J.P.

Morgan Australia Limited, Sydney Economic Research

Stephen Walters Helen Kevans Global Data Watch
May 6, 2011
Ben Jarman

Australia and New Zealand Australian dollar

AUD/USD
• RBA sidelined again, but commentary hints that rate 1.1
hikes are on the way
• Aussie retail volumes flat in 1Q; value of sales de- 1.0
pressed by lower prices
0.9
• NZ employment bounced in 1Q, jobless rate unex-
pectedly dropped 0.8
Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11
Central bank commentary dominated events in Australia
this week, even though there also was a steady flow of eco-
nomic data. The RBA left the cash rate unchanged Tues- Australia: terms of trade and budget balance
day, as expected, but issued a statement that hinted officials Index A$bn
have become more anxious about the inflation outlook. In- 120 10
deed, on Friday, the RBA lifted the official inflation fore- Budget balance
casts to show core inflation above target in two years’ time. 100 5
The change reflects an unexpectedly high 1Q outcome and
0
is a matter of arithmetic, but also is a signal that rate hikes 80
are closer than many believe. We continue to forecast a -5
hike in August, but the risk of an earlier move is rising. 60 Terms of trade -10
Prior to the release of the official forecasts, the RBA’s
commentary Tuesday indicated that elevated AUD, which 40 -15
hit a fresh post-float high this week, was doing some of the 90 95 00 05 10
heavy lifting in tightening monetary conditions, but played
down the significance of AUD on the economy. edged higher since September 2009, albeit at a frustratingly
slow pace. The highlight in NZ next week will be the elec-
Fiscal policy the focus next week tronic card transactions data, which have replaced the retail
sales report. Growth in electronic card transactions (ECT)
This week’s data flow in Australia showed a drop in house accelerated in March following the earthquakes in
prices in 1Q, but a big rise in approvals for new construc- Christchurch (Feb. 22), but we suspect there will be some
tion in March. The retail sales data Friday showed flat sales payback in April. The fact that wage growth pulled back in
volumes in 1Q and a fall in nominal sales in March, but 1Q (to 0.4%q/q from 0.6%) also implies that the retail sec-
much of the weakness in the value of sales can be attrib- tor will continue to struggle and that households will re-
uted to import price falls owing to high AUD. main inclined to pay down debt.
Fiscal policy takes center stage next week when Federal
Treasurer Swan on Tuesday releases the annual Budget (see RBA left cash rate unchanged ... again
research note “Australia’s Budget to include long-overdue The RBA this week left the cash rate unchanged at 4.75%,
austerity,” in this GDW). We expect the Treasurer to an- as we and the majority of market economists had expected,
nounce a deficit of close to A$50 billion for the year ended but there were notable, albeit virtually offsetting, changes
June 30, close to the record deficit he announced last year, in the commentary. The statement, therefore, delivers a
and much larger than Treasury had forecast last November. message broadly consistent with what officials said a month
Receipt of the proceeds from the terms of trade boom has ago. Through all the statistical noise, natural disasters, the
been delayed, but eventually will fill the Treasury’s coffers. soaring currency, last week’s inflation shock, and recent
The Treasurer’s promise of delivering a budget surplus offshore developments, not much has changed. The official
within two years, therefore, seems reasonable. cash rate is headed up, but not yet.

In New Zealand data this week, the jobless rate unexpect- Officials, for example, stepped up the tone of the language
edly fell in 1Q, and although figures were distorted by the in reference to the terms of trade, which is higher than they
impact of the Canterbury earthquake, the labor market ap- expected. Importantly, they now have called the bottom for
pears to be improving. Indeed, trend employment has the inflation cycle. The recent information suggests that the

59
J.P. Morgan Australia Limited, Sydney Economic Research
Stephen Walters Helen Kevans Australia and New Zealand
May 6, 2011
Ben Jarman

marked decline in underlying inflation from the peak in Australia: NAB survey and employment growth
2008 has now run its course. RBA officials did, however, %6m ar Index, advanced 4 mo.
tone down the language elsewhere. For example, the com- NAB employment
mentary says that high AUD (if sustained) will be a source 5 20
of restraint for the traded goods sector, and GDP likely will 4 10
have contracted in 1Q, owing to the floods in Queensland 3
and the later cyclone. 0
2
Employment -10
As we had expected, officials did not add an explicit quali- 1
fier to the paragraph at the end discussing the appropriate- 0 -20
ness of the policy stance (such as “for now” or “for the -1 -30
time being”). Doing so risked ringing alarm bells about an 2006 2007 2008 2009 2010 2011
imminent tightening. There was one addition to the last
paragraph, referring to the Board assessing carefully the
Australia: retail sales
evolving outlook for growth and inflation—but don’t offi- %oya
cials do that every month? We doubt this sends any particu- 12 Food
lar signal about the likely timing of the next hike. For now
then, with the policy stance “appropriate” as before, Board
members seem happy to sit on the policy sidelines while
they watch how things unfold. 6
Total
Indeed, there are enough lingering uncertainties to keep the
RBA sidelined in the near term. As these recede, though,
we expect the tightening cycle to resume. While Board 0
members seem comfortable that a “mildly restrictive” 2005 2006 2007 2008 2009 2010 2011
policy stance is the one to maintain, we still believe the
next rate hike is likely within months. Our preferred timing growth expected to be at or above trend over the next few
is the August Board meeting but, with inflation already years, at a time when spare capacity is limited and the labor
having bottomed, the intervening meetings also are “live.” market continues to tighten (the RBA now forecasts the
unemployment rate at 4.25% by end-2013, comfortably
below the 5% level consistent with full employment).
RBA lifted inflation forecasts in SoMP
On Friday, the RBA released its much-anticipated quarterly The impact of the natural disasters has been greater than
Statement on Monetary Policy (SoMP), which included ma- officials assumed in the February SoMP, mainly owing to
terial official forecast revisions. The most striking of these problems in removing water from flooded coal pits, which
were the upward revisions to the Bank’s inflation forecasts, has delayed the resumption of coal production. These ef-
with the official forecasts for headline and core inflation fects would, though, be temporary. The medium-term eco-
above the RBA’s 2%-3% target range for the year ending nomic outlook continues to be dominated by the booming
December 2013. Indeed, the Board flagged that underlying terms of trade (which the RBA expects will rise further in
inflation would increase gradually over the forecast hori- 2Q to be above the level assumed a few months ago) and
zon, but by end-2013 would be above target at 3.25%. building mining investment. An important offset to this
strength remained the household sector, which remained
The clear message from the SoMP is that further policy cautious and reluctant to spend despite continued strength
tightening is warranted. While higher AUD and household in the labor market. The RBA assumed in its forecasts that
caution are helping to cap the inflation pressures associated households would remain cautious, and the saving rate
with the resources boom, with the underlying inflation fore- would remain steady at elevated levels, but acknowledged
cast to be at the top end of the Bank’s target over much of the risks around this view. On the one hand, recent house-
the next couple of years, our assessment remains that the hold austerity could become even more pronounced—a
cash rate still has further to rise. We forecast another two result of a structural shift in behavior—but, on the other,
rate hikes this year. Indeed, it seems to us that the flood should consumers become more confident as labor market
rebuilding effort will boost aggregate demand when the conditions tighten and wage growth accelerates, then stron-
economy already has little spare capacity. And, with GDP ger consumption growth could follow accordingly.

60
J.P. Morgan Australia Limited, Sydney Economic Research
Stephen Walters Helen Kevans Global Data Watch
May 6, 2011
Ben Jarman

Indeed, the most significant risk to the RBA’s assumed out- New Zealand: unemployment rate
look revolves around the labor market. The RBA high- %
lighted that, should companies compete more aggressively
for labor, upward pressure on wages may intensify. Offi- 7
cials’ discomfort with this scenario stems from past experi-
6
ence. In the early stages of the last resource boom (in 2006-
08), labor market pressures appeared contained, but domes-
5
tic inflation soon picked up significantly amid high levels
of economy-wide capacity utilization and stronger growth
4
in global commodity prices. As such, while our base case is
for the next hike to be delivered in August, an upside sur- 3
prise in the upcoming employment and wage data prior to 00 02 04 06 08 10 12
the RBA’s June Board meeting would significantly in-
crease the likelihood of an earlier rate hike. New Zealand: electronic card transactions
%oya
With respect to the employment numbers next week, after a 10
particularly strong labor force survey in March, which Total
showed a spike in employment (mainly owing to full-time 8 Retail
jobs) and a drop in the unemployment rate (despite a rise in 6
participation), we expect some payback in April. We fore-
cast a sharp pullback in job growth from a jump of 38,000 4
jobs in March to “just” 10,000 last month. A steady partici-
2
pation rate should allow the unemployment rate to remain Core retail
unchanged at 4.9%. 0
2008 2009 2010 2011
Retail sales and house prices weak in 1Q closer to tightening policy. But this week’s retail data sug-
gest that consumers remain cautious, in keeping with the
The Aussie March retail sales report involved twin shocks:
recent theme prominent in RBA commentary. Indeed, the
an unexpected fall in the value of sales in March, and a
RBA this week highlighted the weakness on the consumer
very weak volumes report for the March quarter. Sales vol-
front, with credit growth to households having softened
umes were flat over the quarter; we had anticipated a 1.0%
and house prices having headed south.
rise. The weak volumes result means GDP for the quarter
now is much more likely to have fallen. We had thought
House prices nationally fell in 1Q, but the physical approv-
that higher retail volumes would partly offset the drag on
als data for March showed a 9% rise. The latter, though,
output from the floods in January.
comes after large falls in recent months. Approvals are still
running well below housing demand, so we expect house
Total retail sales values dropped 0.5%m/m in March. The
prices to be supported, at least for now. Indeed, the under-
more discretionary areas of retailing were weakest, with
lying pulse of building approvals and housing finance is
department store sales, for example, plunging 3%m/m. The
weak. Turnover in the housing market is skittish, and now
impact of higher day-to-day living costs on consumer
prices are beginning to suffer as well. We continue to ex-
spending was most evident on discretionary sales, with our
pect dwelling prices to perform better than weakening de-
measure of discretionary spending falling 0.8%m/m. Non-
mand for housing finance would imply, given that the ab-
discretionary spending also was weak, however, falling
sence of a forced seller—due to robust national income
0.3%m/m, thanks mainly to a drop in food sales (-0.4%).
growth and low unemployment—should generate some
The value of food fell, partly as prices dropped back from
withdrawal of supply to compensate.
the flood-induced highs reached in February.

As already highlighted, from the RBA’s standpoint, such
household austerity continues to provide scope for officials
to sit on the policy sidelines. If consumers were less con-
servative, at the same time that the terms of trade and in-
vestment were booming, the RBA likely would be much
NZ labor market heading in right direction
The recovery in the New Zealand labor market continued
into 2011, with the economy adding 30,000 jobs over the
March quarter. The labor force data were, though, affected
by difficulties with data collection in Canterbury following

61
J.P. Morgan Australia Limited, Sydney Economic Research
Stephen Walters Helen Kevans Australia and New Zealand
May 6, 2011
Ben Jarman

the February earthquake, such that a different method from Building approvals
usual had to be used to estimate data from this area. In the Sa
Jan Feb Mar
week after the earthquake, Statistics New Zealand sus-
pended interviews in some areas, resulting in 800 responses %m/m -11.6 -10.7 -7.4 -5.3 3.2 9.1
of the 2,200 Canterbury households in the survey sample %oya -16.4 -15.6 -21.8 -13.3 -25.8 -18.1
not being collected. This implies, though, that just 5% of
Retail sales
the nationwide survey sample of 15,000 was affected; thus, Sa
the impact on the national estimates from this disruption to Jan Feb Mar
data collection was small.
%m/m 0.4 0.3 0.5 0.8 0.3 -0.5
%oya 1.6 3.6 3.1 2.3
The steady rise in the trend employment rate since the Sep-
tember 2009 quarter suggests, however, that a modest re- Retail sales ex. inflation
covery is under way in the labor market. Indeed, on an an- Sa
nual basis, trend employment rose by 39,000 in 1Q, or 3Q10 4Q10 1Q11
1.8%. The trend unemployment rate also has remained %q/q 1.2 0.5 -0.4 1.0 0.0
fairly stable since 3Q09. Furthermore, on a seasonally ad- %oya 3.8 2.7 1.9 1.1 2.8 1.8
justed basis, the unemployment rate fell 0.1%-pt from 6.7%
to 6.6% in 1Q, with the sharp spike in employment growth
being offset by one in the participation rate. New Zealand:
Data releases and forecasts
Australia:
Week of May 9 - 13
Data releases and forecasts
Tue Electronic card transactions
Week of May 9 - 13 May 10
8:45am Jan Feb Mar Apr
Tue Trade balance
May 10 Total %m/m 2.3 0.4 0.5 -1.1
11:30am Dec Jan Feb Mar Total %oya 5.5 6.1 5.6 5.5

A$ mn 1778 1433 -205 500 Retail %m/m 2.4 -0.2 1.3 -0.9
Retail %oya 6.4 6.2 5.9 6.5
Tue NAB business confidence
May 10 Net balance
11:30am Jan Feb Mar Apr Review of past week’s data
Index 4 14 9 10 Private sector wages (ex. overtime)
Sa
Thu Labor force survey 3Q10 4Q10 1Q11
May 12 Sa
%q/q 0.6 0.6 0.6 0.4
11:30am Jan Feb Mar Apr
%oya 1.6 1.9 2.2 2.0
Unemployment rate (%) 5.0 5.0 4.9 4.9
Employment (ch. 000s) 14 -9 38 10 Building permits
Participation rate (%) 65.8 65.7 65.8 65.8
Sa
Jan Feb Mar
Review of past week’s data
%m/m 9.0 -9.8 2.5 2.2
House price index %oya -14.9 -29.1 -25.9 -26.2
Sa
3Q10 4Q10 1Q11 Labor force survey
Sa
%q/q -0.3 -1.1 0.7 0.8 -1.0 -1.7 3Q10 4Q10 1Q11
%oya 10.8 9.9 5.8 5.0 0.5 -0.2
Unemployment rate (%) 6.4 6.8 6.8 6.6
RBA cash rate announcement Employment (000) 23.0 -11.0 13.3 30.0
Participation rate (%) 68.3 67.9 68.2 68.7
No change delivered. See main text.

62