Weekly Economic Commentary 25 September 2023
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
Read full report here (PDF 837KB)
Some rough and some smooth.
Last week was a bumper one for data in New Zealand. It also contained a few surprises – both positive and negative – that provided some insights about how the interest rate outlook may evolve in coming months.
Some positive news came in the form of the June quarter current account deficit, which showed a marked improvement to 7.5% of GDP. Revisions explained a good amount of the improvement, but it’s good to see we have moved noticeably away from that cycle low point of 8.8% of GDP. Exports of services are picking up as tourism recovers, but imports remain high reflecting the still overheated domestic economy.
We expect some further improvement as the full impact of past monetary tightening brings the economy well off the boil. Even so, it’s likely we are going to maintain a relatively high deficit for the foreseeable future given the current weak terms of trade and environmental constraints faced by commodity exports. Ratings agencies and foreign investors will be comforted by the improving trend in the current account, but also watchful at the level given the current weak fiscal position. Our note on risks to the exchange rate are relevant here also. We can’t pat ourselves on the back on this one quite yet!
Last week also saw the second consecutive increase in dairy prices in the second of this month’s GDT auctions. Two swallows don’t make a summer, but it was certainly a relief to the agricultural sector to see another 4.6 % increase in average product prices. Prices for whole milk powder have now rebounded 10.4% from the lows, though they remain around 10% below their end-July levels. It was comforting to see increased participation by Chinese buyers and this outcome has helped balance the downside risks we were seeing to our $6.75 milk price forecast for the current season. However, it’s important to keep in mind that the terms of trade is still down around 7% from its peak this cycle, so this year is not going to be a great one for commodities exporters and there will be a significant drag on incomes. Prices now appear broadly in line with the levels assumed by the RBNZ in their August Statement but remain a bit lower than we factored into our August Overview projections.
The big-ticket item last week was the June quarter GDP report. This showed that the economy rebounded following two soft quarters. Indeed, GDP grew a sturdy 0.9% during the quarter and 1.8% over the year, which was considerably higher than market expectations (and even a touch over our own top of market 0.8%/1.5% call). Importantly, the outcome was also much stronger than the RBNZ’s forecast of 0.5% growth in the quarter. The general picture showed few surprises in terms of the composition of growth. As we expected growth was driven by the service sector, including a strong lift in business services and government-related spending. Unfortunately, as we noted in our full review of the GDP report, even given the rebound in June there has been no growth in per capita terms over the past year.
New Zealand’s GDP data can be volatile at the best of times – even more so given the lingering impact of the pandemic and this year’s storms. Looking through the noise, the economy is still slowing, but it’s doing so from an even more overheated position than we had assumed. All else equal, that means it’s going to take a bit longer to get the economy back to a position where disinflationary pressure is strong enough to get inflation back inside the 1-3% target range. There will be implications for the RBNZ’s assessment of the output gap. The RBNZ estimated potential output growth of 0.8% for the June quarter, so there will be less disinflation pressure coming out of this GDP outcome.
However, it’s important to put these signs of ongoing inflation pressures in perspective. At the time of the August MPS, the RBNZ’s projections indicated that the Monetary Policy Committee saw only a 40% change of the OCR rising to 5.75% in the first half of 2024. We don’t think that the data flow over the past week will have been strong enough to push the RBNZ’s view into line with our own i.e., that the OCR will need rise to 5.75% at the November Monetary Policy Statement. Certainly, we see the risks of a tightening at the October Monetary Policy Review as still being modest: perhaps a 10-20% chance.
The RBNZ’s Monetary Policy Committee is already acutely aware of the lingering inflation pressures in the economy. We expect they will be closely watching upcoming inflation-related indicators in October and November for a more definitive guide on whether quarterly inflation rates will step down significantly from the December quarter as forecast. Of particular importance will be the September quarter CPI, especially the various gauges of core inflation which are yet to show material signs of deceleration. Important also will be pricing indicators in upcoming business confidence surveys (the QSBO and ANZBO), as well as wages and employment indicators in the September quarter labour market report (due early November). The strength of wage growth will be crucial for determining how quickly services prices and non-tradables inflation will slow from their current elevated levels. We doubt the RBNZ will want to move ahead of seeing this important information (in their shoes, we wouldn’t).
As noted above, we don’t think there is much debate that growth is slowing and that it will be very flat (possibly even recessionary) in the second half of 2023. Last week the long running Westpac-McDermott Miller Consumer Confidence Survey confirmed that consumer confidence remains in the doldrums and households are keeping the purse strings tight. Cost of living pressures remain intense and interest costs for leveraged households are steadily increasing as past tightening impacts household budgets.
The issue is really about how fast the current red-hot inflation pressures will ease. Importantly, it looks like the risk on this front are becoming tilted towards more persistent price pressures, with the housing market turning up and population growth at historic high levels. Hence, the various gauges of wage and price pressures will be key to determining the RBNZ’s monetary policy approach from here – is it higher or just longer?
This dilemma is also facing other central banks around the globe. Indeed, last week the Federal Reserve indicated that it now expects its policy rate to remain elevated for longer than had been forecast back in June. This essentially validated the market’s repricing of the US interest rate curve over the past couple of months, which has seen the 10-year US Treasury yield rise to levels last seen in 2007. On that score, our international team have again revised up their forecast for US bond yields and that has flowed through to our forecast of the outlook for bond yields in New Zealand. For example, we now see the 10Y NZGB yield ending this year at around 5.2%, which is 35bps higher than forecast previously. While we see the 10-year yield declining to 4.65% by the end of next year, this is still 55bps higher than we had forecast previously.
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