Australian & New Zealand Weekly

Week beginning 26 January

• Australia: consumers on edge
• RBNZ to cut rates by 150bps to 3.5% as recession deepens
• Australian data: inflation, credit, leading index due
• US FOMC meeting Jan 28: Fed all out of rate bullets, what now?
• US Q4 GDP set for worst drop in 30yrs
• Other US data includes: housing, sentiment, durable goods orders
• Key economic & financial forecasts.

Australia: Consumers on Edge

Much depends on Australian households right now. After coming under intense pressure through most of 2008, their collective response to aggressive policy stimulus since late last year will be a key determinant of how well the broader economy holds up this year in the face of what is shaping as a massive economic shock from abroad.

For now, the early indications remain decidedly mixed. The latest Westpac-Melbourne Institute Consumer Sentiment survey - conducted in mid-January - shows consumers entering 2009 with great trepidation.

The headline index actually held up reasonably well. Although it slipped 2.2% in the month to a reading of 89.9, this was still 1% above the average 2008 level and 13.8% above the most pessimistic lows of last year. The slippage unwinds some of the 12.1% rally in sentiment seen through Nov-Dec and suggests the initial boost from aggressive rate cuts and fiscal payments may be starting to wane.

However, the overall level of sentiment remains notably less pessimistic than readings from similar surveys in the US, Europe, the UK and Japan (see chart opposite). Whereas these are holding at readings well over two standard deviations below their long run average, Australian consumer sentiment is less than one standard deviation below its long run average read of 101.3.

The headline index is also broadly consistent with consumption growth holding at around 2%yr. This is down sharply on the 4%+ rates of 2007 but still well above the sorts of spending slowdowns seen in past recessions.

The survey detail tells the real story. Whereas the last few months have seen sustained improvements in responses to questions on family finances, 'time to buy a major household item' and the economic outlook for the next five years, consumers have become deeply pessimistic about the economic outlook for the year ahead. The reading on this component slumped 18.4% in January alone, hitting 58.3, the lowest level recorded since July 1992.

Australian consumers are deeply concerned about the economic outlook. Interest rate cuts, the fiscal stimulus package and lower fuel prices have given a boost to finances - the index for Family finances compared to a year ago jumped 10.6% in January - and on balance consumers are cautiously optimistic about their own prospects in 2009, but the unrelenting stream of bleak economic news, particularly from abroad, is clearly weighing heavily on the consumer psyche.

Consumers may be pessimistic about the economy but they've had mixed results at predicting it in the past. While this component index correctly anticipated the 1982-83 and 1990-91 recessions, it has been wrong-footed by growth several times as well, most notably after the 1987 crash, during the 1998 Asian crisis and the 'dot-com' bust in 2001.

Whether consumers are right in 2009 remains to be seen, but in the meantime the key question is how much this economic 'fear factor' inhibits spending regardless of how the economy performs.

On this count, the sentiment survey suggests only a minor influence so far. Sentiment towards purchasing a major household item was off in January, but only slightly, falling 3.5% but holding on to most of the stunning 48.4% rise seen through November-December.

Sentiment towards buying a car also improved, rising 6.2% in January to be 27.7% above the average level in 2008. Both of these measures have proven to be good guides to spending in the past. Sentiment towards housing also continues to improve. The index tracking responses to the question 'is now a good time to buy a house?' edged 0.4% higher in January to 137.3, the highest reading since March 2002. The improvement has come across all of the major states.

For consumers, fears about the economy typically centre on issues of job security. Consumers' unemployment expectations - measured in a companion survey to consumer sentiment - continued to deteriorate at a rapid rate in January. The unemployment expectations index rose 5% to 180.7 after a 0.7% fall in December. The measure is 40.5% above its long term historical average, with readings worse than any seen during the early 1990s recession.

For now, our preferred leading indicators of labour demand - job ads, Westpac-ACCI labour market composite, a composite of business survey employment indicators - continue to argue for a less pessimistic outlook, consistent with our view for a slowing in annual jobs growth to zero through 2009, lifting the unemployment rate to 6%, but the signals from consumers' unemployment expectations imply risks of a more marked deterioration.

The Reserve Bank Board next meets on February 3. We expect it to cut rates by a further 0.5% to 3.75% with follow-on moves taking the cash rate to 2.75% by June.

While the aggressive policy easing since September appears to be giving some boost to consumers, the early indications are that it has been fairly modest. Meanwhile, the global economic recession that took hold in 2008 is deepening and broadening at a rapid pace. With the full impact of this weakening yet to be felt in Australia, fear of what lies ahead may continue to stifle the consumer response to aggressive policy stimulus. Under these circumstances, generating a sustained upturn in domestic demand is difficult enough for policy makers let alone generating one strong enough to offset such a large external shock.

Australia: Data Wrap

Dec TD-MI inflation gauge

• The TD-Melbourne Institute inflation gauge fell 0.2% in December following a 0.6% fall previously and the third consecutive monthly fall. As expected, the main sources of lower prices cited were petrol, reinforced by falls in fruit and vegetables. Partially offsetting price increases were seen in rents, household supplies, and holiday travel and accommodation. With a strong +0.59%mth result from December 2007 dropping out, annual growth in the gauge fell sharply further to 2.2%yr from 3.0%yr previously, well down from a peak of 4.8%yr in June 2008 and the lowest since May 2005.
• The mid-month of the quarter gauge historically has the better correlation with the CPI, and the November 3mth pace of -0.42% was well below that seen in August (1.03%) suggesting a markedly weaker Q4 headline CPI than Q3's 1.2%qtr result. That view for Q4 is confirmed by the December gauge, with 3mth growth of -1.06% also well below that seen in September (0.99%). While the negative 3mth gauge rate implies risks of a negative quarterly headline CPI in Q4, we caution that the gauge has underestimated the headline CPI over the last four quarters.
• While headline inflation has eased rapidly in recent months, owing largely to the sharp fall in petrol prices, measures/ indicators of core inflation in this report are easing more gradually. The trimmed mean measure of the inflation gauge rose 0.2%mth in December following a flat November. The 3mth annualised rate rose to 2.1% in December from 0.9% in November. That 3mth rate is down from where it was three months ago (2.7%), but by a far lesser degree than the headline measures. Price pressures were also broader in December than in recent prior months.

Dec merchandise imports

• Australian merchandise imports fell 3.7% unadjusted in December to $20.130bn following a 4.1% fall previously. The Statistician advised that the data is consistent with a fall in seasonally adjusted goods imports on a BoP basis of 2.1%mth, following November's 2.2% rise. Although only reversing November's increase, the December fall would leave in place the profile of slowing trend growth through 2008.
• The breakdown showed the fall was led by a $766mn fall in 'other' goods (led by a $668mn fall in volatile non-monetary gold) and a $334mn fall in fuels and lubricants (no doubt largely price driven). Capital goods imports rose 20.1% led by gains in machinery and industrial equipment, and ADP equipment. Consumption goods imports rose 1.6% led by gains in food and beverages, and transport equipment. While imports were higher after seasonal adjustment in December, volumes were likely still soft in line with weak domestic demand. The AUD/USD fell 17.9% on a monthly average basis in the three months to December, providing a valuation boost to imports.

Jan Westpac-MI consumer sentiment

• The Westpac-Melbourne Institute Index of Consumer Sentiment fell by 2.2% in January from 92.0 in December to 89.9 in January. The small decline unwinds some of the 12.1% rally in sentiment seen through November-December and suggests the initial boost from aggressive rate cuts and fiscal bonus payments may be starting to wane. That said, sentiment remains 1% above the average 2008 level and up 13.8% on the most pessimistic lows seen last year.
• The survey detail tells the real story: consumers are entering 2009 with great trepidation. Whereas the last few months have seen sustained improvements in responses to questions on family finances, 'time to buy a major household item' and the economic outlook for the next five years, consumers have become increasingly pessimistic about the economic outlook for the year ahead. The reading on this component index slumped 18.4% in January alone, hitting 58.3, the lowest level recorded since July 1992.
• Sentiment towards purchasing a major household item was off in January, but only slightly, falling 3.5% but holding on to most of the stunning 48.4% rise seen through November-December. Sentiment towards buying a car also improved, rising 6.2% in January to be 27.7% above the average level in 2008. Both of these measures have proven to be good guides to spending in the past.”
• Sentiment towards housing also continues to improve. The index tracking responses to the question 'is now a good time to buy a house?' edged 0.4% higher in January to 137.3, the highest reading since March 2002.

Jan unemployment and consumer inflation expectations

• The Westpac-Melbourne Institute Unemployment Expectations Index rose 5.0% in January to 180.74 after a 0.7% fall previously. This took their trend deviation from their full history average higher to 40.5% from 33.2%, worse than seen in the 1990/91 recession (high for deviation was 32.2%), implying recession levels of consumer pessimism over the labour market outlook.
• Consumers' inflationary expectations saw their first rise since June in January, rising to a median of 2.7% from 2.5% previously. Nevertheless, their rapid downtrend since June 2008 continued, with the trend level in January just 2.58%, well down from a peak in June of 5.40% and the lowest trend level since April 1999. The median expectation of managers and professionals (collected since 1995) edged up to 2.4% from 2.0%, but also continued their rapid downtrend to 2.22%, the lowest since February 1999.

Dec new motor vehicle sales

• The official ABS estimates showed a small 1.8%mth rise in vehicle sales in December following a sharp 5.2%mth fall in November and consecutive declines in the previous four months that were partially due to an increase in the rate of luxury car tax. The December rise was somewhat smaller than had been suggested by industry sales data from the FCAI, which pointed to a 3%+ gain. It leaves monthly sales down 15.7% on year ago levels, and back at May 2003 levels in trend terms.

Q4 export and import price indexes

• Export prices surged a record 15.9% in Q4 after a 13.8% rise previously, led by sharply higher prices for coal and metalliferous ores and metal scrap, with partially offsetting falls in non-ferrous metals and petroleum. With the USD RBA commodity price index down 8.9% in Q4, the overall XPI surge was clearly driven by valuation effects of the 24.3% drop in the AUD/USD.
• Import prices were stronger than expected, jumping 10.8% in Q4 after a 5.0% rise previously. Petroleum prices fell 25.2% reflecting the sharp retreat in world oil prices. Food and beverage prices were much stronger with a 17.1% jump (vs +2.3% prev). After abstracting from these non-core items, core import prices surged 19.2% reflecting pass-through of the 18.5% fall in the import weighted AUD TWI.

Round-up of local data released last week

New Zealand: The Week ahead & Economic Wrap

Surveying the wreckage

Hopes that the RBNZ was nearing the end of its easing cycle in December have since been overtaken by events. We expect another massive 150bp cut to the OCR next Thursday, on the way to a low of 2.50% in coming months.

Our latest Economic Overview surveys the economic landscape in detail, with the conclusion that the global economy is facing the steepest downturn in decades, and that New Zealand faces a continued rough patch this year even with the help of extra stimulus from fiscal policy, interest rates and a weaker currency. Weak activity and waning inflation pressures have given the RBNZ substantially more room to lower interest rates.

In December, the RBNZ shared our view at the time that the contraction in the New Zealand economy would be limited to the first three quarters of 2008 (though growth would remain sub-par for a while longer than that). More recent information, in particular the latest Quarterly Survey of Business Opinion, has put paid to that hope. Firms are clearly battening down the hatches and see little hope of an improvement in their fortunes in the near future. Consumers are remaining cautious even with more cash in hand from lower fuel prices, personal tax cuts and lower mortgage rates. We now expect several more quarters of negative GDP growth, with the steepest drop coming in Q4 2008.

The other key developments since December are a further significant downgrade to Consensus Forecasts for growth in New Zealand's major trading partners; a sharp fall in capacity utilisation, indicating that there is now a substantial amount of slack opening up in the economy; and a deteriorating outlook for prices of New Zealand's major commodity exports. The ongoing tension in global credit markets is virtually unquantifiable in terms of what it means for monetary policy, but it will certainly be playing on the RBNZ's mind.

Our best guess is that these developments together are worth as much as 200 basis points off the RBNZ's 90-day interest rate projections. That implies a new low point of around 3.00%, which is in line with our forecast of an OCR of 2.50% by mid-year.

A cash rate of 2.50% would be astoundingly low relative to New Zealand's history. But the severity of the global recession and the credit crisis means that the usual benchmarks for monetary policy are out the window. Many developed economies will face zero or near-zero policy rates by the end of this year; the US has already reached that point and is now looking to drive down longer-term market rates by buying bonds and asset-backed securities directly. In this environment, an OCR of 2.50% or lower wouldn't look at all outlandish.

The remaining question is how the RBNZ chooses to deliver that easing. So far, they have favoured cutting rates early and decisively - though this is easier to do when moving towards neutral interest rates, as the RBNZ have been up until now, than when moving away from neutral. Nevertheless, the weak economic outlook, and the high degree of certainty that conditions are getting worse, argues for delivering more easing up front. Last week we noted that a 100bp cut next week looked to be the minimum; we now think the RBNZ will plump for a larger 150bp move.

With a 150bp cut, we would expect the statement to leave the door open for further easing, but to be noncommittal about the size of future moves, in order to hose down expectations of another jumbosized move at the March MPS. For now, we are pencilling in a 50bp cut in March as a base case, but after next week's review we'll be back to world-watching, and the risks are again for a larger move.

This week's data releases would have done little to sway the RBNZ one way or another. Consumer prices fell by 0.5% in the December quarter, bringing the annual inflation rate down from 5.1% to 3.4%. This was a touch lower than RBNZ expected in its December forecasts (though small surprises to past inflation have little bearing on policy). A 22% fall in petrol prices dominated the figures, and indeed outside of this price increases were still fairly widespread. We expect inflation to ease further in Q1, and as some of the large quarterly gains from 2008 drop out of the equation, annual inflation is expected to dip below 1% this year, albeit temporarily.

Retail sales were flat in November, a surprisingly resilient outcome in light of the negative pointers from card transactions data. Fuel sales did not fall as much as we expected given plunging prices, and supermarket sales were very strong (up 2.6%). Recent indicators suggest that spending in December was up slightly on last year in dollar terms, implying that volumes were down. The evidence is becoming clear that the New Zealand consumer is saving a significant portion of their extra cash.

Aside from Thursday's OCR review, next week brings updates on building consents and overseas trade. New dwelling consents are likely to remain weak in December, despite lower interest rates. Non-residential consents are running well ahead of year-ago levels, but may fade as businesses cut back their investment plans. On the trade balance, export receipts will take a hit from lower world commodity prices, but fortunately New Zealand appears to have avoided the slump in exports to Asia that some countries have suffered. Imports of cars, consumer durables and capital equipment are all expected to be softer over coming months.

Round-up of local data released last week

Data Previews

Aus Q4 PPI

Jan 27, Last: 2.0%, WBC f/c: 1.7%

Mkt f/c: 0.4%, Range: -2.0% to 2.7%

• The Q3 PPI rose 2.0%qtr, 5.6%yr. Non-core items added less than expected (0.40ppts) with stronger food prices offset by a small fuel dip. Core import prices rose 2.0% (AUD TWI -4.2%). With a seasonal rise in utilities and more items with price increases, the domestic core ex-construction jumped 2.1% (vs 0.9% prev) and with a higher pace in building prices (1.8% vs 1.6% prev), the overall core PPI leapt a record 2.0% (vs 0.8% prev).
• The core PPI will be high in Q4 courtesy of the 18.5% plunge in the AUD MTWI lifting import prices. We expect +15.5% for the core imports PPI. But weak demand should see the domestic core PPI ex-construction and utilities slow to 0.8%, and utilities should be flat, while we expect stronger building construction (2.0%). This gives a strong overall core PPI of 3.2%qtr. Food prices are expected to fall 0.5% and petroleum drop 21.2%, tempering the total PPI to a pace of 1.7%qtr.

Aus Nov Westpac-MI Leading Index

Jan 28, Last: 0.6% annualised

• The annualised growth rate of the Westpac-Melbourne Institute Leading Index, which indicates the likely pace of economic activity three to nine months into the future, was 0.6% in October, well below its long term trend of 3.8% but still in positive territory. Past Australian recessions have always been preceded by negative growth in the leading index.
• Most monthly components continued to weaken in November. Dwelling approvals slumped badly, falling 12.8%mth. Money supply growth slowed from 1.6%mth in October to 1.3%mth in November. The sharemarket continued its rapid descent, the ASX200 falling another 6.9% in the month after slumping 21.8% over the September-October. Moreover a key factor moderating the pace of decline in the leading index in October - a 1.8%mth bounce in US industrial production - reversed in November with a 1.3%mth drop.

Aus Q4 CPI

Jan 28, Last: 1.2%, WBC f/c: -0.4%

Mkt f/c: -0.4%, Range: -0.9% to 0.2%

• Our Q4 CPI forecast is -0.4%qtr and 3.6%yr (vs 5.0%yr prev). Large detractions are expected from petrol (-19%, contributing -0.92ppts) and deposit and loan facilities from mortgage rate cuts (-3%, contributing -0.14ppts). Others include pharmaceuticals (PBS effect, -0.05ppts), and more than usual pre-Christmas discounting in discretionary items like AV and PC equip't, cars, and some household goods and clothing items. Partially offsetting increases include food (+0.25ppts), rents (+0.12ppts), and house purchase (+0.10ppts).
• Our avg RBA underlying CPI forecast is 0.8%qtr, 4.4%yr (vs 1.2%, 4.7% prev). With big falls in heavily weighted petrol and deposit and loan facilities, and falls in many discretionary items, more price falls will remain in the trimmed distribution this time (12 vs 6 prev), cutting the trimmed mean. Our forecast is 0.76%qtr to two decimals, so risks are to the downside.

Aus Dec private credit

Jan 30, Last: 0.4%, WBC f/c: 0.4%

Mkt f/c: 0.5%, Range: 0.3% to 0.6%

• Credit growth slowed to 0.4% in Nov and is forecast to hold at that pace in Dec.
• The positive news is that housing credit growth, which was 0.5% in Nov, is set to improve - if not in Dec then early in 2009. New lending (housing finance) has turned the corner, increasing in Oct & Nov in response to interest rate cuts.
• By contrast, business credit is likely to moderate as economic conditions deteriorate. The segment was resilient over 2008H2, supported by re-intermediation. However, business credit slowed to 0.6% in Nov from 1.0%.
• Personal credit contracted in five of the last six months, declining by 1.5% in Nov. Another weak result is likely.

NZ RBNZ OCR review

Jan 29, Last: 5.00%, WBC f/c: 3.50%, mkt f/c: 4.00%

• The outlook for both the domestic and global economies has deteriorated further since December. The world is heading for the worst recession in decades, and New Zealand is likely remain in recession for several more quarters.
• Weak growth and waning inflation pressures mean that the RBNZ has substantially more room to lower interest rates. We anticipate a low-point in the OCR of 2.50% by mid-year.
• The RBNZ has so far favoured cutting rates early and decisively. There is a strong case for a 100bp cut at a minimum, and we think they will plump for a larger 150bp move.

NZ Dec merchandise trade NZDm

Jan 29, Last: -520, WBC f/c: 80

• We forecast both sides of the merchandise trade ledger to be only 5% higher than last year, despite an 18% decline in the TWI that tends to boost both export and import values.
• Import volumes will be lower than last year. Car imports have fallen off a cliff. Retail sales of consumer durables have been miserable, so we expect that imports of these have started falling. With businesses expressing such reluctance to invest, imports of capital and machinery is surely in decline.
• Export receipts will be depressed by lower world prices for many products.

NZ Dec building consents s.a.

Jan 30, Last: 4.3%, WBC f/c: -2.0%

• In the past year, dwelling consents have fallen close to 50%, and at the current pace of issuance we are now looking at the possibility of a shortage of housing in the next few years.
• Nevertheless, new dwelling consents are likely to remain weak in December, despite the lower interest rates. Confidence has been hit hard in the construction industry and developers are finding it very difficult to get access to funds.
• Non-residential consents provide a glimmer of hope, with the trend value of consents up nearly 12% in November - the strongest annual pace of growth since March 2005. However, this strength may prove to be short lived, with businesses now strongly suggesting they will be cutting back on building investments over the coming year.

Dec existing & new home sales, Nov house prices

Jan 26, Existing home sales Last: -8.6%, WBC f/c: flat

Jan 29, New home sales Last: -2.9%, WBC f/c: -7.0%

Jan 27, S&P/CS house prices Last: -18.0%, WBC f/c: -18.0%

• Existing home sales plunged more than 8% in Nov, reflecting the renewed freeze in bank lending and the further collapse in household confidence. Other data on new home sales, and especially starts and permits were also very weak in Q4, confirming the housing collapse is yet to bottom, although Oct-Nov pending sale figures suggest the Nov existing sales slump overstated the downtrend, hence our flat Dec forecast.
• The further dive in homebuilder confidence, permits and starts in late 2008 points to continued dramatic shrinkage of the new housing market - already down 70% from its 2005 peak.
• The NAR reported median prices down 13.2% yr in Nov but the preferred S&P-CS measure is down 18% yr and should maintain that pace of decline with a 2% monthly fall in Nov.

US Jan consumer confidence and sentiment

Jan 27, Conference Board Last: 38.0, WBC f/c: 42.0

Jan 30, Uni of Michigan final Act: 61.9, WBC f/c: 63.0

• The CB confidence measure hit a new 40 year low in Dec, dragged down by sharply weaker assessments of the jobs market and business conditions.
• In contrast, the UoM rose off its Nov multi-decade low in Dec and posted a further gain in the preliminary Jan reading. The Dec rise was probably due to lower gasoline prices while Jan's may reflect talk of further fiscal stimulus, including tax cuts.
• Thinking back to Nov, some surveys taken immediately after the Obama election win posted solid - if temporary - gains. We suspect the Obama inauguration may have a similar effect, so expect a bounce in the CB index and an upward revision to UoM. The risk is that these gains prove temporary with gasoline prices edging higher and no economic quick fix likely.

US FOMC rate decision - nothing left to cut!

Jan 28, Last: 0-0.25%, WBC f/c: 0-0.25%

• The FOMC fired the last of its interest rate bullets on December 16, cutting the funds target from 1.0% to close to zero (officially, a target range of 0-0.25%).
• The statement noted that "weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time", and data since then have been consistent with that, with jobs falling 500k+ per month, GDP collapsing in Q4 and inflation just 0.1% yr and about to turn negative.
• The Dec statement said that "the Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities" (to pull yields down which in turn would lower mortgage rates). No announcement has been made on this yet, but the statement should address the issue further, and may contemplate other innovative ways in which the Fed might attempt to stimulate lending and economic activity.

US Dec durable goods orders to keep falling

Jan 29 , Last: -1.5%, WBC f/c: -2.0%

• Durable orders fell 1.5% in Nov - their fourth month without a gain - but the detail included a surprise solid 3.9% jump in core capital goods orders. Weak aircraft orders weighed down the total, while defence partially corrected for a steep Oct decline.
• With the Boeing strike over orders there have picked up again (mainly due to a bulk 787 order), and defence orders are likely to post a further gain. But the Dec business surveys point to weakness elsewhere, consistent with pessimism about the economy and the freezing up of credit markets. Autos and core capital goods are the two sectors we expect to show sharply weak Dec outcomes.
• Overall orders are forecast to fall 2% but the core measures (ex transport to some extent, but especially ex defence) are likely to be considerably weaker.

US Q4 GDP to post steepest drop in nearly 30 years

Jan 29 , Last: -0.5% annualised, WBC f/c: -6.5%

• Although the NBER dates the current recession from late 2007, the US has not yet recorded two consecutive quarters of falling GDP in this cycle. In Q3, GDP was down just 0.5% annualised.
• But in Q4 the economy hit the proverbial brick wall. Plunging auto sales will lead a further steep decline in consumer spending, compounded by confidence, unemployment and saving issues. Housing investment will clearly post a further drop, while orders and shipments figures point to business investment slipping. Compounding this weakness will be the the first drag on growth from net exports in over a year and some inventory rundown.
• Our forecast of a 6.5% annualised GDP decline would be the steepest drop in output since the early 1980s. A risk is that conservative assumptions re Dec partial data by the Commerce Dept could see a sub 6% outcome, but that would merely pave the way for a steeper fall in subsequent revisions next month.

Westpac Institutional Bank
http://www.westpac.com.au

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