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Domestic Demand Strengthens

Data Flash (New Zealand)

NZ: Domestic Demand Strengthens But Tightening By The RBNZ This Side Of Christmas Seems Unlikely


This week the domestic economy continued to buck the trend weakening in the global economy. The housing market showed further signs of buoyancy and retail sales again exceeded market expectations.

The market has now largely priced out any chance of further RBNZ easing in the current cycle, in line with our central view. However, despite our relatively bullish view of the New Zealand economy, we think that with international data continuing to print on the weak side, an easing in August should not be ruled out entirely. Similarly, although we foresee 50bps of monetary tightening on a 12 month view, we think that the market has gotten ahead of itself in pricing a tightening move this side of Christmas.

House sales continue to rise

The plethora of robust domestic data continued this week with Auckland's largest real estate agency reporting a further 4% mom rise in house sales in May, taking the annual rate of increase to over 50%. If this result is translated across the nation, as is usually the case, nationwide sales in May are likely to print some 30% above year-earlier levels.

We think that a number of factors have underpinned the lift in activity. Despite weakening over the past two months, consumer confidence over the first half of this year has been much more buoyant than through most of last year. Both floating and fixed mortgage rates have declined and the proportion of households reporting that it is a good time to buy a house has increased to the highest level reported since 1999. In addition, the net outflow of migrants - which had accelerated in late 2000/early 2001 - has eased over the past two months. In fact, April saw the first net migrant inflow since 1998.

Housing market will underpin consumption

Historical experience suggests that e increase in housing demand will sooner or later begin to put some pressure on prices. Our central outlook is that recent strength we be largely sustained (although a repeat of the 1997 experience, when an emerging boom was cut short by the Asian crisis and drought, remains a risk). Therefore, after declining over the past year, we think that real house prices (nominal prices deflated by the CPI) are likely to stabilise over the coming year, at the very least.

Housing is by far the most important asset on the average New Zealand household balance sheet and thus a key factor underpinning household net wealth. For this reason, it is not surprising that real house prices and private consumption are highly correlated. A lift in house prices will help to underpin household spending. Indeed, the mere absence of declining prices removes a significant negative influence from spending decisions compared with last year.

Retail sales again exceeds expectations

For the third month in a row, retail sales again exceeded market expectations. Sales rose 0.9% mom in April - the market had expected just 0.5% mom - and were 7.2% higher than a year earlier. Both department store and appliance sales grew in April - an outcome that is entirely consistent with higher turnover in the housing market. The outcome, which was in line with our own expectations, leaves retail sales on track to record volume growth of 1% qoq in Q2, following on from the much higher than expected 1.4% qoq growth experienced in Q1.

Clearly, much improved levels of confidence, a buoyant labour market, increasing wage settlements, and a huge increase in New Zealand's terms of trade (close to 10% in the year to March by our estimate) are providing a substantial buffer to the weak global economy at this point. That said, our modelling suggests that the full force of the global slowdown is yet to make itself felt - the New Zealand economy typically lags the US by one year. Therefore we think it would be dangerous to extrapolate recent trends. Our own forecasts allow for some moderation in growth from the levels that now appear likely to be recorded in the first half of this year, consistent with recent declines in business and consumer optimism.

Market no longer expects further easings

Over the past week the market has moved further towards our central view that the easing cycle in New Zealand concluded with the RBNZ's 25bp easing on 16 May. We see very little chance of an easing at the RBNZ's interim review on 4 July, although not all commentators share this view. Thus the differential between short rates in New Zealand and the US look likely to widen further if, as expected, the Fed eases by 25bps at its next meeting.

However, at least over the near-term, we think that the market may be getting ahead of itself in removing virtually all chance of further easing from the curve. An easing in August cannot be ruled out if the global outlook continues to remain stagnant, or worse still deteriorates further. Although data suggests that the global economy may be close to bottoming, at this stage we see little evidence of an imminent recovery. Moreover, it is far from clear that the recent run of very good domestic data will continue over coming months.

Similarly, even if our relatively bullish view of the New Zealand economy unfolds, we think that the market's pricing of a rate hike this side of Christmas is unduly pessimistic. We think that central banks, including the RBNZ, will want to be very sure that the global recovery is entrenched before beginning to unwind the easing put in place this year. Given our expectation that it will be some months yet before global data shows sustained improvement, this leaves us pondering the first quarter of next year as the earliest timing for a rate hike in New Zealand. Indeed, if trading over Christmas proves buoyant, this hike could come as early as the January Interim Review, with the groundwork laid out in the November Monetary Policy Statement. However, our central view is that the RBNZ will begin the retightening process at its March Monetary Policy Statement.

Darren Gibbs Senior Economist

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