down over 1%, and the NZD index could fall 3%.

Fixed vs floating: Reading the tea-leaves is particularly difficult at present, but the Reserve Bank made it clear that as they currently see it, interest rate cuts are off the agenda for the foreseeable future. Wholesale rates have lifted in response to credit market concerns, and if the increases persist, mortgage rates will follow. There are no bargains out there now, but our pick is still fixing for 2 to 3 years.

Key Data Previews

NZ Q4 employment confidence index

Jan 9, Last: 135.9

The Westpac McDermott Miller Employment Confidence Index (ECI) surged in the September 2007 quarter, to 135.9 from 128.4 in June - the highest reading since the series began in June 2004.

Employment conditions remain supportive of confidence: the unemployment rate is low at 3.5%, wage growth is robust, and firms' hiring intentions are at a reasonably high level.

That said, employment growth unexpectedly fell in Q3. In addition, there has been a deluge of bad news, both local (e.g. housing) and international (global credit crisis, US recession fears) that may see employees less confident around future employment prospects.

Aus Nov dwelling approvals

Jan 8, Last: -2.8%, WBC f/c: flat, Mkt f/c: 0.1%, Range: -3.6% to 4.0%

• Approvals fell 2.8% in Oct, partially retracing an 8.6% jump in Sep. Despite the drop, the result was above expectations, consolidating a trend rise in approvals that became evident in June-July and that has continued in spite of a 25bp rate in August. A steady pick-up in the private house approvals has been particularly promising.
• The RBA raised rates by another 25bp in Nov. With credit market concerns also re-emerging, approvals are likely to see at least some negative impact. However, housing markets more generally look to have been resilient with price growth continuing to strengthen. Finance figs and new home sales have been softer but all up, we expect a flat result in Nov.

Aus Nov retail sales

Jan 9, Last: 0.2%, WBC f/c: 0.4%, Mkt f/c: 0.5%, Range: -0.2% to 1.0%

Retail turnover rose 0.2% in Oct after posting a solid 0.7% rise in

• Sep, 0.8% gains in Aug and July and a 1.6% rebound in June from declines in April-May. Trend growth has been running at an average 8.5% annual rate over the last 6 months.
• Consumer sentiment slipped in Nov as a 25bp interest rate rise impacted but was fairly resilient overall, remaining in solid positive territory.
• We expect Nov sales to be fairly subdued, with a 0.4%mth rise forecast. The initial impact of higher interest rates and a more cautious attitude from consumers should constrain spending in the lead-in to Christmas, but not by too much.

Aus Nov international trade balance, AUDbn

Jan 10, Last: -2.98, WBC f/c: -2.6, Mkt f/c: -2.5, Range: -3.25 to -1.40

• The trade deficit surged $1067mn in Oct to a record high of $2.983bn. Exports fell 3.4%, weighed on by further rural weakness, a pullback in non-rural volumes after solid gains in Q3, and weaker prices from a 6% AUD rise. Imports rose 2.3% despite price drag from AUD, indicative of ongoing strong volumes.
• Rural exports to rise 2% (higher meat vols and prices, higher wool prices and a large s. adj. boost, partially offset by sharply weaker wheat vols). Non-rural exports to bounce 6% (rebound from Oct vol weakness and strong s. adj. boost), giving 4.3% rise for total exports. But merchandise imports imply further gains (f/c 2%), limiting the deficit pullback.

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