RBNZ to leave OCR unchanged at 5.75%
New Zealand - RBNZ to leave OCR unchanged at 5.75%
- Retail sales volumes grew 1.3% qoq in Q2. Moreover, labour market data have supported our view that overall economic activity grew by around 1% qoq following a flat Q1.
- There is mounting evidence that the RBNZ has underestimated emerging wage pressures.
- External sector data has been less encouraging but, on balance, the likelihood of a rate cut on 15 August has reduced substantially. We expect the RBNZ to retain the OCR at 5.75%.
- While concerns about the global economy will likely dominate the Bank’s risk assessment, upside inflation risks due to rapid growth in unit labour costs should receive greater attention.
Key view summary
Economy: Indicators of actual activity remain very robust. But downside risks stem from the global growth outlook.
- 2001 1.8% yoy 2.3% Q4/Q4-1
- 2002 3.1% yoy 3.2% Q4/Q4-1
Monetary Policy: We expect no further rate cuts, although there remains the risk of a final 25bp easing.
Official Cash Rate
Now 3Mth 6Mth 12Mth
5.75% 5.75% 5.75% 6.25%
Source: DB Global Markets Research
Retail sales grew strongly in Q2.
Retail sales volumes rose 1.3% in Q2, just a little stronger than the median market expectation, but much stronger than most market economists thought likely as recently as April. This result followed a 1.5% qoq surge in Q1. As we have argued for some time, household spending was always likely to benefit from a combination of robust consumer confidence, strong growth in employment, rising wage settlements, rapid growth in farm incomes, lower interest rates and a gradual recovery in the housing market.
Retail Volumes and Consumer Confidence
Source: DB Global Markets Research, Statistics NZ, Colmar Brunton
Labour market data rebounds strongly in Q2
Despite strong retail sales, overall GDP was unchanged in Q1. The latter result was in line with subsequently revised labour market data, which pointed to little growth in hours worked or employment during the quarter. However, labour market data released over the past fortnight printed stronger than expectations, supporting our contention that GDP growth has rebounded sharply in Q2. The Household Labour Force Survey (HLFS) indicated a 0.9% qoq rise in employment and a 0.3% qoq rise in hours worked. Similarly, the employer-based Quarter Employment Survey (QES) indicated a 0.7% qoq rise in employment and a 1.7% qoq rise in hours paid. With a number of important partial indicators still to be published, at this stage we think that GDP grew by around 1% qoq in Q2.
Employment Growth and Unemployment Rate
Source: DB Global Markets Research, Statistics NZ
The strong employment data had been foreshadowed by continued growth in job advertising, as captured by the ANZ survey. Surveyed job ads rose to yet a new record high in July, suggesting that the momentum of employment growth has carried over into Q3.
A tight labour market is driving wages higher
According to the HLFS, the unemployment rate fell to a new 13-year low of 5.2% in Q2. Business survey measures of skill shortages have also remained at extreme levels. Therefore “real’ factors alone would suggest that a significant rise in nominal wage and salary settlements is close at hand. However, at present, the risk of rising wage inflation is even greater. This reflects the sharp rise in headline inflation over the past year (to 3.2% over the year to June), which means that considerable growth in nominal wages is required just to maintain employees’ real compensation.
In its May inflation projections, the RBNZ was optimistic that nominal wage inflation would peak at around 3.5% in the year to Q1 2002, before declining to around 3% during the following year. Yet, according to the QES, following a 0.8% qoq increase in Q2, annual growth in private sector ordinary time wages has already increased to 3.5%. Moreover, overtime rates rose a record 5.9% qoq in Q2 - another symptom of labour market tightness. „hStatistics New Zealand noted that both the average size of increases and the proportion of wages increasing during each quarter are edging higher, with 5% plus settlements becoming more common.
Wage Growth and Skill Shortages
Source: DB Global Markets Research, Statistics NZ, NZIER
We think that the RBNZ has underestimated annual wage inflation by at least 0.5pps and probably by more. We expect wage inflation to rise towards 4.5% by the end of this year and to remain at around 4% over the following year. Rising wage settlements combined with very weak growth in productivity has generated a strong cyclical upswing in unit labour costs that, in our view, will gradually replace exchange rate driven price rises as the key source of inflation pressure over the period ahead.
Unit Labour Costs (QES Basis)
Source: DB Global Markets Research, Statistics NZ
Trading partner growth has deteriorated
While domestic data has been very robust, thus dealing with the RBNZ’s concerns about the economy’s current momentum, the medium term risk to growth from a weak global economy has increased. According to the most recent issue of Consensus Forecasts, New Zealand’s 14 largest trading partners will report (trade weighted) growth of just 2.0% in 2001, down 0.3pps from the previous month’s expectations, reflecting sharp downward revisions to growth prospects in Asia and Europe. Growth expectations for 2002 have been revised down to 3.3% yoy from 3.2% yoy previously.
14 Key Trading Partner Growth Rates
Expectation in: Trade Weighted Growth (% yoy)
Apr 01 2.3 3.5
May 01 2.3 3.4
Jun 01 2.3 3.4
July 01 2.0 3.3
Source: DB Global Markets Research, Consensus Forecasts
Non-primary export growth has slowed
Growth in non-primary exports has also remained disappointing, hampered by cutbacks in global capital spending, thus failing to alleviate the concerns raised by the RBNZ in its 4 July statement. However, going forward, although the overall outlook for trading partner growth has deteriorated, it is notable that Australia’s near-term outlook (at the very least) has improved. Given that Australia is the key destination for New Zealand’s manufactured exports, it is possible that non-primary export growth will record a lift over coming months, even as overall trading partner growth slows. If so, this will help to reinforce a buoyant commodity sector that continues to benefit from increased volumes and prices that, although having eased slightly over the past two months, remain at levels that are quite atypical for this stage of the global cycle.
Bottom line - the OCR to remain at 5.75%
The RBNZ faces a dilemma. On the one hand, the domestic economy shows unmistakable signs of strengthening from a starting point where the economy is already operating at, if not beyond, its sustainable capacity. We think that the RBNZ’s concerns about the level of momentum in the economy - due to the flat Q1 GDP result - have been dismissed convincingly by recent data. However, on the other hand, aside from in Australia, global data remains very mixed and the forecast recovery remains just that - a forecast. This poses potential downside risks to economic activity and inflation at some point in the future.
On balance, we think that the RBNZ will give greater weight to the concrete evidence from strong domestic data and the consequent inflation risks, and therefore refrain from easing further on 15 August. With two further opportunities available this year to shift rates downward if needed, we see little imperative to ease policy at this point. We think that the chance of a further 25bps cut on 15 August is now no higher than 20%, with the latest Dow Jones survey indicating that no market economists now expect a cut (half had expected a cut just a fortnight ago). While concerns about the global economy will likely dominate the Bank’s risk assessment, upside inflation risks due to rapid growth in unit labour costs should receive greater attention in the Monetary Policy Statement.