Australian & New Zealand Weekly

Week beginning 24 March 2008

• Australia: consistent message coming from recent Westpac surveys.
• RBA publishes Financial Stability Review.
• RBA Governor Stevens and RBNZ Governor Bollard speak in Sydney.
• Busy NZ data week culminates in Q4 GDP.
• Key economic & financial forecasts.

Westpac Surveys & Indexes Consistent Message

Westpac's recent survey and index research continues to give support to our view that interest rates have peaked but are likely to remain on hold in 2008.

The Westpac-ACCI Survey of Industrial Trends has been released today.

The survey shows that activity held up around December quarter levels in the March quarter. The Current Composite rose from 55.8 in December to 56.0 in March. However, expectations for the June quarter were down sharply. The fall in the Expected Composite was 9.9 points - the second largest fall since 1974.

The other key Index measure from the Survey is the Employment Index. That Index has provided a reliable 6 month in advance (see second chart) guide to employment growth. The Index fell from 14 in December to 1 in March - the biggest fall in the Index since December 2000.

However, labour markets are still registering as very tight. The Index of labour tightness fell from a record 43 in December to 29 in March - still the second highest read since 1974.

Finance availability registered as the most difficult since 1982. Current growth in business lending is running at a near 30% pace. With banks unlikely to continue borrowing aggressively in the offshore capital markets at the recent excessive spreads for term funding that pace will probably slow substantially and finance is likely to tighten even further. While more difficult finance still does not register significantly as the dominant constraint to business. That situation may change as 2008 unfolds.

That key message from the Westpac-ACCI Survey was also present in the Westpac-MI Leading Index. The latest read from the Index showed growth slowing below long term trend for the first time since November 2005.

Growth in the Index slowed from 6.3% in November 2007 to 4.1% in January 2008. Around 1 percentage point of the 2.2 percentage points reduction was due to the collapse in the Australian share market, with ½ a point due to a slowdown in overtime worked.

The recent fall in the Westpac Consumer Sentiment Index was spectacular. The Index fell by 9.1% to its lowest level since 1993. The 3 month fall in the Index was the sharpest 3 month decline in the history of the Survey. The measure on whether now is a good time to buy a house was the second lowest on record and sentiment towards purchasing motor vehicles was the lowest on record. Consumers now see bank deposits as the preferred form of saving with real estate and shares losing considerable ground.

In an associated survey, Westpac's measure of unemployment expectations rose sharply. Consistent with the fall in employment Index in the Westpac-ACCI Survey this indicator also points to a substantial slowdown in employment growth (see chart next page).

RBA to release Financial Stability Review on Thursday, March 27

The RBA is expected to confirm the robust condition of Australian banks. However, we will be very interested in the outlook for the survival of mortgage securitisers; the capacity of overleveraged households to cope with the recent rate rises; and views on the extent and impact of likely credit rationing on the corporate sector.

Bill Evans, Managing Director, Economics & Research

Australia: Data Wrap

RBA minutes, March 4 policy decision

• At the meeting, the Bank lowered its inflation forecast from the previous meeting to incorporate the effect of the February rate hike and the higher exchange rate; and there was considerable discussion on the implications of the deterioration in credit conditions, both with regards to the price and supply of credit.
• Critically, the board "judged that the higher setting of the cash rate would leave adequate flexibility to respond as necessary over the months ahead to new information about prospects for economic activity and inflation." A careful literal reading of that sentence suggests that the use of the word "higher" linked with "flexibility" implies that flexibility is more likely to be to the downside. However we prefer at this stage to put this sentence down to an effort to imply that policy is now in balance, rather than being "behind the curve" as was clearly the case in the February minutes. Future Bank utterances will now need to be scrutinised for any further hints that short term downward flexibility is considered a feasible option.

Mar Westpac-MI leading index

• The annualised growth rate of the Westpac-Melbourne Institute Leading Index of Economic Activity, which indicates the likely pace of economic activity three to nine months into the future, was 4.1% in January, just below its long term trend of 4.2%. This is the first time growth in the Leading Index has slipped below its long term trend since November 2005. This is consistent with our view that growth will slow through 2008 and 2009. The annualised growth rate of the Coincident Index was 3.8%, the same as its long term trend.

Feb merchandise imports

• Australian merchandise imports fell 1.3% unadjusted in February to $16.657bn following a 7.5% unadjusted jump previously. The AUD/USD appreciated 3.7% on average in the month, reducing import values, so the small pullback in unadjusted imports implies ongoing volumes strength.
• The Statistician advised that the data is consistent with a rise in seasonally adjusted goods imports on a BoP basis of 0.3%mth. Following January's 6.2% sa surge, this further small rise would help maintain the continuing strong uptrend in goods imports, which in January grew by 1.5%mth. The breakdown showed aircraft-led strength in capital goods (up 7%), partially offset by a 2% pullback in consumption goods (vs up 2.9% prev - so their solid uptrend will remain intact), a 1% fall in intermediate goods, and a 6% fall in 'other' goods (led again by volatility in gold).

Q4 dwelling commencements

• Preliminary data on total dwelling commencements show a solid 2.6% rise in Q4 following a 3.5% rebound in Q3. This strength came after a 3.3% decline in the first half of 2007. We had been expecting a strong 4% rise to bring commencements more in line with strengthening approvals through much of 2007 (+7.2% in H2). Even though the quarterly number was softer than forecast, revisions to Q3 have done the trick in this respect with commencements now showing a 6.2% rise through the second half of last year.

Mar Westpac-ACCI industrial trends survey

• The 186th Westpac-ACCI Survey of Industrial Trends was closed in the week ending 14 March, following February and March RBA rate hikes, additional independent rate hikes, amidst significant share market weakness and continuing credit market gridlock, and associated increasing pessimism over the US outlook.
• The Actual Composite Index rose to 56.0 from 55.8, still well above long run trends, consistent with continued above-trend growth in Q1 despite the deteriorating backdrop. While raw activity indicators softened, they were more resilient than usual for an historically seasonally weak quarter.
• However, the deteriorating environment has soured expectations. Contrary to the usual seasonal Q2 rebound, activity outcomes are expected to weaken, driving the Expected Composite Index below its decade average, implying a slowing to a below-trend growth pace. General business sentiment also fell to its lowest since 2006Q4.

Feb motor vehicle sales

• The official estimate of vehicle sales came in a bit weaker than we had anticipated, with sales down 2.3% in Feb and the gain in Jan nudged back to just 0.2%. Though volatile early in the year, industry data had suggested a slight gain. The main difference in the numbers is that the ABS uses a more detailed and sophisticated approach to seasonal adjustment in compiling the official figures.
• The Feb fall is notable given the circumstances of rising interest rates and deteriorating consumer confidence. However, it shouldn't be "over-read". Sales remain at high levels overall with trend growth still running at a solid 4.4% annual rate - down from double digit pace in mid to late 2007 but still comfortably positive. The 2.3% decline in Feb is also on a par with previous falls seen in the immediate wake of interest rate hikes, and for that matter with previous monthly volatility, e.g. in 2004.

Round-up of local data released last week

New Zealand: The Week ahead & Economic Wrap

Nasty, brutish and short

Very little NZ data was released this Easter-shortened week, but it was memorable due to ructions in international markets.

The value of electronic card core transactions rose a modest 0.6% in February (total sales -0.2%). The data was likely helped out by the leap year effect adding an extra trading day to the month. Spending has eased markedly in the new year as household balance sheets take a pounding from petrol and food prices, as well as debt servicing costs.

February migration data showed that immigrants outnumbered emigrants by 170 in the month (s.a.). Annual net migration fell to a six year low of 4,643, versus 13,000+ a year ago. The Reserve Bank assumed in December that migration would trough at a net 5,000 annually. We see significant downside risk to this view, and accordingly, substantial downside risk to the RBNZ's house price forecasts (-5%). Partly offsetting this, lower net migration also means more inflationary pressure coming from the fact that the labour market will remain tighter for longer.

In offshore developments, the Federal Reserve last Friday bailed out the 85 year old investment bank Bear Stearns from a complete dearth of funding. Markets initially reacted positively to the Fed's action, but quickly became concerned about the wider implications of the funding issues. This sentiment increased when it was revealed on Monday morning NZ time that Bear Stearns had been sold at a massive discount to JP Morgan (sold at $2 a share, whereas shares were trading at $170 in mid-2007, just under $50 last week, and $30 on Friday after the emergency funding was announced).

In conjunction with the announcement, the Federal Reserve cut the discount rate a quarter of a percent and announced they would lend to a wider range of institutions (i.e. investment banks); for a longer time - 90 days rather than 30; and in exchange for a wider range of AAA collateral. This represents an attempt to ease the drying up of credit and the collapse of more investment banks. The Sunday evening timing was aimed at forestalling a bloodbath in US financial and equity markets on the Monday open. The NZ sharemarket was open at the time, however, and was quickly 2% in the red. Asian sharemarkets fell by even more. NZ interest rates dropped around 15 points along with global rates as the market decided the Fed would ease by more at their policy meeting Tuesday, and the NZD spiked up back towards USD0.82 as the USD was punished, before plummeting as low as USD0.7925 over the rest of the day as Jupiter lined up with Saturn and markets decided that peripheral currencies were the next target.

Wednesday morning NZ time it was confirmed that the Federal Reserve is decisively in emergency mode. The fed funds rate was cut 75bps from 3.00% to 2.25%, with the accompanying commentary that the “outlook for economic activity has weakened further”. Markets responded positively although many had been hoping for an even bigger cut: the US sharemarket had its best day in five years. But the euphoria has tended to get briefer with each Fed cut, and this week followed the same pattern. By the next day pessimism was reasserting itself across markets, including the NZD and world sharemarkets.

Critics claim that the Federal Reserve's actions move credit risk from the private sector to the public sector, bail out risky lenders, and delay necessary corrections in the market. However, the Federal Reserve has clearly (and correctly) concluded that the collapse of the world's eighth largest investment bank would seriously endanger the stability of the US financial system and the overall availability of credit - essential oil in the macroeconomic engine. The stakes are extremely high.

Upcoming NZ data is likely to be largely overlooked in such a volatile environment. However, for what it's worth, next week brings a swathe of data. Credit card transactions data for February are released on Tuesday, and the Westpac McDermott Miller consumer confidence Q1 read is out on Wednesday. On Thursday the Q4 balance of payments is released. We expect a solid improvement in the current account deficit, from 8.3% of GDP to around 8.0%, on the back of improving terms of trade. We expect the dairy bonanza and softening domestic spending growth will continue to see the current account deficit narrow in coming quarters - and just as well, since every dollar NZ has to fund is getting more expensive and difficult to obtain. We also receive merchandise trade statistics for February - we expect a deficit of $300m.

On Friday GDP for Q4 will be released. The indicators suggest that growth was strong - we're picking 0.9% for the quarter (RBNZ: 0.7%). Some of this is timing effects in agricultural production and processing, however, and some of it is a base effect of a weak Q3. We expect that growth in Q1 this year was substantially weaker. This Q4 GDP data is therefore “historical”, but nonetheless is an important input into the Reserve Bank's estimate of spare capacity in the economy, and hence inflation pressures.

Round-up of local data released last week

Data previews

NZ Q1 Consumer confidence

Mar 26, Last: 110.0

• Consumer confidence deteriorated in the December 2007 quarter, with the Westpac McDermott Miller Index falling to 110.0, from 113.5 in September.
• Consumer confidence has steadily deteriorated over the past year, except for a brief flurry of optimism in September, and in the December quarter confidence was at its lowest level since June 2006.
• This trend is likely to have continued into the March quarter. Household budgets are under even more pressure from high interest rates and rising food and petrol prices. On top of that house prices are falling (down 4.1% from the November 2007 peak) and much of the country is experiencing drought. These factors will be weighing heavily on consumers' minds.

NZ Consumer Confidence

NZ Q4 Current account deficit NZDm

Mar 27, Last: -3,639, WBC f/c: -3,160

• We expect the annual current account deficit improved from 8.3% to 8.0% of GDP in 2007 Q4.
• The dairy bonanza can take the credit, with the terms of trade up a solid 2.9% in the quarter.
• The deficit should continue to improve in the near-term as the dairy cash continues to flow in at the same time as domestic spending growth eases.

NZ annual current account deficit

NZ Feb merchandise trade NZDm

Mar 27, Last: -320, WBC f/c: -300

• February data is expected to show a retreat from recent trends, with a widening of the merchandise trade deficit.
• Import volumes continue to retreat with subdued retailing, although expensive oil tends to increase the import bill.
• Export receipts have been rampant in recent months, thanks to ballistic dairy prices and new oil exports. However, February export volumes will be affected by drought, and NZD prices will be affected by the strong currency. All up, export receipts will be low by the standards of February, causing a mild increase in the trade deficit. The deficit will actually widen in annual terms, for the first time since July 2007.

NZ merchandise trade balance

NZ Q4 GDP

Mar 28, Last: 0.5%, WBC f/c: 0.9%

• GDP data next week are expected to show a strong bounce in economic activity. We forecast 0.9% growth in Q4, a substantial kick up from the 0.5% recorded in Q3.
• This forecast is an upward revision from our early estimate of 0.6%, and we still think the risk is to the upside.
• Business services, manufacturing and construction will be the star performers, while business investment and net exports will shine on the expenditure side. Residential construction will provide an offset as activity contracts. Household spending is expected to moderate from its previously frantic pace.
• Much of the extra strength in Q4 is likely to come at the expense of a weaker Q1 2008.

NZ GDP growth

US Feb existing and new home sales

Mar 24, Existing: Last: -0.4%, WBC f/c: -0.8%, 4.85m

Mar 26, New: Last: -2.8%, WBC f/c: -2.0%, 576k

• The housing market continues to weaken, a trend that appears to have extended through February.
• Existing home sales fell 0.4% in January to be 23.4% lower over the year. A further decline in Feb is likely, with our forecast for a 0.8% drop. While pending home sales stabilised in Jan, earlier weakness (a 1.2% drop in in Dec and a 3.1% fall in Nov) has yet to fully translate.
• New home sales look set for a further fall in Feb, with our forecast for a drop of 2%. Single family home starts fell 3.1% in Jan and slumped 6.7% in Feb. In addition, permits for this segment continue to run below starts.

US housing sales

US Mar consumer confidence and sentiment

Mar 25, Conference Board confidence: Last: 75.0, WBC f/c: 74

Mar 28, Uni of Michigan sentiment final: Last: 70.5, WBC f/c: 70

• The CB confidence index is well off the 112 high of last Jul. Indeed, there was a sharp 12.3pt plunge in Feb, taking confidence to the lowest level since Mar 2003 (the start of the Iraq war). The expectations for the next six months dropped to the lowest level since Jan 1991, the start of the Gulf war.
• Consumers are being hit by the housing recession, falling employment, rising food and gasoline prices, tightening credit conditions and a plunging share market. On the plus side, the Fed is cutting rates aggressively.
• Sentiment appears to have held at these lows in Mar. The Uni of Michigan sentiment index preliminary reading for Mar was 70.5, virtually unchanged from 70.8 in Feb.

US consumer confidence slumps

US Feb durable goods

Mar 26, Last: -5.3%, WBC f/c: 1.0%

• Durable orders, after a strong Dec result, pulled back in Jan. Headline durables fell 5.3% in Jan, while core capital goods (ie ex defence and ex aircraft) were more resilient, declining by only 1.4%.
• We expect durables to rise by 1% in Feb, boosted by a significant rebound in Boeing orders.
• By contrast, durable orders ex transport are expected to be flat. Notably, the business surveys are pointing to softness in Feb. The ISM manufacturing new orders index was stuck below 50 (at 49.1 vs 49.5 in Jan). Also, the regional surveys showed weakness in Feb.

US durable goods orders

US Feb core PCE deflator

Mar 28, Last: 0.3%, WBC f/c: 0.1%

• The core PCE deflator rose 0.3% in Jan, holding the annual rate at 2.2%. The headline deflator was up 0.4%, ticking the annual number up to 3.7%. The Fed is concerned by these elevated headline numbers, as expressed in the latest FOMC statement.
• In Feb, the core CPI was flat. That was partly due to a below trend rise in rents, which have a lower weight in the core PCE deflator. Hence we expect a 0.1% gain in the core PCE. Underlying inflation pressures should moderate through 2008 given the weak activity backdrop.
• The report should also show subdued gains in personal income (0.2%) and personal spending (0.1%) in Feb, reflecting the impact of employment declines and with retail sales slipping in the month.

Sticky inflation hasn't prevented rate cuts

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Disclaimer

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