The New Zealand economy contracted in the first quarter of this year, according to the national accounts released this week. But before those on this side of the Tasman get too smug, it is worth recalling that the New Zealand economy still grew faster at an annual rate than the RBA is forecasting for non-farm GDP growth in Australia by the end of this year. New Zealand’s experience points to the sharp slowdown in activity that will be required in Australia to contain inflation, in the absence of supply-side measures to enhance potential output.
Few seem to appreciate the magnitude and implications of this prospective cyclical downturn, although this may reflect a fundamental lack of conviction that the RBA’s forecasts will in fact be realised. Consumer inflation expectations suggest that most are betting on rising inflation rather than a substantial downturn in activity that would contain inflation pressures. Consumer confidence is very sensitive to inflation, even controlling for the effects of nominal interest rates, suggesting that it is rising inflation expectations that is largely behind the downturn in consumer confidence.
This week saw further increases in bulk commodity export contract prices that will be back-dated to the beginning of the June quarter and that continue to exceed the RBA’s forecasting assumptions. This implies a larger boost to the terms of trade than previously expected, from a starting point in the March quarter that was already a record high on a national accounts basis.
Australia continues to benefit from being a net producer and exporter of goods that are rising in price, but it has also benefited from declining prices for manufactured imports. The boom in Australia’s terms of trade is the flip-side of the downturn in the terms of trade seen in the economies of East Asia. In this context, the federal government’s manufacturing fetish, which has seen it back-sliding into the industry policies of the 1960s and 1970s, can only be damaging to national welfare.
Next week’s data should continue to place pressure on the inflation and interest rate outlook. The June TD-MI inflation gauge is released Monday and is forecast at 0.4 per cent month-on-month and 4.7 per cent year-on-year, compared to 4.5 per cent year-on-year previously, a new record annual growth rate for this series. The Melbourne Institute will also release its final estimate of June quarter CPI inflation. Close attention should also be paid to the Melbourne Institute’s trimmed mean series, which has recently been running at a monthly rate of 0.5-0.6 per cent.
May private sector credit is also released, forecast at 0.8 per cent month-on-month compared to 0.4 per cent month-on-month in April. There is a RBA Board meeting Tuesday, widely expected to leave the official cash rate steady at 7.25 per cent, ahead of what we expect will be an August tightening. May building approvals are released Wednesday, forecast to fall 5.4 per cent month-on-month. May retail trade is forecast to rise 0.5 per cent month-on-month. The May trade balance is expected to post a deficit of 1.885 billion, driven by a 5.1 per cent month-on-month increase in imports and a 0.8 per cent month-on-month rise in exports. However, export values could increase more sharply due to the backdating of recent increases in iron ore contract prices not yet included in the published measures of commodity prices, yielding a smaller deficit on the month.
Dr Stephen Kirchner is an independent financial market economist. His blog can be found at www.institutional-economics.com