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Monthly Economic Indicators July 2008

Monthly Economic Indicators July 2008

Executive Summary

* CPI inflation rose to 4% in June 2008 and is expected to peak around 5% in September
* Our view is that GDP growth was negative in the second quarter of 2008
* With continuing weak growth, inflation is expected to ease in the medium term
* The international financial situation remains uncertain and the outlook is for lower world growth

Consumer price inflation rose to 4.0% in the year to June and was greater than forecast at the Budget Update. Tradable inflation increased and was driven by higher food and petrol prices. Annual inflation is expected to peak at around 5% in September 2008, again due to higher food and petrol prices and higher non-tradable inflation. A weakening New Zealand dollar will influence the extent and speed at which inflation falls beyond this period.

Firms' activity was down in the June quarter and more are expecting activity to be down in the September quarter. Cost pressures have increased and firms' profitability has declined. Although pricing intentions have increased, firms will find it difficult to pass on higher costs and have reduced employment and investment intentions.

Domestic demand has weakened and private consumption is expected to have fallen in the June quarter. As food and petrol prices increase, spending on more discretionary items has fallen. Retail sales fell in May and reflected a sharp fall in motor vehicle sales. Consumer confidence declined in July and weak electronic card transactions data suggests retail sales were soft in June.

House sales remain weak and building consents fell further in June. As the housing market weakens, residential investment is expected to decrease. Falling exports and higher imports also point to weak GDP growth in the quarter. With world growth expected to slow in the second half of 2008 and international financial conditions remaining uncertain, we look at the global economic outlook as a Special Topic.

Our view is that the economy contracted for the second consecutive quarter in June. Annual average growth in real production GDP in the calendar 2008 year is expected to slow to ½% - ¾%. With demand weakening, capacity constraints will ease and inflation will decrease in the medium term. With risks of the economy slowing further and CPI inflation expected to fall back within the 1-3% range in the medium term, the Reserve Bank cut the Official Cash Rate by 25 basis points to 8.0%.

Growth is expected to pick up in the December 2008 quarter owing to the combined effects of tax cuts on 1 October 2008, recovery from the drought, high export prices, the weakening New Zealand dollar and more reductions in the OCR.



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