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BNZ Weekly Overview, 26 May 2005

BNZ Weekly Overview
0800 ASK BNZ 0800 275 269

The Week Gone By 1
Exchange Rates 7
Interest Rates 4
Economic Data/Forecasts 10
Housing Market Update 5

This Week 4 wks 3 mths Yr 10 yr
week ago ago ago ago average
Official Cash Rate 6.75% 6.75 6.75 6.50 5.50 6.5
90-day bank bill 7.07% 7.05 7.03 6.84 5.97 6.8
10 year govt. bond 5.81% 5.79 5.93 6.04 6.28 6.7
1 year swap 7.04% 7.03 7.02 6.92 6.18 6.9
5 year swap 6.66% 6.68 6.69 6.74 6.58 7.2
NZD/USD 0.714 0.712 0.721 0.721 0.617 .565
NZD/AUD 0.936 0.937 0.926 0.916 0.871 .856
NZD/JPY 76.8 76.2 76.2 75.9 69.0 64.4
NZD/GBP 0.39 0.387 0.377 0.378 0.341 .35
NZD/EURO 0.567 0.562 0.56 0.544 0.51 .50

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BNZ Fortnightly Survey

This week we are running our fortnightly survey again. It is interesting to note an increasing number of news media picking up on what we produce in our report on the following Tuesday. So please feel free to say whether you think the economy will get better or worse and in particular make a comment about how things are developing at the moment in your particular sector.

The Week Gone By
Things are on the light time this week because of four days spent travelling down South for talks in a variety of places including one with no resemblance to Chernobyl (bring on the oysters). Data have thankfully been thin on the ground over the past week with just some confirmation of rising producer inflation, net migration inflows continuing to ebb away at a steady pace, and data showing tourist numbers falling 6.9% seasonally adjusted in April. This dearth of data has left plenty of space in the business pages for discussion about possible tax changes. For anyone interested in working out what tax cuts are possible, figure out how much you want to reduce the 2006/07 $5.3b operating surplus by and chip away
at it using the very good Tax Ready Reckoner supplied by Treasury on their website. Go to

Page 2

Fri 20
Migration Flows Ebbing Away
There was a net loss to New Zealand’s population from permanent and long term migration flows in April of 733 people. This compared with a loss of 69 people in April 2004 and an average April loss for the past ten years of 70 people. Recent monthly net results have been running around 600 worse than the ten year average and given a ten year average 12 month gain of 13,300 this suggests a net gain for the next 12 months near 5,000. However we feel the turnaround in flows will get worse than currently being revealed - as NZ’s growth rate slows and the attractiveness of moving to Australia goes through its usual cyclical lift - and a net gain near zero for the year is likely. In the three months to April the number of immigrants was down by 3.8% from a year earlier and this would have been a lot worse were it not for an unusual jump in immigrant numbers in April of 8.5% from a year ago – possibly caused by April not being affected by Easter this year whereas it was last year. This was the first annual gain since February 2003. Emigrant numbers in April were up 21% from a year ago and up 16% in the April quarter. The annual net migration gain now stands at 9,349 from 10,013 in March and 25,712 a year ago. This is the lowest net annual gain since November 2001.

Visitor Numbers Fall Away
In April the number of visitors to New Zealand was down by a relatively strong 5.2% from a year ago. This result means numbers in the three months to April were up just 3.9% from a year ago which is the lowest such rate of growth since September 2003. The annual average rate of inward visitor growth has fallen to 8.2% from a peak of 12.7% in October but is still up from 6.2% a year ago. In seasonally adjusted terms visitor numbers fell a strong 6.9% in April after rising 4.7% in March. Over the April quarter the seasonally adjusted change was +0.4% which is a very low rate of growth. The data support the view that visitor number growth is essentially flattening out. Taken in conjunction with evidence of falling average number of days stayed in NZ and some exchange-rate related easing in spending levels the tourism sector looks like it will be going through a lean time – after the Lions tour is out of the way. Perhaps the low April number for UK visitors reflects some delaying their travel until the tour is on.

Page 3

The number of Kiwis travelling overseas was up 22% in the year to April from a year earlier, up 13% in the April quarter from a year ago (the rate of growth slowing then) and up 3.8% in the April quarter seasonally adjusted.

Mon 23
Business Costs Rising
The Producers Price Index inputs index rose by a relatively low 0.3% during the March quarter rising 0.9% during the December quarter. Compared with a year ago the index was up by 4.2% and this is the highest rate of inflation using this measure since September quarter 2001. The rise has come about in spite of a rising exchange rate pushing down the prices of imported goods. Output prices on average rose by 0.5% in the quarter but were up 3.2% for the year so margins have reduced slightly over the past year. The indexes exclude labour costs.
Source: Statistics NZ

Thurs 26
Trade Balance Still In The Red
The merchandise trade account recorded a slightly smaller than expected deficit in April of $147m compared with $194m a year ago. Exports were 4.2% ahead of a year earlier while imports were just 2.3% ahead. The annual trade balance now stands at -$4.3b from -$3.9b a year ago and is the second largest on record after the $4.4b recorded in the year to March. Consumer goods imports were 3% up on a year ago and 8% up in the three months to April from a year ago. This three month rate of growth compares with 9% in the January quarter and 6% a year ago so suggests a still steady underlying rate of growth in consumption activity. Imports of plant & machinery were only 1% up from a year ago in April but this followed 11% growth in March and 26% growth in February giving 11% from a year ago for the three month period. April last year was exceptionally strong – up 32% on April 2003 – so the underlying trend in investment goods imports still looks quite strong.

Source:Statistics NZ

Page 4

The yield on 90-day bank bills has ended the week slightly up near 7.07% from 7.05% last week with the markets seeing a chance that there will be a rate rise from the RBNZ at the next official cash rate review on June 9. A rise is certainly possible and one key determining factor will be whether the RB feels the financial markets are taking the inflation threat as seriously as they are. Given that the RB have said they see no scope for any easing of policy in the “foreseeable future” whereas the markets are pricing in rate cuts early next year we suspect some strong words from the RB in their review.

But the bigger problem for the RB is the way fixed borrowing costs continue to remain low. The two year swap rate at which we banks borrow to lend fixed two years has ended this afternoon near 6.82% which is basically where it has been for the past month and a half. The rate is up from 6.2% when the RB started their rate tightening cycle at the end of January last year. But given some reduction in bank lending margins one can get two year fixed rate loans near 7.6% from 7.4% back then – completely undermining the effectiveness of monetary policy in the housing market.

Over the past three weeks we have seen falls in US bond yields taking their benchmark ten year government bond yield to 4.07% from 4.09% last week and 4.25% a month ago. Given that the main determinant of fixed rates in New Zealand is fixed rates in the United States the recent rally in the US bond market has caused small falls in long term borrowing costs here and means borrowers still face little threat of any housing-market sapping rise in borrowing costs in the near future.
Given that changes in the official cash rate are largely ineffective as a monetary policy instrument now we see a high chance that the RB will have to explicitly state to the markets that this cycle they are replying on economic restriction from a high exchange rate to get growth down to where it needs to be. This is obviously bad news for exporters and the non-pastoral part of the economy is where we think the greatest weakness is likely to appear generally during this period of slowing growth in the NZ economy.

If I Were A Borrower What Would I Do?
The usual, fix 2-3 years and not get optimistic about floating rates falling before 2007.

Page 5

BNZ Fixed Lending Interest Rates BNZ Term Deposit Rates
Housing Business Farm Days $10-50K $50-100K $100-250k
Advantage* First*
Float 9.00% 9.30% 9.25% 30 3.00 3.00 5.25
1 yr 7.70 8.70 8.55 90 5.60 5.65 5.70
2 7.60 8.70 8.55 180 6.95 6.95 6.95
3 7.80 8.70 8.55 1 yr 6.50 6.55 6.60
4 7.80 8.70 8.55 5 yr 6.50 6.55 6.60
5 7.80 8.70 8.55
7 8.00 - 8.55
10 - - 8.65
• Rates shown do not include normal margins.

We’ve made a lot of the fact that with fixed interest rates remaining low home buyers have been able to get their debt costs relatively insulated from rising floating mortgage rates. Nonetheless, with so much growth in debt (15% over the past year) the relative burden of servicing it has been growing. We measure debt servicing as interest cost compared with disposable income using a series compiled and published by the Reserve Bank. Their latest data run to the December quarter last year and show a debt servicing ratio of 10.7%. This was up from 9.5% at the end of 2003 and 2002 and was the highest such ratio on record.


Of some interest is the fact that this record high level of debt servicing has occurred at a relatively low average interest rate for all mortgages of 8.1%. The last peak in the debt servicing ratio of 9.4% in mid-2000 came about with an average interest rate of 9.1%. The previous peak of 9.9% in mid-1998 came with an average interest rate of 10.7%.

Page 6

So far so good for the puritanical folk wanting to scare young people of today with stories about high interest rates and falling house prices. But there is a key thing older generations need to remember. People taking on debt today are doing so in the strongest jobs market for three decades. Ability to “safely” service debt is far higher now than it has been for a long time. More than that people can gain insulation against rapid interest rate changes by using fixed interest rates. Such rates were not available before 1990 so changes in monetary policy and floating interest rates back then hit all mortgagors very quickly. In addition, in the bad old days of high inflation nominal debt servicing costs could go all over the place as nominal interest rates changed over a wide range. These days interest rates don’t tend to change anywhere near as much.
Because of these factors one needs to be careful when looking at the graphs we run sometimes comparing house prices with inflation or incomes. The graphs look scary but they fail to take into account the factors mentioned just above. The difficulty however is that these new factors we are talking about are very subjective and it is impossible to say what higher job security is worth in house price terms. Perhaps all we economists can usefully say after having failed to pick the extent to which average house prices would comfortably rise, is that structural changes can have temporary impacts. That is, as you move from one state to another very interesting things happen – in this case strong rises in house prices. But there comes a time when things settle down in the new state. History however suggests people tend to misread one-off changes as being permanent things and over-extend themselves. That is probably the territory we are in now.
The main implication of this is the following. On average over the past four years house prices have risen 12.9% per annum. The ratio of the median house sale price to income per capita has risen to 8.5 from 7.5 four years ago. It is possible that house prices remain near high levels because of the strong labour market etc. But it is extremely unlikely that house prices keep rising near 13% per annum. This means investors should watch that they don’t adopt over-optimistic assumptions about capital gains by blindly extrapolating what has been happening in the past four years. The circumstances have been special and wonderful for anyone who got a property early in the piece. But now the special factors are ending or reversing.

Page 7

To whit..
• Net migration flows are below 10,000 p.a. and headed to zero from an average of 30,00 p.a. over the past four years.
• The unemployment rate has fallen from 5.4% four years ago and 7.1% six years ago to 3.9%. It does not now head to 2%.
• Interest rates have been at unusually low levels because the Fed. funds rate in the United States was cut to a 46 year low of 1% and there were worries about deflation, SARs, the Iraq War, Japanese deflation, terrorist attacks, and a large fall in the US sharemarket.
• For a while here there was a massive boom in foreign student numbers.
• The NZD was well under-valued for about four years and made NZ property very attractive to foreign buyers.
• We saw a structural shift in desire to live near water – one would need a new shift to produce another round of such excitement about a particular group of properties.
• The rate of economic growth in New Zealand averaged 4.0% per annum the past six years while OECD growth averaged 2.5%. Such an optimism-inspiring differential will not continue as NZ growth now slows to reflect resource shortages.

At the moment the greenback is going through a generally firm phase with support from some better than expected economic data, rising sharemarket, expectations of continued tightening of monetary policy at a steady pace – and the fact that things don’t look so good in Europe where an early election may be held in Germany. Plus there are the upcoming French and Dutch referendums on the proposed European constitution which may produce No votes that will raise doubts generally about European cohesiveness. In addition there has been a pullback in expectations (misplaced we always thought) of an imminent revaluation of the Chinese Yuan against the US dollar.

At the end of trading this afternoon the USD was costing 107.6 yen from 107 a week ago. During the week the greenback traded over 108 yen which was the highest dollar/yen rate in five weeks. Against the pound the USD ended near $1.832 from $1.841 a week ago. A low for the pound near $1.825 was seen during the week – the lowest level since October last year. Against the increasingly over-stretched looking euro the USD ended near $1.26 from $1.27 last week and almost $1.30 a month ago. The euro is now trading near its lowest level against the USD since October 2004.

Page 8

In a few weeks time we could however just as easily see the greenback go through a weak period following the current strong period. If and when that happens the recent fall in the NZD to around the 71 cent area from over 74 cents could quickly reverse. This may be especially so as we see a high risk that monetary policy will be tightened again here, and that the Reserve Bank will make some strong statements about the potential need for rates to remain high for a long time. Plus we could even see the Reserve Bank in their June 9 Monetary Policy Statement note that effectively their raising of the official cash rate 1.75% since January last year has had no impact on the domestic economy because of continued low fixed interest rates.
In fact fixed interest rates are facing a fresh bout of downward pressure as we speak due to rallying US bond yields.
The RB may note that they need a strong exchange rate to help slow growth in the economy – especially after last week’s Budget revealed extra fiscal stimulus beyond what had been indicated by Treasury last December.

The NZD has ended this afternoon against the USD at 71.4 cents from 71.2 a week ago. For manufacturers the news remains all bad with the NZD’s cross rate against the Australian dollar still at a profit-sapping 93.6 cents from 93.7 last week. Against the yen we are strong near 76.8 from 76.2, and against the pound the FX markets are still providing bad news for people wanting to bring money from pounds into NZDs with the cross rate at 39 pence from 38.7 last week. This is the highest rate since October 1997.

Page 9

The Australian dollar over the past week has weakened then recovered to end against the greenback near 76.3 cents from 76 a week ago.

-A useful comment on the Chinese economy received form our NAB economists this week.
We expect China’s growth rate this year to easily exceed the 8% official target and the 7% medium-term target set in the Plan. The economy should expand by 91/% in 2005, slowing to 81/% in 2006. Export growth should slow as the pace of global economic expansion has subsided from 2004’s exceptional rate. Business investment should also slow as the authorities continue to target it with measures designed to cut fixed investment growth to around 15% from its current 25% to 30% range. The government will keep policy focussed on maintaining rapid growth. If the currency is revalued at all this year, it will not be by much - the aim being to minimise the loss in competitiveness and limit the effect on job growth. The main policy interest
rates only rose by around 25 bps last year as important sectors of the economy overheated and we expect this reluctance to tighten aggressively to continue. Tax cuts will continue as well, particularly those aimed at helping farm incomes. This publication has been provided for general information only. Although every effort has been made to ensure this publication is accurate the contents should not be relied upon or used as a basis for entering into any products described in this publication. BNZ strongly recommends that readers seek independent legal/financial advice prior to acting in relation to any of the matters discussed in this publication. Neither the Bank of New Zealand nor any person involved in this publication accepts any liability for any loss or damage whatsoever that may directly or indirectly result from any advice, opinion, information, representation or omission, whether negligent or otherwise, contained in this publication.

Page 10

All % Latest Previous Latest Year 2 Yrs
qtr only qtr only year ago ago
Inflation RBNZ target is 1% - 3% on average 0.4% 0.9 2.8 1.5 2.5
GDP growth Average past 10 years = 3.4% 0.4 0.6 4.8 3.4 4.7
Unemployment rate Average past 10 years = 6% 3.9 3.6 ...... 4.2 4.9
Jobs growth Average past 10 years = 2.3% 0.0 1.5 3.4 3.1 1.5
Current a/c deficit Average past 10 years = 4.7% of GDP 6.4 5.6 ...... 4.2 3.6
Terms of Trade 0.7 -0.3 4.8 6.6 -6.1
Wages Growth Average past 10 years = 2.9% 2.6 0.2 4.2 4.2 1.6
Retail Sales ex-auto Average past 7 years = 3.7%. 2.0 0.4 7.2 5.9 5.2
House Prices Long term average rise 4.2% p.a. 2.7 2.3 12.2 24.8 11.7
Net migration gain Av. gain past 10 years = 14,000 +9,349 12,808yr ...... 25,712 42,047
Latest Prev mth 6 mths Year 2 yrs
year rate year rate ago ago ago
Consumer conf. 10 year average = 15%. Colmar survey -13 -17 9 -11 -6
Business activity exps 10 year average = 29%. NBNZ 15 30 25 20 7
Household debt 10 year average growth = 11%. RBNZ 15.1 15.2 16.3 15.5 9.9
Dwelling sales 10 year average growth = 4.6%. REINZ -7 -9 -25 6 -2
Tourist numbers 10 year average growth = 6.1%. Stats NZ -5.2 10.6 9.4 22.6 4.5
Floating Mort. Rate 10 year average = 8.7% 9.00 8.75 8.25 7.50 7.85
3 yr fixed hsg rate 10 year average = 8.4% 7.80 7.70 7.65 6.90 6.95

Forecasts at May 12 2005 March Years December Years
2003 2004 2005 2006 2007 2003 2004 2005 2006 2007
GDP - annual average % change
Private Consumption 4.6 5.6 5.4 3.1 2.1 5.1 6.1 3.6 1.8 2.8
Government Consumption 2.5 3.1 5.8 3.7 4.1 2.3 6.3 3.3 4.3 3.3
Investment 7.3 13.7 8.8 2.8 3.3 10.8 12.7 2.6 2.6 5.0
GNE 4.2 7.0 6.7 2.6 2.7 5.4 8.0 3.0 2.3 3.4
Exports 7.6 1.0 5.0 4.0 3.7 1.9 5.2 4.1 3.5 4.8
Imports 7.4 11.9 12.9 3.3 3.5 8.115.7 4.1 3.2 4.9
GDP 4.6 3.6 4.3 2.3 2.7 3.4 4.8 2.6 2.3 3.3
Inflation – Consumers Price Index 2.5 1.5 2.7 3.5 3.2 1.6 2.7 3.0 3.3 2.9
Employment 1.5 3.1 3.4 0.9 1.2 2.6 4.4 0.9 1.0 1.1
Unemployment Rate % 4.9 4.2 3.9 3.6 3.7 4.5 3.6 3.6 3.7 3.9
Wages 2.5 3.1 2.9 4.3 3.7 2.7 1.9 4.3 4.3 3.2
NZD/USD 0.55 0.66 0.73 0.63 0.56 0.65 0.71 0.66 0.57 0.57
USD/JPY 119 109 105 103 100 108 104 104 100 100
EUR/USD 1.08 1.23 1.32 1.20 1.16 1.23 1.34 1.23 1.16 1.17
NZD/AUD 0.92 0.88 0.93 0.89 0.84 0.88 0.93 0.90 0.85 0.83
NZD/GBP 0.35 0.36 0.38 0.35 0.33 0.37 0.37 0.37 0.33 0.33
NZD/EUR 0.51 0.54 0.55 0.53 0.48 0.53 0.53 0.54 0.49 0.49
NZD/YEN 65.8 71.9 76.8 64.9 56.0 69.7 74.2 68.6 57.0 57.2
TWI 60.9 66.3 70.7 63.6 57.6 65.1 69.0 65.9 58.6 58.5
Official Cash Rate 5.75 5.25 6.75 6.75 5.75 5.00 6.50 7.00 6.00 5.75
90 Day Bank Bill Rate 5.8 5.5 6.9 7.0 6.0 5.3 6.7 7.2 6.2 6.0
10 Year Govt Bond 6.0 5.9 6.0 6.5 6.8 6.1 6.0 6.4 6.8 6.7
• Forecasts under review. All actual data excluding interest & exchange rates sourced from Statistics NZ.
The BNZ Weekly Overview is prepared by Tony Alexander, Chief Economist at the Bank of New Zealand.


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