Monetary Policy Statement June 20141 This Statement is made pursuant to Section 15 of the Reserve Bank of New Zealand Act 1989. Contents 1. Policy assessment 2 2. Key policy judgements 3 3. Financial market developments 9 4. Current economic conditions 14 5. The macroeconomic outlook 26 A. Summary tables 31 B. Companies and organisations contacted by RBNZ staff during the projection round 37 C. The Official Cash Rate chronology 38 D. Upcoming Reserve Bank Monetary Policy Statements and Official Cash Rate release dates 40 E. Policy Targets Agreement 41 Appendices This document is also available on www.rbnz.govt.nz ISSN 1770-4829 1 Projections finalised on 30 May 2014. Policy assessment finalised on 11 June 2014. Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 1 1 Policy assessment The Reserve Bank today increased the Official Cash Rate (OCR) by 25 basis points to 3.25 percent. New Zealand’s economic expansion has considerable momentum, with GDP estimated to have grown by around 4 percent in the year to June. Global financial conditions remain very accommodative and are reflected in low long-term interest rates and narrow risk spreads. Economic growth among New Zealand’s trading partners is gradually improving and global inflation remains low. Prices for New Zealand’s export commodities remain historically high, but their recent falls will reduce farm incomes over the coming year. A continued acceleration in construction in Canterbury, and more broadly, is supporting growth, together with strong net immigration flows that are adding to housing and household demand. Business and consumer confidence remains buoyant, as do businesses’ reported intentions to invest and to hire. While house price inflation remains high, the housing market has moderated since late last year when restrictions were applied to high loan-to-value ratio mortgage lending and when mortgage interest rates began rising. Fiscal consolidation continues to moderate demand growth, though by less than previously assumed. The exchange rate has not yet adjusted to weakening commodity prices, but is expected to do so. The Bank does not believe the exchange rate is sustainable at current levels. Headline inflation remains moderate and tradables inflation is expected to be low for some time. However, abovetrend growth has been absorbing spare capacity and adding pressure to non-tradables inflation. These pressures are particularly evident in construction cost increases. Nevertheless, overall wage inflation remains moderate, reflecting recent low headline inflation, increased labour force participation and strong net immigration. Inflationary pressures are expected to increase. In this environment, it is important that inflation expectations remain contained and that interest rates return to a more neutral level. The speed and extent to which the OCR will need to rise will depend on future economic and financial data, and its implications for inflationary pressures. By increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point, the Bank is seeking to ensure that the economic expansion can be sustained. Graeme Wheeler Governor 2 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 2 Key policy judgements The New Zealand economy is estimated to have depends on developments in several key economic grown by 2 percent over the first half of 2014. Spending drivers – in particular export prices, the exchange rate, on construction continues to accelerate, net immigration net immigration, the housing market and construction. flows have increased sharply over the past year, and How households and businesses react to these drivers, high prices for New Zealand’s commodity exports have and to increases in interest rates, will also be important. led to strong growth in export incomes. These factors, The Bank’s judgements about these factors are discussed together with an extended period of low interest rates, are below. supporting the continued recovery in domestic demand. Some offset is coming from the high exchange rate, which Export prices is a drag on tradables sector incomes, and continued fiscal consolidation. New Zealand’s commodity export prices have been very high over the past year and have combined Annual CPI inflation is expected to be 1.7 percent with weak import price inflation to push the terms of trade in the June quarter (figure 2.1). The high exchange rate to their highest level in more than 40 years, increasing and low global inflation have led to falling prices in the New Zealand’s purchasing power. While the projection traded goods sector, but capacity pressure has been assumes aggregate export prices will fall by 11 percent increasing and annual non-tradables inflation is 3 percent. over 2014, leading to a 10 percent fall in the terms of trade, export prices and the terms of trade are projected to Figure 2.1 CPI inflation (annual) settle at a high level by past standards. This is expected to support domestic incomes and demand over the medium term. % % 6 While global meat prices have continued to 6 increase over 2014, dairy prices have fallen further since 5 5 the March Statement. The projected fall in export prices 4 4 over 2014 incorporates a 27 percent fall in dairy prices, 3 3 2 2 1 1 0 Projection 2006 2008 2010 2012 2014 2016 allowing for the sharp recent falls and the possibility of further decreases. It also incorporates falls in international prices for forestry products over coming months, in light of signs of weakening in China’s construction sector. Box C in chapter 4 explains the measurement 0 Source: Statistics New Zealand, RBNZ estimates. Low interest rates have played an important role in supporting GDP growth in the past few years, of New Zealand’s export prices, given their importance for incomes. Given the past tendency of export prices to move sharply, Box B in Chapter 2 looks at the implications of a larger than projected fall in commodity prices. especially in the early stages of the recovery from the 2008/09 recession. More recently, growth has become The New Zealand dollar more self-sustaining and very low interest rates are no The high New Zealand dollar trade-weighted longer appropriate given the rise in inflationary pressures. index (TWI) reflects New Zealand’s high export prices and Consequently, the Bank expects to raise the OCR towards relatively strong economic outlook. The exchange rate is a more neutral level. weighing on tradables sector incomes and, together with The projection for inflationary pressures, and so low global inflation, is keeping tradables inflation low. how far and how quickly interest rates will need to move, Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Our projection assumes that the TWI falls 3 gradually, by about 7 percent over the next three years. This reflects an expectation that falls in commodity export The housing market and household demand prices will be reflected in the exchange rate. To date, While net immigration is adding to housing the fall in the currency has been smaller than the drop demand, momentum in the housing market has eased in commodity prices would suggest. If the exchange rate since the middle of 2013. Annual house price inflation remains strong, it is likely to be reflected in continued low fell to 9 percent in the December quarter, following the or negative tradables inflation. introduction of restrictions on high loan-to-value ratio (LVR) mortgage lending and the beginning of mortgage Net immigration rate increases. House price inflation is expected to Net immigration has picked up rapidly in the continue moderating over the next three years as a result past year, reflecting New Zealand’s relatively strong of projected interest rate increases, easing immigration job market prospects. Net immigration is expected to and high household debt. Increased construction to remain an important boost to activity and inflationary address housing shortages in Auckland and Canterbury is pressures over the medium term, through its contribution also expected to slow house price inflation. to consumer demand and to demand for existing and new Annual average household consumption growth housing. Past experience suggests that over the short is expected to remain at a solid rate of about 3.5 percent term net immigration’s contribution to demand is greater over the next two years. Nonetheless, the rate of growth than its contribution to supply capacity. Box D in chapter is modest compared with the mid-2000s cycle, reflecting 4 discusses in more detail how net immigration affects weakening export incomes, rising interest rates and demand and supply, and how the composition of flows in moderating house price inflation over the medium term. the current cycle might mean a slightly lesser increase in A source of uncertainty is how households will respond housing demand than in the past. to rising interest rates, following an extended period of With the outlook for labour demand in Australia very low rates and with household debt remaining high. expected to improve, the projection assumes annual net As chapter 3 discusses, the movement of mortgage inflows peak in mid-2014 at 37,000 working-age persons, borrowers from floating rate to fixed rate mortgages may and then ease steadily for three years. The projected help insulate some borrowers from rising interest rates. net inflow adds about 70,000 people to the working age population over the projection, equivalent to an increase of around 2 percent. Construction Construction work is expected to continue boosting Past experience, including stronger than expected GDP growth over the next two years, and then remain near inflows since the March Statement, shows how turning its mid-2000s peak – about 10.5 percent of GDP – over points in net immigration are difficult to predict, and the remainder of the projection. The rebuild in Canterbury highlights the risk that flows could continue to rise further is a major component, while growth in residential building and for longer than expected. Box B in this chapter looks is expected to continue to rise in Auckland to address the at a scenario in which net flows hold up for longer than housing shortage. The large scale of work is assumed to expected, resulting in a larger upswing in demand that continue drawing labour and capital from other sectors. comes through both the housing market and stronger Reflecting strong increases in activity, the annual rate of spending. This scenario results in higher inflationary construction cost inflation climbed to 5.1 percent in March pressures that would require higher interest rates. 2014, and will continue to be an important influence on the outlook for non-tradables inflation over coming years. 4 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Box A Review of recent monetary policy decisions and economic conditions After an extended period at 2.5 percent, the OCR was increased to 2.75 percent at the March 2014 Monetary Policy Statement and then 3 percent at the April 2014 OCR review (figure A1). The long period for which the OCR was at 2.5 percent reflected a slow recovery from the recession of 2008/09, and the consequent weak inflationary pressures. Figure A1 Official Cash Rate % % 9 9 Figure A2 Growth in GDP and estimated potential output (annual, dashed lines represent forecasts) % 7 6 5 4 3 2 1 0 −1 −2 −3 −4 2000 % Potential Actual 2003 2006 2009 2012 7 6 5 4 3 2 1 0 −1 −2 −3 −4 Source: Statistics New Zealand, RBNZ estimates. 8 8 Low wage inflation in part reflects low recent headline 7 7 inflation, rising labour force participation, and lags 6 6 between increased activity and wages. Wage inflation is 5 5 expected to increase over the medium term. However, 4 4 continued weakness could have implications for our 3 3 assessment of the pricing environment and outlook, and 2 so for the pace of interest rate increases required. 2 2000 2003 2006 2009 2012 Source: RBNZ. This document sets out projections for economic activity, inflation and the 90-day bank bill rate over a Interest rates have their greatest effect on three year horizon. Consistent with the requirements of inflation with a 12-18 month lag, so need to increase the Reserve Bank of New Zealand Act (1989), the Bank when pressures are building rather than when inflation is mindful of how monetary policy will be formulated and has emerged. Doing so allows more-gradual movements implemented beyond this period. Many of the factors in interest rates, reducing volatility in the economy. currently affecting the outlook for monetary policy – such The recent increases in the OCR have reflected as reconstruction in Canterbury and continuing changes an assessment that growth had been at or above the in the composition of global demand – will affect the economy’s estimated potential supply for some time economic environment for an extended period. The (figure A2). Consequently, inflation was expected to precise stance of monetary policy over the coming five rise even though inflation in the tradables sector was years will depend on such factors, as well as prevailing negative. economic conditions. Over this period, the Bank will Tradables inflation remained weak in the March continue to conduct monetary policy with a view to quarter out-turn, holding down headline CPI inflation. keeping future average CPI inflation outcomes near 2 Non-tradables inflation has continued to pick up, and percent, as required by the Policy Targets Agreement. economic activity is running ahead of potential output. Current wage inflation appears low in that context. Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 5 Inflation and monetary policy Annual CPI inflation has increased over the past year, but remains below 2 percent as the high exchange Figure 2.2 (a) CPI inflation uncertainty (annual) % % rate and low global inflation weigh on tradables inflation. 6 Nominal wage inflation has also been subdued. However, 5 5 4 4 3 3 inflation expectations, while well below their 2011 peak, 2 2 have increased over the past year. Strong output growth 1 1 annual non-tradables inflation has increased over the past year to 3 percent, following increasing pressure on resources over the past 18 months. Measures of is expected to maintain pressure on resources over the medium term (figure 2.2c). Given the increase in capacity pressure, and evidence that demand growth is no longer reliant on 6 0 2000 2003 2006 2009 2012 Source: Statistics New Zealand, RBNZ estimates. 2015 (b) 90-day interest rate uncertainty % 0 % interest rate support, it is important for the OCR to be 10 increased towards a more neutral level. This is consistent 9 9 8 8 7 7 6 6 5 5 The discussion above sets out what we see as 4 4 the most important drivers of the economic outlook – the 3 3 with inflation and inflation expectations settling near the 2 percent target midpoint over the medium term, and helps ensure the recovery continues at a sustainable pace. terms of trade, the exchange rate, net immigration, the housing market and construction. It describes the view we have taken on how each of these drivers will develop over the next three years, and how these views underlie the central projection. Past experience shows that each of 10 2 2000 2003 2006 Source: RBNZ estimates. 2009 2012 2015 2 (c) Output gap uncertainty (percent of potential GDP) % % these drivers can be volatile, and so the discussion in this 5 chapter also outlines the main risks we see around these 4 4 judgements. The discussion in Box B in this chapter looks 3 3 2 2 1 1 0 0 −1 −1 −2 −2 at two particular scenarios in which things could turn out differently, and describes the implications for the economy and monetary policy. To explore more broadly how different judgements about the main drivers discussed in this chapter would lead to different paths for inflation, interest rates and output, figure 2.2 summarises the outcomes of running 1000 scenarios. Each scenario involves a different set of outcomes, based on the historical variation in these key drivers of the outlook. The bands illustrate the range of outcomes for inflation, the output gap and interest rates that would result from this collection of scenarios. 6 5 −3 2000 2003 2006 2009 2012 2015 −3 Source: Statistics New Zealand, RBNZ estimates. Note: The exercise involves 1000 simulations based on shocks to key the drivers of the outlook discussed in this chapter. The size of the shocks is determined by the actual volatility experienced in these drivers over the period September 1992 to June 2014, and by their correlations with one another. The dark band shows the middle two thirds of outcomes of this collection of 1000 scenarios, while the light band shows the middle 90 percent of outcomes. For this exercise there is assumed to be no other source of uncertainty, such as revisions to historical data, changing economic relationships or other economic events that cause surprises. The technical method for generating fan charts is outlined on p36. Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Box B How external factors can affect monetary policy Figure B2 House price inflation (annual percent change) Global conditions can affect the New Zealand economy significantly. Global prices for our exports are one source of global influence, while net immigration % % 30 Projection 25 30 25 20 20 reflects both international and domestic economic 15 Scenario 15 conditions. Both can be very difficult to predict, and this 10 10 5 5 box considers the implications for monetary policy of some alternative outcomes to the central projection. 0 0 Central −5 −5 −10 −10 −15 2000 Stronger net immigration inflows The central projection assumes quarterly net immigration declines later this year as global economic conditions improve, particularly in Australia. However, there are risks in both directions. The scenario here is an upside one, with annual net immigration of workingage people peaking at 45,000 compared with 37,000 in the central projection (figure B1). Over the three-year projection horizon this results in a total net inflow of 113,000 persons compared with 70,000 persons in the central projection. 2003 2006 2009 2012 −15 2015 Source: Property IQ, RBNZ estimates. Figure B3 90-day rate (stronger net immigration scenario) % % 10 Projection 8 10 8 Scenario 6 6 While stronger immigration increases the supply of labour resources and capacity in the economy over 4 4 Central the medium term, the experience of past cycles suggests that over the short term the boost to domestic demand tends to dominate. Box D, chapter 4 discusses how net immigration affects demand and supply in the economy, 2 2000 2003 2006 2009 2012 2015 2 Source: RBNZ estimates. and ways in which this cycle could be different from Figure B1 Net permanent and long term immigration (working-age persons, annual total) 000s 000s 70 Projection 60 70 60 previous ones. In this scenario, increased housing demand encourages residential investment, but the new building occurs over a protracted period resulting in increased pressure on house prices in the interim. Annual house 50 Scenario 50 price inflation increases to 11 percent in 2015 – 4 40 40 percentage points higher than assumed in the central 30 30 20 20 10 Central 0 stronger. 0 −10 −20 2000 10 projection (figure B2). Consumption growth is also −10 2003 2006 2009 2012 Source: Statistics New Zealand, RBNZ estimates. 2015 −20 Stronger domestic demand adds to pressure on domestic resources and non-tradables inflation. To keep CPI inflation contained, the outlook for the 90-day rate is higher than in the central projection (figure B3). A higher Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 7 outlook for the 90-day rate results in a slightly higher New Zealand dollar, dampening activity in the tradables sector and providing a partial offset to stronger domestic Figure B4 SNA terms of trade Index Index 1.4 demand. Projection 1.3 Weaker world export prices In the central projection, aggregate export prices 1.1 prices. Beyond this, prices are expected to settle at a 1.0 level that is still high by historical standards. This scenario considers the implications of a more pronounced decline in New Zealand’s export prices resulting in lower terms of trade (figure B4). The resulting lower terms of trade reduce national income and domestic demand. Weaker domestic demand leads to lower capacity pressures and non tradables inflation. The New Zealand dollar TWI is assumed to depreciate (figure B5). This acts as a shock absorber, providing some offset 1.3 Central 1.2 are expected to decline in 2014, driven by falling dairy 0.9 2000 1.4 1.2 Scenario 1.1 1.0 2003 2006 2009 2012 0.9 2015 Source: Statistics New Zealand, RBNZ estimates. Figure B5 New Zealand dollar TWI Index Index 90 Projection 85 Central 80 to weaker export incomes by supporting activity in the 75 tradables sector. While the lower exchange rate leads 70 90 85 80 75 70 Scenario 65 65 60 60 for demand and incomes means the 90-day rate track 55 55 is lower than in the central projection (figure B6). An 50 50 to higher tradables sector inflation, the weaker outlook important feature of this scenario is that the exchange rate falls and acts as a shock absorber. If the exchange rate were to remain elevated while commodity prices fell, the 90-day rate track would need to be even lower than depicted here for inflation to settle at 2 percent. 45 2000 2003 2006 2009 2012 45 2015 Source: RBNZ estimates. Figure B6 90-day rate (weaker world export prices scenario) % % 10 Projection 8 10 8 6 Central 4 6 4 Scenario 2 2000 2003 2006 2009 2012 2015 2 Source: RBNZ estimates. 8 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 3 Financial market developments Financial market sentiment remains positive. to keep rates low for some time yet. Equity market indices have recorded new highs recently, One feature of financial markets over recent global bond yields have been trending lower this year and months has been the decline in implied volatility across volatility in a range of market prices has reached multi- a number of asset prices. Implied volatility is measured year lows. Some factors behind these trends include a using options prices for various traded instruments. The positive global economic outlook with little inflationary VIX index, which measures implied volatility for the United pressure, and expectations that easy global monetary States S&P 500 index, recently fell to levels not seen since policy will continue. 2007, pre-dating the Global Financial Crisis. Volatility has Since the March Statement, the New Zealand also been subdued in United States 10-year Treasury dollar has remained high, with the trade-weighted index yields, and the lack of volatility has also been transmitted averaging about 80. Pricing in the overnight indexed to currency markets (figure 3.1). swaps (OIS) market suggests that expectations for the pace of increases in the OCR have dampened a little, with about 15 basis points less tightening priced in for the year ahead. New Zealand interest rates have been dragged Figure 3.1 Implied volatility indices (index) Index lower by global trends, particularly at the longer end of 90 the yield curve. 80 Marginal funding costs for local trading banks continue to trend down, driven by lower spreads of term deposit rates to wholesale rates. These lower costs and lower swap rates are enabling banks to reduce some of their fixed mortgage rates. The average two-year and three-year fixed mortgage rates for the four major trading banks are lower compared to March and the start of the year. Borrowers continue to steadily migrate from floating Index 300 S&P 500 (VIX) 70 250 US Treasury bonds (MOVE, RHS) 60 50 200 150 40 30 100 20 50 10 0 2005 2007 Source: Bloomberg. to fixed-rate mortgages. G7 currencies (JPM) 2009 2011 2013 0 Low market volatility is typically associated with high levels of risk appetite. This is evident in global equity International market developments market indices, with some developed country benchmarks Since the March Statement financial market such as the United States S&P 500 reaching record highs sentiment has remained positive, with a range of asset in early 2014. Emerging market equity prices have also prices performing well. Equity prices continue to trend rebounded after a poor start to the year. Between mid- higher, albeit less quickly than last year, and fixed income March and the end of May the MSCI emerging markets markets have performed strongly. Credit spreads have index rose more than 10 percent. continued to decline and global government bond yields The macroeconomic environment of steady global are lower, surprising many market participants who began growth and low global inflation is one likely factor behind the year positioned for higher long-term interest rates. low market volatility. Further, monetary policy has remained The positive market environment reflects a a key focus for financial markets with expectations that gradual but steady increase in global growth, with signs global monetary policy will remain stimulatory for some that inflationary pressures remain well contained. The time. In the case of the United States and Japan, central central banks in major economies continue to keep their bank buying of government bonds on a large scale has policy rates at historically low levels, and indicate a desire likely contributed to low bond market volatility in those Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 9 markets, with some spill-over effect on other asset continue in 2014. Those expectations have not been met, classes. With major investment banks reducing their with government bond rates actually trending lower. The business in proprietary trading, some commentators point yield on 10-year United States Treasury bonds began the to regulatory factors as contributing to low volatility. year at 3.0 percent and was down to around 2.4 percent by The United States Federal Reserve has continued the end of May, its lowest level since June last year (figure to gradually scale back its purchases of Treasury bonds 3.2). Weaker economic momentum and the FOMC’s and mortgage-backed securities. Monthly purchases consistent message that monetary policy tightening will of those assets are down to USD 45 billion, compared not occur until well into the future may have been partly with USD 85 billion before tapering began. The Federal responsible for the decline in bond yields. However, the Reserve Open Market Committee (FOMC) reiterated at extent of the reduction in long-term bond rates is a puzzle the end of April that the current target range for the federal to many market participants. Some analysts point to funds rate is likely to remain appropriate for a considerable downwardly revised expectations of how high policy rates time after the asset purchase programme ends. Based on might need to go during the upswing as one reason bond current market pricing, the Federal Reserve will hold off yields have fallen, while others note the closure of losing raising its policy rate until around mid-2015. short positions pushing yields down. Some point to lower Over recent months, pressure has been building net issuance of US Treasury bonds, as the government’s on the European Central Bank (ECB) to deliver more fiscal position improves, as a contributing factor to lower policy stimulus. CPI inflation is tracking lower than the yields. ECB expected and well below its target of maintaining inflation rates below, but close to, 2 percent. At its June meeting the ECB announced a range of measures to provide additional policy stimulus and support lending to Figure 3.2 10-year government bond yields % the real economy. This included a negative deposit rate, 3.5 making the ECB the first major central bank to charge 3.0 commercial banks on their excess reserves. 2.5 In China, authorities have tightened criteria around interbank lending and increased monitoring of default risk, while outlining principles for ongoing capital market reform. Stress tests undertaken by the People’s Bank of China indicated that China’s formal banking system is resilient to severe shocks. This provides some degree of comfort in light of perceived increased risks following % 3.5 USA 2.5 Germany 2.0 1.5 2.0 1.5 1.0 Japan 0.5 0.0 3.0 1.0 0.5 Jan13 Apr13 Jul13 Oct13 Jan14 0.0 Apr14 Source: Reuters. a period of very strong credit growth. After depreciating The fall in 10-year German yields has been even sharply through February and early March, the renminbi greater, from 1.95 percent at the beginning of the year to has stabilised over the past two months. In mid-March, a low of 1.3 percent. Bonds of core European countries Chinese authorities widened the renminbi trading band have benefited from safe-haven flows, as tension between – allowing it to fluctuate 2 percent each side of the daily Russia and the Ukraine escalated. Investors remained reference rate set by the central bank. attracted to the high relative yield of some countries such as Italy and Spain, and 10-year government bond yields in Financing and credit these countries fell to record low levels of below 3 percent. Global bond rates rose in the fourth quarter last Portugal’s yields followed a similar path. The country year and the market was positioned for that trend to announced a clean exit from its 2011 bail-out programme, 10 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 following a successful auction of bonds. Expectations of by a reduction in the NZD-USD five-year basis swap and easier monetary policy by the ECB leading up to its June New Zealand swap-bond spreads. Local banks’ funding costs continue to fall (figure meeting helped support the European bond market. Japanese bond yields have been in a much tighter 3.3). Deposit growth has remained high relative to credit range (about 0.6 to 0.7 percent), with the Bank of Japan growth, thereby covering much of the funding requirements continuing its large scale purchases of government bonds. for new loans. This has reduced the banks’ incentives to Corporate credit spreads have continued to pay higher rates for this source of funding. For example, narrow, with riskier assets showing the greatest spread despite rising six-month bank bill rates as the market contraction this year. The spread on Barclays Capital’s anticipates increases in the OCR, the average six-month global corporate bond index was down to 105 basis points term deposit rate has remained steady for the past year. at the end of May and the high yield spread was down to This shows up as a reduction of about 100 basis points 377 basis points, down 14 and 34 basis points respectively in the term deposit funding spread over that time. Retail for the year to date. deposits make up more than half of total bank funding, Ahead of the ECB’s review of the quality of and are a key driver of lower funding costs for banks. banks’ assets later this year and the European Banking Authority’s stress tests, European banks have been actively raising capital and equity raisings have reached a record high. In most cases, these have been met with strong demand. Euro area bank credit to non-financial corporates continues to decline by around 3 percent per annum, as banks focus on repairing their balance sheets. Lower global bond yields have dragged down rates in Australia and New Zealand. From the March Statement to the end of May, the yield on 10-year New Figure 3.3 Indicative bank funding margins (spread to OCR) Basis points 300 250 200 150 Retail term deposits 100 50 0 4.25 percent, while the fall in Australian yields was even bonds has improved over the past couple of months, and 250 150 −50 evidence suggests that global interest in New Zealand 300 200 Zealand government bonds fell by 35 basis points to greater, down 50 basis points to 3.7 percent. Anecdotal Basis points Long−term wholesale −100 100 50 Short−term wholesale 2007 2008 2009 2010 2011 2012 2013 0 −50 −100 Source: RBNZ estimates. this is reflected in the spread of New Zealand to United Highly favourable global funding conditions have States 10-year government bond rates falling to around also driven down funding spreads for long-term debt 170 basis points. Official Reserve Bank data on non- issuance. Banks have issued very little long-term debt resident holdings of New Zealand government stock do over the past couple of months after being fairly active in not show this tendency, with estimated overseas holdings the market in the first quarter. The credit default spread fairly steady over recent months to the end of April. for Australian banks’ five-year senior debt is a reasonable Issuance of New Zealand dollar-denominated debt proxy for the trend in New Zealand banks’ long-term by overseas entities (Kauris, Eurokiwis and Uridashis) wholesale funding costs. Since the beginning of the year, was strong in the first quarter at about $4.0 billion, but has this spread has fallen by about 25 basis points to less than dropped off significantly in the second quarter with about 60 basis points, its lowest level in about six years. Lower $1.1 billion issued through to the end of May. Seasonally, New Zealand dollar basis swap spreads have reduced the the June quarter is weaker for issuance of these products, cost by a further 10-15 basis points for offshore issuance. and conditions have been made less favourable for issuers Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 11 Foreign exchange market market had priced in an OCR of 3.85 percent by March The New Zealand dollar TWI was on an 2015. At the end of May that pricing had fallen to 3.70 appreciating trend in the month prior to the March percent. Market liaison suggests that overseas investors Statement and that continued through to the end of March. have been the dominant market participants in driving Since then, the New Zealand dollar has traded in a tight rates lower, more than offsetting the flows from domestic range, with a modest downward bias. In early June the banks wanting to fund fixed rate mortgages that put TWI was trading within half a percent of the level that upward pressure on rates. Since the March Statement the yield curve has prevailed just before the March Statement. Over recent months, the Australian dollar has flattened (figure 3.5). The OCR was increased by 25 basis found increased support after dropping by 11 percent points at the time of the March Statement and again at the against the United States dollar between October and April OCR review. Expectations are for further increases January. The NZD-AUD cross rate has weakened to in the policy rate, although the global trend towards lower reach, in early June, its lowest level for the year at just interest rates has put significant downward pressure on under AUD 0.91 (figure 3.4). The yen has found increased rates for longer maturities. The three-month bank bill rate support over recent months as traders reduce their is up 42 basis points while the 10-year swap rate is down expectations of the chance of further monetary stimulus 37 basis points, a significant flattening. by the Bank of Japan. Figure 3.5 Wholesale bank bill and swap rates Figure 3.4 New Zealand dollar cross rates (1 January 2014 = 100) % Basis points 5.5 50 5.0 Index 30 Index 108 108 106 106 NZDUSD 104 NZDJPY 104 28 May 2014 4.0 100 100 3.0 98 2.5 NZDAUD 96 96 Jan14 Feb14 Mar14 Apr14 May14 94 10 0 −10 3.5 102 98 20 4.5 102 94 40 12 March 2014 −20 Change from March (RHS) 3m 6m 1y 2y 3y 4y −30 −40 5y 7y 10y −50 Source: Bloomberg. As previously noted, banks’ funding costs have Source: Reuters. fallen. Lower funding spreads mean that for any given Other domestic financial market developments level of the OCR or wholesale swap rate, banks can offer lower mortgage rates without affecting their profit margins. The upward trend in New Zealand equity prices Over recent months, banks seeking to attract borrowers continues, although the rate of increase has moderated have been competing for two-year and three-year over recent months. Between the end of February and the fixed rate mortgages as borrowers seek to fix rates in the end of May the NZX50 index rose by 3.6 percent, broadly face of expected interest rate rises. The combination of in line with world indices. competition for borrowers and lower global rates (which The OIS market suggests that the expected have pulled down wholesale swap rates) has resulted in a increase in the OCR has reduced somewhat since the reduction in average two- and three-year fixed mortgage March Statement. Just prior to the March Statement, the rates offered by the major banks. Compared to the 12 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 beginning of the year, two- and three-year fixed mortgage While these figures are based on borrowers with rates are down about 15 basis points, in contrast to an LVR ratio lower than 80 percent, the price of mortgages average rates for short terms, which are higher. The has also fallen for high-LVR borrowers. Some interest average floating mortgage rate, for example, is up 50 rate penalties for new high-LVR borrowers have been basis points. removed, so many high-LVR borrowers presently face lower interest rates compared to the beginning of the year. Figure 3.6 Average mortgage rates by term and the best possible rate Many borrowers have taken advantage of the lower two- and three-year fixed mortgage rates. Between the end of January and the end of April, the value of the stock of floating-rate mortgages fell by $10.4 billion while % % 7.0 7.0 3y 6.5 6.5 2y 6.0 Floating 6m 5.5 4.5 Jan12 Jul12 Jan13 Source: interest.co.nz, RBNZ estimates. Jul13 Jan14 percent of outstanding mortgages). The tendency to switch mortgages from floating to fixed rates is not new – 5.5 the trend to move to fixed rate mortgages began two years 5.0 rate $5.5 billion of that fixed for two years or more (about 3 6.0 1y 5.0 Best possible the value of fixed-rate mortgages rose by $9.7 billion, with 4.5 ago. Thus, estimates suggest the weighted average time before a mortgage faces re-pricing has roughly doubled from a low of 4.7 months in 2012 to 9.8 months as at the end of April. Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 13 4 Current economic conditions The New Zealand economy has continued to strengthen, with real GDP in the June quarter estimated to be 4.2 percent higher than a year earlier. Growing demand means spare capacity has been absorbed and inflationary Figure 4.1 China manufacturing PMIs and annual growth in industrial production Index pressures are building in the non-tradables sector. The 65 high exchange rate continues to dampen tradables sector 60 inflation. Annual CPI inflation is expected to rise to 1.7 55 percent in the June quarter. in New 22 20 NBS manufacturing 18 PMI 16 14 50 12 HSBC manufacturing PMI 45 External demand Growth Annual % Zealand’s trading partner economies continued at a moderate pace into 2014. Growth transitions are under way in Australia and China. 40 10 Industrial production (RHS) 35 2000 2002 2004 2006 2008 2010 2012 8 6 4 2 Growth in major advanced economies has been gradually Source: Haver Analytics. increasing with the help of considerable monetary outside the resource sector remains weak. The labour stimulus. Spare capacity remains in most advanced market softened in 2013, but the unemployment rate has economies, contributing to subdued global inflation. stabilised more recently at just below 6 percent, and there GDP growth in China remains moderate by are signs that labour demand is now growing. past standards, as the Government seeks to balance maintaining current economic momentum with structural reforms to improve the sustainability of growth in the future. GDP growth slowed to 7.4 percent in the year to March 2014, as the property market weakened and credit Figure 4.2 Australian real capital expenditure 2011/12 AU$b 30 growth slowed. Authorities have taken a number of steps 25 to support growth, including improving liquidity conditions 20 and accelerating public investment, but have refrained from the large-scale stimulus measures employed in the past. Growth in industrial production and measures of sentiment in the manufacturing sector have improved in recent months (figure 4.1), suggesting policy measures may be having some effect. The Australian economy is in a period of transition 2011/12 AU$b 30 Mining 25 20 15 Non− mining 15 10 10 5 5 0 2000 2002 2004 2006 2008 2010 2012 0 Source: Haver Analytics. away from high investment in the resource sector towards The recovery in major advanced economies now more broad-based growth across sectors. Declining appears entrenched, although the overall pace of growth resource investment has begun to drag on growth (figure remains moderate relative to history. Monetary policy 4.2), although a significant increase in resource exports remains accommodative across these economies, and in recent quarters has partially offset this weakness. GDP fiscal consolidation is becoming less of a drag on growth. expanded by 3.5 percent over the year to March 2014. Low In the euro area, while business and consumer confidence interest rates are supporting the transition by stimulating have improved over the past year, the labour market housing market activity and household consumption. While remains weak. In the United States, recent indicators of business confidence has improved, business investment activity in the labour market and manufacturing sector 14 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 have recovered following weather-related weakness remained high in recent months despite large falls in dairy through the beginning of 2014. In Japan, strong growth prices. of 2.7 percent in the year to March 2014 partly reflected domestic spending being pulled forward ahead of the sales tax increase on 1 April, with activity indicators weakening following the tax increase. Slow growth in major advanced economies, along with slower growth in China, continues to weigh on export growth in New Zealand’s other Asian trading partners. GDP growth across these trading partners has been mixed over the past year. GDP growth has strengthened Figure 4.3 Export commodity prices (world terms) Index 400 Dairy Aggregate 350 350 300 300 250 200 outflows have generated policy challenges in some Asian 150 economies, particularly in Indonesia where growth has 100 slowed. Political disruption resulted in Thailand’s GDP 50 The continued recovery in trading partner 450 400 in South Korea, Malaysia, Taiwan and Singapore. Capital contracting in the first quarter of 2014. Index 450 250 Meat Forestry 2006 2008 2010 2012 200 150 100 50 Source: ANZ Bank. economies has supported New Zealand’s export volumes. The high exchange rate continues to dampen Demand and prices for New Zealand’s commodity exporters’ incomes and reduce the competitiveness of the exports have been strong, particularly reflecting growing tradables sector. It is also lowering the domestic prices incomes and urbanisation in China. Export commodity of imported goods, so dampening tradables inflation and prices remain high relative to history, despite a large fall supporting demand for imported consumer and investment in dairy prices over the past four months (figure 4.3). As goods. measured by the GlobalDairyTrade index, dairy prices Despite the high New Zealand dollar, tourism have fallen by 26 percent from a peak in early February, exports appear to be increasing. Visitor arrivals in the three reflecting increased global supply including a strong end months to April were up 4.5 percent on the same period a to New Zealand’s production season. While rising meat year earlier. Arrivals from China continue to increase, and and forestry prices have partly offset the recent fall in dairy visitor numbers from the European Union and the United prices, there have recently been indications that forestry States appear to be recovering. The greater proportion of prices are falling as construction activity slows in China. arrivals from these higher-spend regions has contributed Combined with subdued global inflation that has to a modest increase in the average spend per visitor, contributed to weak import price inflation, strong export which had trended down over the past decade (figure 4.4, prices have resulted in very high terms of trade relative overleaf). to history. Due to falling dairy prices, the terms of trade appear to have declined since their assumed peak in the March 2014 quarter. Box C on p 21 discusses in more detail how recent commodity price movements might influence the terms of trade. The New Zealand dollar exchange rate has remained high since the March Statement. While this has partly reflected New Zealand’s relatively strong economic outlook and high commodity prices, the exchange rate has Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 15 Figure 4.4 Average spend per international visitor (seasonally adjusted) 4500 $ $ 4000 Figure 4.6 New dwelling consent issuance (seasonally adjusted, 3 month moving average) 4500 4000 1600 1600 1400 1400 1200 3500 3500 1200 Rest of New Zealand 1000 800 3000 3000 800 Auckland 600 600 400 2500 2000 2002 2004 2006 2008 2010 2500 2012 400 200 200 Canterbury 0 2000 Source: Statistics New Zealand, RBNZ estimates. 1000 2003 2006 2009 2012 0 Source: Statistics New Zealand, RBNZ estimates. Domestic demand Domestic growth has become more broad-based, Ex-primary manufacturing output in the December as reflected in growing services sector output (figure quarter was 4 percent higher than the previous year, after 4.5), and increasing manufacturing output. Business and being broadly flat for the previous two years. Growth consumer sentiment remain high, with growth in business in 2013 was due to increased domestic sales while investment and household consumption reinforcing the exports were fairly stable (figure 4.7). The Performance pace of economic expansion. of Manufacturing Index remains at levels indicating expansion in the sector, underpinned by strength in new Figure 4.5 QSBO indicators of service sector output and quarterly services sector GDP growth (seasonally adjusted) Net % % 80 2 Volume of services 60 40 Merchants’ sales in NZ 1 20 0 −20 −40 −80 −100 in construction sector activity, supporting demand for building materials from New Zealand’s manufacturing sector. Figure 4.7 Manufacturing sales 95/96 $m 0 −60 orders and production. In part, this reflects strong growth SNA services (RHS) 2006 2008 95/96 $m 8000 8000 7000 Merchants’ new forward orders 7000 −1 Domestic 6000 2010 −2 2012 Source: NZIER, Statistics New Zealand, RBNZ estimates. 5000 5000 4000 remain so in the first half of 2014. Residential consent issuance indicates strong growth in construction, 3000 4000 Exports Increasing construction has been a key factor supporting GDP for the past few years, and appeared to 6000 2002 2004 2006 2008 2010 2012 3000 Source: Statistics New Zealand, RBNZ estimates. underpinned by reconstruction in Canterbury and increasing residential investment in Auckland (figure 4.6). 16 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Net immigration of working-age people rose to 31,000 in the year to April (figure 4.8), supporting growth in housing demand and wider domestic demand. As discussed in box D, p 24, the composition of migration flows suggests migration will also help alleviate skill shortages in the construction sector in Canterbury and elsewhere. Figure 4.8 Permanent and long-term working-age migration (annual) 000s 000s 90 40 Net (RHS) 80 Arrivals 70 Departures 40 2000 2002 2004 2006 2008 2010 2012 000s 12 11 11 10 10 9 9 8 8 7 7 6 6 5 5 4 4 3 2000 2002 2004 2006 2008 2010 2012 3 Source: REINZ, RBNZ estimates. According to REINZ data, annual house price 20 inflation eased to 8.6 percent in April from a peak of 9.8 0 50 000s 12 30 10 60 Figure 4.9 House sales (monthly, seasonally adjusted) percent in November last year. LVR restrictions have been a key factor dampening high house price inflation, and the Reserve Bank estimates that LVR restrictions have −10 reduced annual house price inflation in the year to March −20 2014 by about 2.5 to 3.5 percentage points compared with what it might have been. Source: Statistics New Zealand, RBNZ estimates. Despite recent falls, house price inflation in through Auckland remains high at 14.6 percent. In Christchurch, much of 2013, momentum in the housing market has annual house price inflation is 10.5 percent, and house moderated. This moderation follows the introduction of price inflation in the rest of New Zealand is 4.1 percent LVR restrictions in October last year and increases in (figure 4.10). After strong house price inflation mortgage rates. Housing turnover has fallen considerably. The number of house sales in March was 11 percent lower than in September last year (figure 4.9). Sales fell a further 7 percent in April, though the decline in April was likely exaggerated by the unusual timing of Easter and ANZAC day holidays. Figure 4.10 Annual house price inflation by region (3 month moving average) % % 35 35 30 30 Christchurch 25 25 20 20 15 15 10 10 5 0 −5 0 Rest of New Zealand −10 −15 2000 5 Auckland 2003 2006 2009 2012 −5 −10 −15 Source: REINZ, RBNZ estimates. Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 17 While the REINZ monthly index shows some increase in house price inflation in the past few months, there has been a disproportionately large drop in sales of lower priced houses, which may cause the REINZ data to overstate the degree of recent price increases. Further, Figure 4.12 QSBO domestic trading activity and profit expectations (seasonally adjusted) Net % Net % past relationships would imply that the significant fall in 40 house sales will have contributed to further easing in 20 20 0 0 DTA (next 3 months) 40 annual house price inflation over the first half of 2014. Consumer sentiment measures have eased slightly in recent months but remain high, consistent with an improving labour market and strong growth in labour incomes (figure 4.11). Growth in incomes has also been −20 Profit expectations (next 3 months) −40 supported by high export prices. In addition, the high −60 2000 exchange rate and low imported inflation are supporting Source: NZIER. households’ purchasing power. Though quarterly growth in retail sales volumes softened to 0.7 percent in the March quarter, annual growth remained robust at 3.8 percent. 2003 2006 −20 DTA (past 3 months) 2009 2012 −40 −60 Labour demand is also growing strongly. The number of people employed in the March quarter was 3.7 percent higher than a year ago, and total labour hours Figure 4.11 Growth in QES total earnings (annual) increased at a similar rate. Survey measures of firms’ hiring intentions indicate that robust growth in labour demand will continue through 2014 (figure 4.13). % % 9 9 8 8 7 7 6 6 5 5 4 4 3 3 2 2 1 1 0 0 −1 2000 2003 2006 2009 2012 −1 Figure 4.13 Annual growth in QES filled jobs and surveyed employment intentions (seasonally adjusted) Index ANZBO (advanced six months) 2 1 0 −1 Source: Statistics New Zealand. QES jobs filled (RHS) −2 Conditions faced by businesses have improved, and survey measures of both business confidence and firms’ own activity outlook have increased over the past year (figure 4.12). Reflecting increased demand and profit expectations, real market business investment looks to QSBO (advanced six months) −3 −4 2000 2003 2006 2009 2012 % 5 4 3 2 1 0 −1 −2 −3 −4 −5 −6 Source: ANZ Bank, NZIER, Statistics New Zealand, RBNZ estimates. Fiscal consolidation continues to partly offset have continued increasing through the first half of the year robust demand by households and businesses. Fiscal after increasing by 11 percent in 2013. consolidation has been occurring through a combination of limited growth in government spending and increases in taxes on tobacco and petrol. 18 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Capacity pressure and inflation Annual CPI inflation in the June quarter is expected to rise to 1.7 percent, driven by increasing Figure 4.15 Construction cost inflation (annual) non-tradables inflation. Annual tradables inflation has % % increased over the past year, but is estimated to remain 14 negative at -0.1 percent in the June quarter. This reflects 12 12 10 10 the high New Zealand dollar TWI and low global inflation, which have contributed to negative tradables inflation since early 2012. 8 0 outpace estimated growth in the economy’s supply −2 capacity. Survey measures of capacity pressure from the QSBO have generally continued to increase over the past Figure 4.14 QSBO survey measures of capacity (standardised) 2 Orders as a limiting factor (inverted) 1 2 2010 2012 −2 % 1 −1 1 −3 −4 Source: NZIER, RBNZ estimates. Headline CPI Factor model 0 5 4 3 −1 −2 6 4 2 −4 2000 2002 2004 2006 2008 2010 2012 2008 5 0 −3 2006 % 3 Difficulty finding skilled labour 0 Source: Statistics New Zealand. 0 −2 4 2 Auckland 6 Index Capacity as a limiting factor 6 Figure 4.16 Headline and selected core inflation measures (annual) year (figure 4.14). 3 Nationwide 2 over the past year as GDP growth has continued to 8 Canterbury 6 4 Pressure on productive capacity has increased Index 14 Weighted median Trimmed mean 3 2 1 2006 2008 2010 2012 0 Source: Statistics New Zealand, RBNZ estimates. Note: Core inflation measures are adjusted for changes in GST. While inflation has increased over the past year, Increased pressure on capacity has resulted in the rise has been less than suggested by some indicators. increasing inflationary pressures over the past year. Non- In particular, firms’ pricing intentions increased sharply tradables inflation is estimated to be 2.9 percent in the June through 2013 and, despite recent declines in the ANZBO quarter. reflecting continued strong growth in demand. An measure, remain above average levels (figure 4.17, important contributor to non-tradables inflation has been overleaf). increasing growth in construction costs. While the rate of construction cost inflation in Canterbury has been slowing since early 2013, the rate has been increasing in Auckland (figure 4.15). Increases in inflation have also been apparent outside the construction sector, with various measures of core inflation increasing gradually over the past year (figure 4.16). Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 19 Figure 4.17 Pricing intentions (seasonally adjusted, standardised) Wage growth has remained low, and eased across a range of measures in the March quarter (figure 4.19). In part, low wage inflation reflects the increase in labour Index Index 4 ANZBO (next three months) 3 2 4 rate, and the lags between resource pressure and wage 3 movements. Recent low headline inflation also appears to 2 1 1 0 0 −1 QSBO (next three months) −2 force participation and the still elevated unemployment be contributing to low wage inflation. Although movements in inflation expectations have been mixed over the past −1 year, they are generally lower than they were through the −2 second half of the last decade (figure 4.20). −3 −3 −4 2000 2002 2004 2006 2008 2010 2012 −4 Source: ANZ Bank, NZIER, RBNZ estimates. While pressures on both physical capital and Figure 4.19 Nominal wage inflation (annual) % % the labour market are increasing, the degree of pressure 6 appears more modest in the labour market, limiting the 5 increases in non-tradables inflation. The improvement 4 4 3 3 in labour demand has encouraged people to enter the labour force. This, along with demographic changes and net immigration, is boosting labour supply. Increases 6 Unadjusted LCI − Private sector 2 LCI − Private sector in the labour force participation rate over the past year 1 mean the unemployment rate has fallen less quickly – and 0 2000 skill shortages have increased less quickly – than might otherwise have been the case. The participation rate rose to 69.3 percent in the March quarter (figure 4.18), while 6 percent of the labour force was unemployed. Figure 4.18 Labour force participation rate (percent of working-age population, seasonally adjusted) % % 70 QES average hourly earnings − total 2 1 2006 2009 0 2012 Source: Statistics New Zealand. Figure 4.20 Inflation expectations (annual) % % 6 6 UMR − 1 year 5 5 4 3 4 ANZBO − 1 year 3 70 69 69 68 68 67 67 66 66 65 65 64 2000 2003 5 2002 2004 2006 2008 2010 2012 2 AON − 4 year RBNZ − 2 year 1 2000 2002 2004 2006 2008 2010 2012 2 1 Source: ANZ Bank, AON Hewitt, RBNZ/UMR Research, RBNZ. 64 Source: Statistics New Zealand. 20 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Box C New Zealand’s export prices transactions when goods physically cross the border, and in general move similarly to SNA prices (figure C2). During 2013, New Zealand experienced its highest terms of trade in more than 40 years. The result has been a large boost to New Zealanders’ real purchasing power. The terms of trade are measured as export prices relative to import prices, and for New Zealand it is movements in export prices that tend to drive cycles in the terms of trade (figure C1). Consequently, developments in New Zealand’s export prices have a significant influence on the overall economic outlook. Figure C2 Terms of trade (SNA and OTI measures) Index Index 1.4 1.5 SNA basis 1.3 1.3 1.2 1.2 1.1 OTI basis (RHS) 1.0 Figure C1 Composition of the terms of trade on an SNA basis Index 110 Export prices (world terms) 100 Terms of trade (RHS) 80 Import prices (world terms) 70 60 50 1996 1999 2002 2005 2008 2011 2002 2004 2006 2008 2010 2012 0.9 Source: Statistics New Zealand, RBNZ estimates. 1.4 Many other export price measures are available, 1.3 and given their timeliness the Bank uses them as leading 1.2 90 1.1 1.0 0.9 2000 Index 120 1.4 indicators of SNA export prices. Such measures include the ANZ and ASB Commodity Prices Indexes. Many 1.1 other price measures are available for individual export 1.0 goods, such as the prices for dairy goods traded on the 0.9 Source: Statistics New Zealand, RBNZ estimates. Measuring export prices GlobalDairyTrade (GDT) auction platform. These other export price measures capture only a sub-section of New Zealand’s export goods, and so (by definition) they are less comprehensive in terms of national income than the SNA measure. The Bank’s forecasting framework incorporates the System of National Accounts (SNA) ‘implicit’ measures of export and import prices. These measures Recent developments in export price measures are implicit because they are export and import deflators On an SNA basis, world export prices in the (values relative to volumes), rather than explicit price December quarter were almost 7 percent higher than the indices that measure price changes based on fixed Bank had forecast at the time of the March Statement baskets of goods. The SNA measures capture all of New (figure C3, overleaf). Zealand’s international trade at the point in time when the good or service changes ownership. The Bank’s forecast uses these SNA measures because of their full coverage and because their implications for real income are consistent with other components of GDP. Alternative measures of export and import prices published by Statistics New Zealand are the Overseas Trade Indices (OTIs). These capture Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 21 Figure C3 SNA goods export price (world terms) A number of compositional differences between the SNA measure of dairy prices and other measures may help to explain the divergence in the December Index % 115 12 Projection 105 10 Mar MPS 95 Jun MPS at the composition of exports sold through the GDT 6 platform we may be able to better understand why SNA 2 export prices were stronger than the Bank expected, 0 and whether this has any future implications. −2 75 65 Difference (RHS) 2006 2008 2010 2012 2014 2016 GDT index closely over history (figure C4), so by looking 8 4 85 quarter. The ANZ dairy price index has followed the −4 Total volumes sold through the GDT platform −6 generally account for less than a quarter of New −8 Zealand’s total dairy exports that are captured by SNA, Source: Statistics New Zealand, RBNZ estimates. and not all products sold on the GDT platform are from While the different export price indicators move New Zealand. Further, whole milk powder – one of the similarly to one another over time, measurement and higher-priced dairy commodities at the time2 – made compositional differences can result in large divergences up a lower share of GDT exports than it did total dairy over short periods. Indeed, the 9.1 percent quarterly exports over the second half of 2013 (figure C5). increase in SNA world export prices in December was higher than what these other indicators had suggested. Much of the increase in New Zealand’s total export prices over 2013 was driven by increases in world Figure C5 Whole milk powder as a share of total dairy export volumes prices for dairy, and it appears much of the surprise in the % December out-turn was also accounted for by dairy. On 85 an SNA basis, world dairy prices increased by more than 80 Figure C4 Dairy price indexes 1700 220 1500 200 ANZ dairy (3 month lead) 180 1300 160 1100 140 900 GDT (3 month lead,RHS) 120 700 100 80 2009 2010 2011 2012 2013 2014 65 60 55 55 50 50 Jan13 Apr13 Jul13 Oct13 45 Source: GlobalDairyTrade, Statistics New Zealand, RBNZ estimates. Notes: Dairy products sold on the GDT platform are for delivery periods between 1 and 6 months later. The GDT volume data for each auction have been adjusted so that they correspond to the month of delivery. Merchandise Trade data have been used as a proxy for SNA export data. Although there are conceptual differences between these data, Merchandise Trade data have been used because sufficiently detailed SNA export data were not available. 500 Source: ANZ Bank, GlobalDairyTrade, Statistics New Zealand, RBNZ estimates. 22 70 GDT 60 45 Index 75 65 dairy prices would remain flat or fall slightly (figure C4). SNA 80 SNA 70 ANZ dairy price index and the GDT index indicated that USD 85 75 7 percent in the December 2013 quarter. In contrast, the 240 % 2 Whole milk powder prices were about US$300/MT higher on average than skim milk powder prices over 2013. Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 The difference between ANZ and SNA could The divergence between whole milk powder also be partly explained by the fact that SNA measures prices and other products has narrowed in 2014, the prices of export goods that changed ownership meaning that the compositional effect seen in December in the current period. In contrast, the ANZ measure is assumed to be temporary. Recent Merchandise Trade weights price movements in world markets by the share data suggest that dairy prices on an SNA basis will of each commodity in New Zealand’s total exports in the remain high in the March 2014 quarter. However, SNA previous year – not by the volume of exports that have export prices are assumed to fall in the June quarter, actually been sold in each month. primarily accounted for by falls in dairy prices. The Bank had already forecast a fall in dairy Outlook for SNA export prices prices, and SNA export prices, in the March Statement. While dairy prices remain high compared to However, the recent falls in GDT prices were larger than history, they have fallen by 26 percent on the GDT expected. In addition to recent declines in forestry prices, auction platform since early February 2014. Dairy has a these larger falls have resulted in a downwards revision weight of 47 percent in the ANZ Commodity Price Index, of about 4 percent to the outlook for SNA export prices in so the aggregate index has also fallen in recent months. world terms beyond the next quarter (figure C3). An important assumption in the Bank’s forecast is how the recent falls in dairy prices on the GDT platform translate into SNA goods export prices, and so to New Zealand export incomes. Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 23 Box D The effects of net immigration on economic activity in New Zealand.1 It is also notable that the current composition of net immigration differs from the high levels in early 2000. Net immigration affects the economy through During that period, there was a much larger increase in a number of channels, on both the demand side and arrivals of non-New Zealand citizens, peaking at a net supply side. Historically, the most significant effect has annual inflow of about 57,000 (figure D1). been through increased demand for housing. Increases in net immigration contribute to both house price inflation and construction activity. In the case of construction, this boost to demand can persist for some time after Figure D1 Immigration flows (annual, permanent and long term) net immigration moderates. In addition, net immigration 000s 70 65 60 55 50 45 40 35 30 25 20 15 2000 supports wider demand for goods and services, directly through increased population and indirectly through the contribution to house price inflation. Over the coming years, an increase in net immigration is expected to be an important factor adding to aggregate demand. In the year to April, net immigration increased to an annual inflow of about 34,000 persons, including 31,000 of working age. This was up sharply from a net inflow of about 5,000 in the previous year. However, 000s Net arrivals − Non−NZ citizens Departures − NZ citizens Arrivals − NZ citizens 2003 2006 2009 2012 70 65 60 55 50 45 40 35 30 25 20 15 Source: Statistics New Zealand. the effects of the recent increase in net immigration on Increases in net immigration also add to the demand pressures in the economy may be more modest economy’s productive capacity. With recent inflows than in previous cycles, as discussed below. concentrated among those aged in their 20s and 30s, In part, the increase in net immigration over and with entry requirements favouring skilled workers, the past year was due to an increase in net arrivals of most new migrants in this cycle are likely to enter the non-New Zealand citizens, up about 8,000 over the past labour force. Indeed, the number of people arriving on year. However, the larger contributor to the increase in temporary working visas increased by about 4,500 over net immigration over the past year has been changes the past year. In contrast, the numbers arriving under in migration flows of New Zealand citizens. The level of the residency category have remained stable (figure departures of New Zealand citizens has fallen by about D2). 17,000 over the past year and is currently at low levels compared with history. At the same time there has been a more modest increase in the number of New Zealanders returning from off shore. These trends have been encouraged by New Zealand’s relatively favourable economic performance, in particular, the improvement in employment prospects compared to Australia. Research by the Bank has found that a given reduction in departures from New Zealand has less of an effect on housing demand and house price inflation than an equally-sized increase in the number of people arriving 24 1 See McDonald (2013) ‘Migration and the housing market’, AN2013/10. Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Figure D2 Permanent and long term arrivals by visa type (annual, year to April) Figure D3 Net immigration by region (annual, permanent and long term) 000s 000s 25 000s 000s 35 20 30 15 25 10 20 5 15 15 0 10 10 5 5 0 0 35 2014 30 25 20 2010 Residency 2013 2012 2011 Work Source: Statistics New Zealand. −5 −10 2000 25 20 15 Auckland 10 5 Other 0 Wellington Canterbury 2003 2006 2009 2012 −5 −10 Source: Statistics New Zealand. The increase in the labour supply due to net immigration helps address the need for skilled labour in the economy. This has been particularly important in Canterbury with reconstruction picking up at the same time as economic activity more generally is strengthening. Labour inflows related to the Canterbury rebuild – which appear to be an important driver of the increase in net immigration – may have a different impact on housing demand than other in-flows. Housing needs for workers in Canterbury might, for example, be oriented more towards higher density forms of housing like flats or temporary housing. However, there has also been a pick-up in net immigration into other regions, particularly Auckland (figure D3). Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 25 5 The macroeconomic outlook The New Zealand economy is projected to grow 3.3 percent in the year to the December quarter 2014, before moderating further ahead (figure 5.1). Demand growth is becoming increasingly broad-based, and pressure on productive resources is expected to cause Figure 5.2 Construction expenditure (quarterly, seasonally adjusted, share of potential GDP) inflation to rise. Consequently, interest rates are projected 12 % Projection 12 to increase over the coming years to ensure that CPI 11 11 inflation settles near 2 percent over the medium term. 10 10 9 9 8 8 7 7 Figure 5.1 GDP growth (annual) % 6 2000 % 7 6 5 4 3 2 1 0 −1 −2 −3 −4 2000 % Projection 7 2003 2006 2009 2012 2015 6 5 4 3 2 1 0 −1 −2 −3 −4 2003 2006 2009 2012 2015 6 Source: Statistics New Zealand, RBNZ estimates. accommodate future population growth. The Auckland Housing Accord fast-tracks the consenting process for building in “Special Housing Areas”, and is expected to support growth in residential building over the next few years. Strong construction work in Canterbury and Auckland is expected to result in an unusual construction Source: Statistics New Zealand, RBNZ estimates. cycle compared to history. Typically, the timing of construction cycles has been in sync with cycles in GDP. Activity outlook However, over coming years construction is expected to Strong increases in construction spending will remain elevated as a share of GDP, drawing on resources support robust domestic demand over coming years. from other sectors in which capacity pressures are Construction sector output is expected to increase over moderating. the next two years to around 10.5 percent of potential After rising to elevated levels over the past year, GDP – similar to the levels in the mid-2000s expansion net immigration is projected to moderate over the coming – and remain around those levels for an extended period years as conditions in other economies, particularly (figure 5.2). Australia, improve (figure 5.3). Over the coming three Post-earthquake reconstruction in Canterbury is years, this will result in net immigration adding around expected to continue for an extended period. The share 70,000 people to the economy (equivalent to around of higher-value residential work in the rebuild is gradually 2 percent of the working-age population); the largest increasing, and significant non-residential investment – migration cycle since the early 2000s. much of which is related to central and local government The boost to the population from immigration projects – is planned. Outside Canterbury, the largest is expected to be an important contributor to housing increases in residential building are expected to take demand and consumer demand over the coming years. place in Auckland with an estimated 10,000 new dwellings (As discussed in Box D in chapter 4, the composition of needed on average per year for the next 30 years to net immigration may mean the boost to demand is slightly 26 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 more modest than in previous cycles). Net immigration will also add to the economy’s productive capacity through increases in the labour force. Figure 5.3 Net permanent and long-term immigration (annual) 000s % 000s 90 45 80 30 Arrivals 70 15 60 50 Net (RHS) Departures 40 2000 2003 2006 2009 2012 0 Projection 2015 Figure 5.5 GDP growth in selected trading partner economies (annual) −15 Source: Statistics New Zealand, RBNZ estimates. 16 14 China 12 10 Other 8 Asia 6 4 2 0 Australia −2 Other −4 advanced −6 −8 2000 2003 2006 2009 % 2012 2015 16 14 12 10 8 6 4 2 0 −2 −4 −6 −8 Source: Haver Analytics, RBNZ estimates. Note: ‘Other Asia’ includes Hong Kong, India, Indonesia, Malaysia, Singapore, South Korea, Taiwan, Thailand and the Philippines. ‘Other advanced economies’ includes the United Kingdom, the United States, Canada, Japan, and the euro area. Strong net immigration and income growth will In China, economic growth has slowed slightly boost housing demand. However, over the coming years over recent quarters, but remains high relative to our other house price inflation is expected to moderate (figure 5.4) trading partners. Chinese authorities are implementing an as housing construction alleviates supply shortages, ambitious economic reform agenda. Successful reform mortgage interest rates increase gradually from current will be vital for ensuring continued strong growth over low levels, and the flow of net immigration is assumed to the long term, but may cause growth to slow in the near wane. term as the structure of the economy changes. We expect annual GDP growth of around 7 percent in the next few Figure 5.4 House price inflation (annual) years. However, recent weakness in property market activity in China poses a risk of much weaker GDP growth. Including its direct and indirect linkages to other sectors % % 30 Projection 25 30 25 of the economy, the property market comprises a large share of output in China. In recent months, property sales have declined, the pace of new construction has slowed, 20 20 15 15 and house price inflation has fallen. If the property market 10 10 weakens sharply, growth could slow further over the next 5 5 0 0 few years. China’s growing importance to the global −5 −5 −10 −10 slowdown in growth could lead to a significant reduction in −15 demand for New Zealand’s exports. −15 2000 2003 2006 2009 2012 2015 Source: Property IQ, RBNZ estimates. economy and the Asian region in particular mean that a In Australia, resource investment is expected The economic recovery in our major trading to continue declining from historically high levels, but partners is projected to continue, but growth is expected there is considerable uncertainty about the pace of the to remain modest compared to history (figure 5.5). decline. Increasing resource export volumes will continue Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 27 to contribute to GDP growth, but the drag from declining Asia. Continuing growth in these economies’ demand for resource investment is expected to become more our commodity exports is expected to continue supporting pronounced over the next year. Over time, strengthening export prices and earnings. Combined with softness in household demand, supported by low interest rates, is global inflation, this strength in export prices is expected expected to encourage an increase in business investment to result in the terms of trade remaining at historically outside of the resource sector. The outlook for the labour elevated levels over the projection. market is uncertain, as indications of strengthening labour The New Zealand dollar TWI is assumed to demand outside the resource sector may be offset by a depreciate only gradually over the projection (figure 5.7), decline in employment related to resource investment. reflecting that global demand is recovering and New In major advanced economies, monetary policy Zealand’s economic outlook remains relatively favourable. is expected to remain supportive and the pace of fiscal Commodity prices are also expected to remain high by consolidation is expected to slow. As economic recoveries past standards even after recent sharp falls. While the continue and labour market conditions improve, growth in high New Zealand dollar will boost domestic purchasing advanced economies is expected to become more self- power, it will continue to weigh on tradables sector sustaining. The ongoing recovery in advanced economies competitiveness and export incomes. will provide support for external demand in our Asian trading partners. Due to the modest pace of the global recovery, excess capacity in developed economies is likely to be absorbed only gradually. This will continue to dampen the prices of many internationally traded goods (figure 5.6), with the resulting softness in import price inflation boosting New Zealanders’ real purchasing power. Figure 5.7 New Zealand dollar TWI Index Index 85 Projection 80 Index 70 65 65 120 Projection 1.4 110 90 80 1.3 Export prices (world terms) 100 1.2 Terms of trade (RHS) 1.1 70 60 1 Import prices (world terms) 50 2000 2003 2006 2009 2012 Source: Statistics New Zealand, RBNZ estimates. 60 Quarterly 55 Index 75 70 60 Figure 5.6 SNA terms of trade and components 80 Daily 75 85 55 50 50 45 45 40 2000 2003 2006 2009 2012 2015 40 Source: RBNZ estimates. Consistent with Budget Economic and Fiscal Update 2014, fiscal consolidation is expected to continue weighing on GDP growth over the projection. Crown revenue is expected to increase with domestic activity and incomes, and through increases in indirect taxes (such 2015 0.9 as the tobacco excise tax), while core Crown expenses are expected to grow by around 1.2 percent per annum. These measures result in a cumulative fiscal impulse of As discussed in box C in chapter 4, it appears around -2 percent of nominal GDP over the projection that aggregate prices for New Zealand’s exports peaked (figure 5.8). This is slightly less negative than in the March in early 2014. Prices for dairy have fallen sharply since Statement due to a $500 million upwards revision to the February. However, New Zealand is continuing to benefit operating allowance each year from 2014/15. from increasing trade with faster-growing economies in 28 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Figure 5.8 Fiscal impulse (share of nominal GDP, June year) Figure 5.9 Private consumption and income growth (annual) % % % % 5 10 4 8 3 3 6 2 2 4 4 1 1 2 2 0 0 0 −1 −1 −2 −2 −2 −4 −3 −6 2000 5 Projection 4 −3 2006 2008 2010 2012 2014 2016 Source: The Treasury. Robust economic growth over the coming years is expected to underpin continued growth in employment. At the same time, the economy’s productive capacity is expected to be boosted by increases in the Projection Private consumption 10 8 6 0 Real income −2 −4 2003 2006 2009 2012 2015 −6 Source: Statistics New Zealand, RBNZ estimates. Figure 5.10 Household saving rate (March years, share of disposable income) % % working-age population associated with net immigration 4 and demographic changes. In addition, labour force 2 2 participation is expected to remain elevated in response 0 0 to improving employment prospects. Overall, employment −2 −2 growth is expected to be stronger than labour force −4 −4 −6 −6 −8 −8 growth, resulting in the unemployment rate declining to just over 5 percent. Growth in employment will underpin robust increases in real labour incomes. Combined with the high New Zealand dollar and low import price inflation, this will result in real household spending growth of around 3 Projection −10 2000 2003 2006 2009 2012 2015 4 −10 Source: Statistics New Zealand, RBNZ estimates. Capacity pressures and inflation percent per annum over the coming two years (figure 5.9). Consumer price inflation is projected to remain in Household spending growth does moderate over the latter the lower part of the target band over the remainder of part of the projection as income growth eases and interest 2014, largely because of the high New Zealand dollar and rates rise to contain inflationary pressures. soft import price inflation. After being boosted in the March 2014 year by Further ahead, demand growth is expected to exceptionally-high export incomes, the household saving result in continued inflationary pressures. Pressures are rate is expected to decline slightly over the coming year as expected to be centred on the non-tradables sector, and GDP and income growth slow. However, the improvement are expected to be particularly acute in the construction in the household savings rate in recent years is expected sector. to be maintained (figure 5.10) To ensure that inflation settles around 2 percent over the medium term, the 90-day interest rate is projected to increase over the coming years (figure 5.11, overleaf). This results in a moderation in capacity pressures over Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 29 the latter part of the projection (figure 5.12). Underlying As in the past, inflation is expected to be the increase in headline inflation, annual non-tradables influenced over the projection by changes in some inflation is expected to peak at 3.8 percent. Annual specific administered prices, indirect taxes and levies. tradables inflation remains negative for much of the Consistent with the Policy Targets Agreement, the projection, due to the high New Zealand dollar and low projection anticipates that monetary policy does not try to imported inflation (figure 5.13). offset the direct effect on headline inflation, but focuses on any implications for inflation expectations and medium- Figure 5.11 90-day interest rate term inflation. This was the approach taken to recent changes to tobacco excise taxes and road user charges % % 10 Projection 10 that temporarily added to headline inflation. More recently, Budget Economic and Fiscal Update 2014 announced 9 9 8 8 7 7 that in the projection is assumed to reduce annual 6 6 headline inflation by around 0.25 percentage points in the 5 5 September 2015 quarter. 4 4 3 3 2 2000 2003 2006 2009 2012 2 2015 Source: RBNZ estimates. an expected reduction in ACC levies for motor vehicles Figure 5.13 CPI inflation and components (annual) % Figure 5.12 Output gap (percent of potential GDP) 6 5 % % Projection 5 Headline 3 2 1 0 2 2 −2 1 1 −3 2000 0 0 −1 −1 −2 −2 2015 4 0 3 2012 6 1 3 2009 7 5 2 4 2006 Non− tradables 3 4 2003 Projection 4 5 −3 2000 % 7 −1 −1 Tradables 2003 2006 −2 2009 2012 2015 −3 Source: Statistics New Zealand, RBNZ estimates. −3 Source: RBNZ estimates. 30 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Appendix A1 Summary tables Table A Projections of GDP growth, CPI inflation and monetary conditions (CPI and GDP are percent changes, GDP seasonally adjusted) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1 Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun GDP Quarterly CPI Quarterly CPI Annual TWI 90-day bank bill rate 1.3 0.7 0.4 1.0 1.2 0.8 0.7 0.1 -0.4 -1.2 -0.2 -0.7 -1.0 -0.2 0.6 1.4 0.2 1.0 -0.3 -0.5 0.9 0.8 0.9 0.6 0.9 0.2 0.2 1.2 0.5 0.4 1.2 0.9 1.1 0.9 0.7 0.6 0.5 0.5 0.6 0.6 0.7 0.6 0.6 0.5 0.5 0.5 0.6 1.5 0.7 -0.2 0.5 1.0 0.5 1.2 0.7 1.6 1.5 -0.5 0.3 0.6 1.3 -0.2 0.4 0.2 1.1 2.3 0.8 1.0 0.4 -0.3 0.5 0.3 0.3 -0.2 0.4 0.2 0.9 0.1 0.3 0.3 0.8 0.1 0.7 0.6 0.6 0.1 0.6 0.6 0.7 0.2 0.6 0.6 3.3 4.0 3.5 2.6 2.5 2.0 1.8 3.2 3.4 4.0 5.1 3.4 3.0 1.9 1.7 2.0 2.0 1.7 1.5 4.0 4.5 5.3 4.6 1.8 1.6 1.0 0.8 0.9 0.9 0.7 1.4 1.6 1.5 1.7 1.5 1.5 1.8 2.1 1.9 1.9 1.8 1.8 2.0 2.0 2.1 2.1 68.2 62.8 63.6 67.0 68.8 72.0 71.4 71.0 71.9 69.3 65.5 57.8 53.7 58.4 62.6 65.5 65.3 66.8 66.9 67.8 67.1 69.1 72.0 68.7 72.5 71.2 72.6 73.6 75.9 76.5 75.2 77.3 78.4 80.0 79.7 79.0 78.4 77.7 77.3 76.9 76.4 75.9 75.5 75.1 74.8 74.6 7.5 7.5 7.5 7.6 7.8 8.1 8.7 8.8 8.8 8.8 8.2 6.3 3.7 2.9 2.8 2.8 2.7 2.9 3.2 3.2 3.0 2.7 2.8 2.7 2.7 2.6 2.7 2.6 2.7 2.6 2.6 2.7 2.9 3.3 3.6 4.0 4.3 4.5 4.6 4.7 4.9 5.0 5.1 5.2 5.2 5.3 Notes for these tables follow on pages 35 and 36. Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 31 32 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Quarterly house price index (Property IQ) REINZ Farm Price Index (quarterly average to date) NZX50 (quarterly average to date) Asset prices (annual percentage changes) Pricing and costs (net balances) ANZ Bank Business Outlook - Pricing intentions, next 3 months (quarterly average to date) QSBO Average selling prices, next three months (Economy wide) QSBO Average costs, past three months (Economy wide) Inflation expectations RBNZ survey of expectations - inflation one-year-ahead RBNZ survey of expectations - inflation two-years-ahead ANZ Bank Business Outlook - inflation one-year-ahead (quarterly average to date) AON Hewitt Economist Survey - inflation one-year-ahead AON Hewitt Economist Survey - inflation four-years-ahead Inflation (annual rates) CPI CPI non-tradables CPI tradables Sectoral factor model estimate of core inflation ex-GST CPI trimmed mean (of annual price change) ex-GST CPI weighted median (of annual price change) ex-GST GDP deflator (derivd from expenditure data) PPI - Input prices PPI - Output prices Table B Measures of inflation, inflationary pressures and asset prices 6.8 3.8 21.0 8.7 20.7 13.2 24.1 4.8 -1.6 8.4 15.5 2.0 2.4 2.0 2.5 16.9 1.8 2.3 2.3 0.9 2.5 -1.0 1.5 1.0 1.6 -2.2 -0.5 -0.8 0.8 2.3 -1.2 1.5 1.1 2.0 -1.1 0.3 -0.6 2.0 2.3 2.4 Dec 2012 Sep 7.6 -6.5 26.9 10.7 16.5 20.3 1.9 2.4 1.7 2.2 2.3 0.9 2.4 -1.1 1.5 1.0 1.5 0.1 0.0 0.1 2013 Mar 9.1 -1.8 28.9 18.1 18.5 22.2 1.8 2.3 1.5 2.1 2.3 0.7 2.5 -1.6 1.5 0.8 1.3 0.2 0.0 0.8 Jun 10.2 10.8 26.7 24.0 21.0 29.4 2.0 2.3 1.9 2.4 2.3 1.4 2.8 -0.5 1.6 1.4 1.8 3.2 3.3 4.1 Sep 9.0 5.7 20.6 23.3 22.1 26.0 2.0 2.3 1.9 2.3 2.4 1.6 2.9 -0.3 1.6 1.6 2.0 7.0 2.8 3.8 Dec 9.0 16.5 37.2 18.4 31.6 2.2 2.2 2.0 2.3 2.6 3.1 4.0 1.5 3.0 -0.6 1.6 1.5 1.7 2014 Mar 14.7 28.9 2.1 2.3 2.1 2.4 2.6 Jun Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 33 3.4 GDP (production, March qtr to March qtr) Percentage point contribution to the growth rate of GDP. 2.8 GDP (production) 1 1.8 -1.6 Imports of goods and services Expenditure on GDP 3.8 Exports of goods and services Gross national expenditure 0.1 1.3 2.9 3.5 10.8 3.7 6.0 1.1 -1.1 Stockbuilding 4.8 1.2 1 Final domestic expenditure 7.4 8.8 -2.7 -2.9 Other 1.8 4.0 4.8 3.7 2008 Total -2.1 Residential Gross fixed capital formation 2.6 3.6 Public authority Total 2.3 2007 Private Final consumption expenditure March year -3.0 -1.9 -1.9 -4.0 -2.7 -2.4 -0.5 -2.2 -7.8 -4.6 -21.3 -0.3 4.5 -1.6 2009 2.1 -0.1 2.2 -8.9 4.0 -2.3 -1.1 -1.3 -9.5 -9.7 -8.6 1.2 -0.1 1.6 2010 Actuals (annual average percent change, seasonally adjusted, unless specified otherwise) Composition of real GDP growth Table C 1.2 1.8 0.7 11.4 2.9 3.4 1.1 2.2 1.8 2.1 0.3 2.3 2.0 2.4 2011 3.2 2.4 2.3 6.6 2.7 3.7 0.5 2.9 4.4 5.4 -0.5 2.4 0.2 3.1 2012 2.1 2.3 2.6 1.2 2.6 2.1 -0.4 3.1 7.3 5.1 19.4 1.9 -0.6 2.6 2013 3.7 3.1 2.6 7.8 0.4 5.2 0.0 4.8 10.7 9.9 14.2 3.1 1.5 3.5 2014 2.7 3.5 3.5 6.0 2.4 4.7 0.2 4.6 10.2 9.0 16.1 2.8 0.6 3.4 2015 2.4 2.3 2.3 5.1 2.1 3.4 0.1 3.4 4.9 3.5 11.1 2.8 1.3 3.2 2016 Projections 2.3 2.5 2.5 3.7 3.0 2.8 -0.0 2.8 4.1 3.9 4.8 2.4 1.8 2.5 2017 34 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 3.0 2.3 0.6 Labour costs Export prices (in New Zealand dollars) Import prices (in New Zealand dollars) 65.6 TWI (year average) 2.6 2.7 Potential output (annual average % change) Output gap (% of potential GDP, year average) 3.9 1.1 Unemployment rate (March qtr, seasonally adjusted) Trend labour productivity -6.9 -1.6 -4.5 Current account balance (% of GDP) Terms of trade (SNA measure, annual average % change) Household saving rate (% of disposable income) 3.8 1.9 Trading partner GDP (annual average % change) Trading partner CPI (TWI weighted, annual % change) World economy 3.4 Government operating balance (% of GDP, year to June) Key balances 2.0 Total employment (seasonally adjusted) Labour market 2.8 GDP (production, annual average % change) Output 7.6 90-day rate (year average) Monetary conditions 2.5 2007 CPI Price measures March year Table D Summary of economic projections (annual percent change, unless specified otherwise) 3.3 4.2 -1.7 8.8 -6.8 3.1 1.0 3.8 1.3 3.4 2.2 2.9 71.6 8.6 0.1 11.5 3.5 3.4 2008 0.9 0.3 -1.9 -2.4 -7.1 -2.1 0.9 5.2 -0.9 -0.3 1.7 -1.9 61.6 6.7 17.6 7.2 3.1 3.0 2009 1.7 1.1 0.2 -4.1 -1.5 -3.3 0.8 6.2 -0.2 -1.7 1.3 -0.1 62.9 2.8 -11.2 -7.6 1.3 2.0 2010 Actuals 2.2 4.4 1.0 7.7 -2.8 -9.2 0.9 6.7 1.8 -1.1 1.2 1.8 67.1 3.1 3.4 7.8 2.0 4.5 2011 2.2 3.5 0.4 1.5 -3.1 -4.5 0.9 6.8 1.0 -0.2 1.5 2.4 70.6 2.7 -1.9 -3.2 2.1 1.6 2012 1.6 3.2 -0.7 -4.2 -3.9 -2.1 0.9 6.2 0.4 0.0 2.0 2.3 73.3 2.6 -4.3 -5.4 1.8 0.9 2013 1.6 3.6 1.5 11.7 -2.5 -0.9 0.9 6.0 3.7 0.7 2.4 3.1 76.9 2.7 -3.3 12.2 1.7 1.5 2014 2.0 3.8 0.1 -3.3 -4.3 -0.1 0.9 5.3 2.1 1.5 2.7 3.5 79.3 3.8 0.8 -10.5 1.7 1.8 2015 2.0 4.2 -0.9 -2.0 -5.9 0.4 0.9 5.2 1.5 1.0 2.8 2.3 77.1 4.7 3.0 4.1 2.1 1.8 2016 Projections 1.9 4.2 -0.8 0.9 -6.1 1.0 1.0 5.1 1.2 0.7 2.8 2.5 75.3 5.1 2.9 3.5 2.2 2.1 2017 Notes and definitions CPI Consumers Price Index. Weighted median inflation To calculate weighted median inflation, first the percentage changes in all components of the CPI are ranked. The weighted median is the rate of price change that half of all weighted price movements are below, and half are above. Trimmed mean inflation To calculate trimmed mean inflation, first percentage changes in all components of the CPI are ranked, then the price changes for a specified weight of the CPI are removed. The trimmed mean is the average of the remaining price changes. Sectoral factor model estimate of core inflation Estimates core inflation by up weighting those components of the CPI that most closely reflect the general trend in the CPI inflation and down weighting those that do not. The weightings evolve over time as the volatility of each component changes. TWI Nominal trade-weighted index of the exchange rate. Defined as a geometricallyweighted index of the New Zealand dollar bilateral exchange rates against the currencies of Australia, Japan, the United States, the United Kingdom, and the euro area. 90-day bank bill rate The interest yield on 90-day bank bills. World GDP RBNZ definition. 16-country index, export weighted. Seasonally adjusted. World CPI inflation RBNZ definition. Five-country index, TWI weighted. Import prices                     Domestic currency import prices. System of National Accounts. Export prices                     Domestic currency export prices. System of National Accounts. Terms of trade                                                                  Constructed using domestic currency export and import prices. System of National Accounts. Private consumption System of National Accounts. Public authority consumption System of National Accounts. Residential investment RBNZ definition. Private sector and government market sector residential investment. System of National Accounts. Other investment RBNZ definition. Total investment - residential investment. Final domestic expenditure RBNZ definition. The sum of total consumption and total investment. System of National Accounts. Stockbuilding Percentage point contribution to the growth of GDP by stocks. System of National Accounts. Gross Domestic Income The real purchasing power of domestic income, taking into account changes in the terms of trade. System of National Accounts. Gross national expenditure Final domestic expenditure plus stocks. System of National Accounts. Exports of goods and services System of National Accounts. Imports of goods and services System of National Accounts. GDP (production) Gross Domestic Product. System of National Accounts. Potential output RBNZ definition and estimate. Output gap RBNZ definition and estimate. The percentage difference between real GDP (production, seasonally adjusted) and potential output GDP. Current account balance Balance of Payments. Total employment Household Labour Force Survey. Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 35 Unemployment rate Household Labour Force Survey. Household saving rate Household Income and Outlay Account. Government operating balance Operating balance before gains and losses. Source: The Treasury, adjusted by the Reserve Bank. Labour productivity The series shown is the annual percentage change in a trend measure of labour productivity. Labour productivity is defined as GDP (production) divided by Household Labour Force Survey hours worked. Labour cost Private sector all salary and wage rates. Labour Cost Index. Quarterly percent change (Quarter/Quarter-1 - 1)*100 Annual percent change (Quarter/Quarter-4 - 1)*100 Annual average percent change (Year/Year-1 - 1)*100 Fan charts in figure 2.2 The fan charts in Figure 2.2 represents the uncertainty about the outlook for inflation, interest rates and the output gap due to incorrectly assessing the size of the factors that drive the projection. This represents only one of three different types of uncertainty that can cause projection to be incorrect. Forecast errors could be due to: firstly, incorrectly identifying the current drivers of the economy (e.g. failing to forecast the Canterbury earthquake); secondly, incorrectly characterising the impact these drivers will have on the economy (e.g. underestimating the inflationary impact from the Canterbury rebuild); thirdly, failing to anticipate data revisions; and finally, incorrectly assessing the magnitudes of the drivers (e.g. underestimating the amount of rebuild spending to occur). By summarising only the final one of these sources, the fans understate the ‘true’ uncertainty around the projections. The procedure used to produce the fans around the central projection involved varying the importance of the drivers of the economic outlook. Of the all drivers that could potentially be used to shape our forecasts, only those we judge to be most relevant at the current time have been used. These drivers are terms of trade, the exchange rate, net immigration, the housing market and construction. For different assumed outturns of the drivers over the forecast horizon, a different scenario for the New Zealand economy will result. The fans summarise a collection of a 1000 such scenarios. The shocks to each driver in each scenario were randomly selected from a normal distribution based on the standard deviations and correlations of the shocks identified by the forecasting model. These standard deviations and correlations were estimated over the period September quarter of 1992 and the June quarter of 2014. The dark grey fans cover 68% of the possible outcomes for each variable shown and the light grey fans cover 90% of the possible outcomes. Source: Unless otherwise specified, all data conform to Statistics New Zealand definitions, and are not seasonally adjusted. Rounding: All projections data are rounded to one decimal place. 36 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Appendix B Companies and organisations contacted by Reserve Bank staff during the projection round Arthur Barnett Ltd Macpac Ltd ASB Bank Ltd Macrennie Commercial Construction Ltd Auckland Chamber of Commerce Motor Trade Finances Ltd Auckland City Council NALCO Ltd Augusta Capital Ltd Naylor Love Construction Ltd Barfoot and Thompson Ltd The Neil Group Ltd Bellingham Wallace Ltd New Zealand Council of Trade Unions Canterbury Development Corporation The Otago Chamber of Commerce Inc. CBRE New Zealand Polson Higgs Ltd CERA Port Otago Ltd Christchurch International Airport Ltd PricewaterhouseCoopers Ltd Colliers International New Zealand Ltd Progressive Enterprises Ltd Colliers International New Zealand Ltd - Christchurch Real Rabobank Ltd Estate Management Office Ray White (Real Estate) Ltd Contact Energy Ltd Recruitment & Consulting Services Association Countrywide Property Trust Ltd Remax Ltd Delta Ltd RR Fisher & Co Ltd Downer Ltd Scott Technology Ltd Dunedin City Holdings Ltd Silver Fern Farms Ltd Fisher & Paykel Appliances Ltd SKYCITY Entertainment Group Ltd Freshmax New Zealand Ltd Southern Response Earthquake Services Ltd Ganellen Ltd Stonewood Homes Ltd Hancocks Ltd Synlait Milk Ltd Harris Home Fires Ltd Tecpak Industries Ltd Heartland Bank Ltd Tonkin & Taylor Ltd Juken New Zealand Ltd Villa Maria Estate Ltd Kirkcaldie & Stains Ltd Warren and Mahoney Ltd Mace Group Head Office Ltd Wellington Employers’ Chamber of Commerce Windsor Engineering Group Ltd Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 37 Appendix C The Official Cash Rate chronology Date Percentage Date Percentage 17 March 1999 4.50 29 January 2004 21 April 1999 4.50 11 March 2004 5.25 19 May 1999 4.50 29 April 2004 5.50 30 June 1999 4.50 10 June 2004 5.75 18 August 1999 4.50 29 July 2004 6.00 29 September 1999 4.50 9 September 2004 6.25 17 November 1999 5.00 28 October 2004 6.50 19 January 2000 5.25 9 December 2004 6.50 15 March 2000 5.75 27 January 2005 6.50 19 April 2000 6.00 10 March 2005 6.75 17 May 2000 6.50 28 April 2005 6.75 5 July 2000 6.50 9 June 2005 6.75 16 August 2000 6.50 28 July 2005 6.75 4 October 2000 6.50 15 September 2005 6.75 6 December 2000 6.50 27 October 2005 7.00 24 January 2001 6.50 8 December 2005 7.25 14 March 2001 6.25 26 January 2006 7.25 19 April 2001 6.00 9 March 2006 7.25 16 May 2001 5.75 27 April 2006 7.25 4 July 2001 5.75 8 June 2006 7.25 15 August 2001 5.75 27 July 2006 7.25 19 September 2001 5.25 14 September 2006 7.25 3 October 2001 5.25 26 October 2006 7.25 14 November 2001 4.75 7 December 2006 7.25 23 January 2002 4.75 25 January 2007 7.25 20 March 2002 5.00 8 March 2007 7.50 17 April 2002 5.25 26 April 2007 7.75 15 May 2002 5.50 7 June 2007 8.00 3 July 2002 5.75 26 July 2007 8.25 14 August 2002 5.75 13 September 2007 8.25 2 October 2002 5.75 25 October 2007 8.25 20 November 2002 5.75 6 December 2007 8.25 23 January 2003 5.75 24 January 2008 8.25 6 March 2003 5.75 6 March 2008 8.25 24 April 2003 5.50 24 April 2008 8.25 5 June 2003 5.25 5 June 2008 8.25 24 July 2003 5.00 24 July 2008 8.00 4 September 2003 5.00 11 September 2008 7.50 23 October 2003 5.00 23 October 2008 6.50 5.00 4 December 2008 5.00 4 December 2003 38 5.25 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Date Percentage Date Percentage 29 January 2009 3.50 27 October 2011 2.50 12 March 2009 3.00 8 December 2011 2.50 30 April 2009 2.50 26 January 2012 2.50 11 June 2009 2.50 8 March 2012 2.50 30 July 2009 2.50 26 April 2012 2.50 10 September 2009 2.50 14 June 2012 2.50 29 October 2009 2.50 26 July 2012 2.50 10 December 2009 2.50 13 September 2012 2.50 28 January 2010 2.50 25 October 2012 2.50 11 March 2010 2.50 6 December 2012 2.50 29 April 2010 2.50 31 January 2013 2.50 10 June 2010 2.75 14 March 2013 2.50 29 July 2010 3.00 24 April 2013 2.50 16 September 2010 3.00 13 June 2013 2.50 28 October 2010 3.00 25 July 2013 2.50 9 December 2010 3.00 12 September 2013 2.50 27 January 2011 3.00 31 October 2013 2.50 10 March 2011 2.50 12 December 2013 2.50 28 April 2011 2.50 30 January 2014 2.50 9 June 2011 2.50 13 March 2014 2.75 28 July 2011 2.50 24 April 2014 3.00 15 September 2011 2.50 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 39 Appendix D Upcoming Reserve Bank Monetary Policy Statements and Official Cash Rate release dates The following is the Reserve Bank’s schedule for the release of Monetary Policy Statements and Official Cash Rate (OCR) announcements. Please note that the Reserve Bank reserves the right to make changes, if required due to unexpected developments. In that unlikely event, the markets and the media would be given as much warning as possible. Announcements are made at 9.00am on the day concerned and are posted to the website shortly after. 2014 24 July 2014 OCR announcement 11 September 2014 Monetary Policy Statement and OCR announcement (media conference and webcast) 30 October 2014 OCR announcement 11 December 2014 Monetary Policy Statement and OCR announcement (media conference and webcast) 2015 29 January 2015 OCR announcement 12 March 2015 Monetary Policy Statement and OCR announcement (media conference and webcast) 30 April 2015 OCR announcement 11 June 2015 Monetary Policy Statement and OCR announcement (media conference and webcast) 40 Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 Appendix E Policy Targets Agreement This agreement between the Minister of Finance and the Governor of the Reserve Bank of New Zealand (the Bank) is made under section 9 of the Reserve Bank of New Zealand Act 1989 (the Act). The Minister and the Governor agree as follows: 1. a) Price stability Under Section 8 of the Act the Reserve Bank is required to conduct monetary policy with the goal of maintaining a stable general level of prices. b) The Government’s economic objective is to promote a growing, open and competitive economy as the best means of delivering permanently higher incomes and living standards for New Zealanders. Price stability plays an important part in supporting this objective. 2. a) Policy target In pursuing the objective of a stable general level of prices, the Bank shall monitor prices, including asset prices, as measured by a range of price indices. The price stability target will be defined in terms of the All Groups Consumers Price Index (CPI), as published by Statistics New Zealand. b) For the purpose of this agreement, the policy target shall be to keep future CPI inflation outcomes between 1 per cent and 3 per cent on average over the medium term, with a focus on keeping future average inflation near the 2 per cent target midpoint. 3. a) Inflation variations around target For a variety of reasons, the actual annual rate of CPI inflation will vary around the medium-term trend of inflation, which is the focus of the policy target. Amongst these reasons, there is a range of events whose impact would normally be temporary. Such events include, for example, shifts in the aggregate price level as a result of exceptional movements in the prices of commodities traded in world markets, changes in indirect taxes, significant government policy changes that directly affect prices, or a natural disaster affecting a major part of the economy. b) When disturbances of the kind described in clause 3(a) arise, the Bank will respond consistent with meeting its medium-term target. Reserve Bank of New Zealand: Monetary Policy Statement, June 2014 41 4. a) Communication, implementation and accountability On occasions when the annual rate of inflation is outside the medium-term target range, or when such occasions are projected, the Bank shall explain in Policy Statements made under section 15 of the Act why such outcomes have occurred, or are projected to occur, and what measures it has taken, or proposes to take, to ensure that inflation outcomes remain consistent with the medium-term target. b) In pursuing its price stability objective, the Bank shall implement monetary policy in a sustainable, consistent and transparent manner, have regard to the efficiency and soundness of the financial system, and seek to avoid unnecessary instability in output, interest rates and the exchange rate. c) 42 The Bank shall be fully accountable for its judgements and actions in implementing monetary policy. Reserve Bank of New Zealand: Monetary Policy Statement, June 2014