economics@

Economics, interest rates and currencieschart pack

Economics, interest Economics, interest rates and currenciesrates and currencieschart packchart pack

Saul EslakeChief Economist

ANZ Bank

Saul EslakeSaul EslakeChief Chief EconomistEconomist

ANZ BankANZ Bank

April 2005April 2005April 2005

Charts prepared for ANZ Senior ManagementCharts prepared for ANZ Charts prepared for ANZ Senior ManagementSenior Management

www.anz/com/go/economicswww.anz/com/go/economicswww.anz/com/go/economics

Cut-off date for charts: 18 April 2005

economics@

2

Summary of key economic forecastsSummary of key economic forecastsSummary of key economic forecasts

6½5¾6.3NZ current account deficit (% GDP)

11¼r11½r12.5Australian credit growth (%)a

5¾r9½r11.7NZ credit growth (%)a

2¾ 32.7NZ CPI inflation (%)a

22¾r4¾NZ GDP growth4¼ 3½ 3.6 NZ unemployment rate (%)a

6½r6½r6.4Aust. current account deficit (% GDP)

322.6Australian CPI inflation (%)a

5¾5½r5.2Australian unemployment rate (%)a

3r2¾r3.2Australian GDP growth (%)

445World GDP growth (%)

404541Oil prices (US$ per barrel)

200620052004

a Year to December quarter; all other forecasts are calendar year-average. r Revised since last month; see slide 4.

economics@

3

Summary of key market forecastsSummary of key market forecastsSummary of key market forecasts

6.006.756.756.50RBNZ cash rate (% pa)

1.161.151.101.09A$ - NZ$

5.70r5.50r5.70r5.33Australian 10-year bond yield (% pa)

0.62r0.68r0.79r0.78A$ - US$

0.53r0.59r0.68r0.70NZ$ - US$

5.25

8.28

103

1.36

4.22

2.25

Dec 2004*

5.75

8.25

105r

1.32r

4.80r

3.25

Jun 2005

5.75

8.15

109r

1.20r

5.00r

4.25r

Dec 2005

8.00US$ - Yuan

5.50RBA cash rate (% pa)

113rUS$ - ¥

1.11r€ - US$

5.50rUS 10-year bond yield (% pa)

5.00rUS Fed funds rate (% pa)

Dec 2006

* actual r revised

economics@

4

Major revisions to forecasts over the past monthMajor revisions to forecasts over the past monthMajor revisions to forecasts over the past month

l Federal Reserve now expected to continue raising rates ¼ pc pt at each FOMC meeting for longer than previously thought

– implying funds rate at 4¼% by end-2005 (previously 3¾%) and peaking at 5% (previously 4%) in 2006

l US dollar now seen as having ‘bottomed’ against freely-floating currencies (€, £, C$, A$, NZ$ etc) sooner and at lower levels than previously

– US will find it easier to finance its current account deficit through borrowing from foreign private sector lenders given higher interest rate profile

– US$-€ now not expected to reach low of $1.40, but instead to strengthen from mid-year onwards to $1.20 by end-2005

l A$ and NZ$ to fall further and sooner against US$, to US68¢ and 59¢ by end-2005, and 62¢ and 53¢ by end-2006

– largely reflects much narrower interest rate differentials in these currencies’ favour due to higher US rate profile

l Australian 2005 GDP growth revised up from 2¼% to 2¾%, 2006 down from 3½% to 3%

– largely reflects much stronger than expected employment growth in March quarter, for which we assume there will be ‘payback’ later in 2005 or 2006

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5

World economy is slowing – but from a very fast pace to a fast pace World economy is slowing World economy is slowing –– but from a very fast but from a very fast pace to a fast pace pace to a fast pace

OECD LEI – monthly changes

l OECD leading indicator fell in February, after three consecutive increases around the turn of the year

l We expect global growth to slow from 5% (fastest since 1976) in 2004 to 4% this year and next (still above long-term trend of 3¾%)

-6

-4

-2

0

2

4

6

8

00 01 02 03 04 05

% change from year earlier

World industrialproduction (3-mthmoving average)

OECD compositeleading indicator,4 months forward

World IP and the OECD leading indicator

-0.4-0.2

0.00.2

0.40.6

0.81.0

03 04 05

% change from previous month

economics@

6

World economic growth is expected to average 4% this year and next, down from 5% in 2004World economic growth is expected to average World economic growth is expected to average 4% this year and next, down from 5% in 20044% this year and next, down from 5% in 2004

Note: GDP is in US$ at purchasing power parityexchange rates.Sources: IMF; Economics@ANZ.

World GDP growth Why slower growth?

l No new fiscal stimulus– although G7 governments are

not seriously tackling their deficits, nor are they this year (for the first time since 2000) adding to them

l Gradual withdrawal of monetary policy stimulus in the US

– US short-term interest rates will be back at ‘neutral’ (around 4½%) by this time next year

– interest rates in ‘currency-pegging’ countries will also tend to rise

l Drag from persistently high oil prices

– although not nearly as much of a negative as in the 1970s and 80s, oil prices continuing in the US$45+ range will detract from global growth

0

1

2

3

4

5

6

94 95 96 97 98 99 00 01 02 03 04 05 06

% change from previous year

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7

Macro-economic policy settings in major economies are becoming less stimulativeMacroMacro--economic policy settings in major economic policy settings in major economies are becoming less stimulativeeconomies are becoming less stimulative

Source: IMF World Economic Outlook April 2005.

Economic policy changes in the G7

-5

-4

-3

-2

-1

0

1

-5 -4 -3 -2 -1 0 1

Fscal policy - change in structural fiscal balance (% of potential GDP)

Monet

ary

polic

y -

change

in r

eal 6-m

th

LIBO

R (

pc

pts

)

US

UK

Euro area

Japan

Canada

Easier

Tighter

2000-2004

-2

-1

0

1

2

-0.6 -0.4 -0.2 0.0 0.2 0.4

Fscal policy - change in structural fiscal balance (% of potential GDP)

Monet

ary

polic

y -

change

in r

eal 6-m

th

LIBO

R (

pc

pts

)

US

UK

Euro area

Japan

CanadaEasier

Tighter

2004-05

economics@

8

Persistently high oil prices reflect exceptionally tight conditions in global oil marketsPersistently high oil prices reflect exceptionally Persistently high oil prices reflect exceptionally tight conditions in global oil marketstight conditions in global oil markets

Sources: BP Statistical Review of World Energy 2004;IMF World Economic Outlook April 2005; Economics@ANZ.

World oil supply anddemand

50

55

60

65

70

75

80

85

70 75 80 85 90 95 00 05

Mn barrels ofoil per day

Demand

Supply

Capacity utilization inthe global oil industry

60

65

70

75

80

85

90

95

100

70 75 80 85 90 95 00 05

%

OPEC productionas a % of capacity

Global oil refinerycapacity utilization

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9

Oil prices are again striking new (nominal) highs – but so far aren’t hurting consumers too muchOil prices are again striking new (nominal) highs Oil prices are again striking new (nominal) highs –– but so far aren’t hurting consumers too muchbut so far aren’t hurting consumers too much

Sources: BP Statistical Review of World Energy 2004; IMF World Economic Outlook April 2005; Datastream; US Bureau of Economic Analysis; Economics@ANZ.

Crude oil pricesEnergy as a % of total US household spending

3.8

4.3

4.8

5.3

5.8

6.3

6.8

7.3

7.8

8.3

8.8

70 75 80 85 90 95 00 05

% (3-mth moving average)

Average forpast 25 yrs

0

10

20

30

40

50

60

70

80

90

70 75 80 85 90 95 00 05

US$/barrel

Nominal

Real(2004 $)

economics@

10

40

45

50

55

60

65

70

01 02 03 04 05

Net balance (%)

Manufacturing

Services

US economic indicators are mixed but on balance pointing to some slowing in growthUS economic indicators are mixed but on balance US economic indicators are mixed but on balance pointing to some slowing in growthpointing to some slowing in growth

Purchasing managers’ (ISM) indices

-30

-20

-10

0

10

20

01 02 03 04 05

% change fromyear earlier

Trend

Actual

Orders for non-defence capital goods (excl. aircraft)

Retail sales

-1

0

1

2

02 03 04 05

% change from previous month(excl. auto dealers and garages)

Actual

Trend

Sources: Institute of Supply Management; US CommerceDepartment; Federal Reserve; Bureau of Labor Statistics.

Non-farm employment

-300-200

-1000

100200

300400

02 03 04 05

Change from previousmonth ('000s)

Actual

Trend

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11

The US trade deficit is exerting a significant (and The US trade deficit is exerting a significant (and still growing) drag on overall growthstill growing) drag on overall growth

Sources: US Census Bureau

US exports and imports l US imports are now more than 60% higher than US exports –implying that exports need to grow nearly two-thirds as fast again as imports merely to stop the trade deficit from widening

l The continually widening trade deficit is subtracting ½-¾ pc points from GDP growth annually

l The deficit will be difficult to reduce without a recession

– exporters to the US tend to price to the US market, absorbing the impact of currency changes

– US demand for imports is highly income ‘elastic’

– but foreign demand for US exports is neither income nor price (currency) ‘elastic’

75

100

125

150

175

97 98 99 00 01 02 03 04 05

US$ bn per month

Exports

Imports

-800

-600

-400

-200

0

97 98 99 00 01 02 03 04 05

US$ bn (annual rate)

US trade balance

economics@

12

Producer prices –intermediate goods

-5

0

5

10

00 01 02 03 04 05

% ch. from year earlier

Headline

Core (excl.food & energy)

2nd

highestsinceSep ’81

Producer prices –finished goods

-3

0

3

6

00 01 02 03 04 05

% ch. from year earlier

Headline

Core (excl.food & energy)

Gradually rising inflation (albeit from very low base) means Fed will continue ‘normalizing’ ratesGradually rising inflation (albeit from very low Gradually rising inflation (albeit from very low base) means Fed will continue ‘normalizing’ ratesbase) means Fed will continue ‘normalizing’ rates

Consumer prices

0

1

2

3

4

00 01 02 03 04 05

% ch. from year earlierHeadline

Core (excl. food & energy)

HighestsinceSep ’02

HighestsinceDec’91

HighestsinceJun ’01

Sources: US Bureaux of Labor Statistics andEconomic Analysis.

Labor costs

-2

0

2

4

6

00 01 02 03 04 05 05

% ch. from year earlierAverage hourly

earnings

Unit labor costs

economics@

13

01234567

98 99 00 01 02 03 04 05 06

% pa Fore-cast

Federal Reserve raises rates again but with slightly more ‘hawkish’ languageFederal Reserve raises rates again but with Federal Reserve raises rates again but with slightly more ‘hawkish’ languageslightly more ‘hawkish’ language

Sources: US Federal Reserve; Datastream.

US fed funds rate l The Federal Reserve has now raised the funds rate seven times, to 2¾%

l The Fed’s most recent statement re-iterated the view that ‘policy accommodation can be removed at a pace that is likely to be measured’

– ie, ¼ pc point movements at each FOMC meeting is still the most likely scenario for the rest of 2005

l But other parts of the FOMC statement were more ‘hawkish’

– ‘… pressures on inflation have picked up in recent months and pricing power is more evident’

– ‘… with appropriate monetary policy action, the upside and downside risks to … sustainable growth and price stability should be kept roughly equal’ (instead of the risks merely being ‘roughly equal’ without ‘ policy action’ in previous statements2005

l Fed funds rate likely to reach 4% before year end and 5% by mid-06

344556677

98 99 00 01 02 03 04 05 06

% paFore-cast

10 year bond yield

economics@

14

Japan’s economy still looks incapable of self-sustaining growthJapan’s economy still looks incapable of selfJapan’s economy still looks incapable of self--sustaining growthsustaining growth

Real GDP

Unemployment rate

Sources: Economic & Social Research Institute; WelfareMinistry; Bank of Japan; Home Ministry; Economics@ANZ.

-2

-1

0

1

2

01 02 03 04 05

% change from previous qtr 5th ‘technical recession’ inpast decade

3

4

5

6

7

8

9

01 02 03 04 05

% of labour force

Actual

With unchangedparticipation rate

‘Tankan’ business sentiment

-50-40

-30-20

-100

1020

01 02 03 04 05

Net balance optimistic (%)

Large companies

Small companies

Inflation

-2

-1

0

1

01 02 03 04 05

% change from year earlier

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15

To date there’s only limited evidence that China’s To date there’s only limited evidence that China’s economy is slowing from last year’s rapid paceeconomy is slowing from last year’s rapid pace

Sources: China National Statistics Bureau;People’s Bank of China.

Industrial production

0

5

10

15

20

25

00 01 02 03 04 05

% ch. from year earlier Actual

6-mth moving average

Primary energy production

-20

-10

0

10

20

30

00 01 02 03 04 05

% ch. from year earlier Actual

6-mth moving average

Retail sales

0

5

10

15

20

00 01 02 03 04 05

% ch. from year earlierActual

6-mth moving average

Freight traffic

-20

-10

0

10

20

30

00 01 02 03 04 05

% ch. from year earlier

Actual

6-mth moving average

economics@

16

Monetary growth and inflation have slowed, but Monetary growth and inflation have slowed, but a mushrooming trade surplus will boost liquiditya mushrooming trade surplus will boost liquidity

Sources: China National Statistics Bureau;People’s Bank of China.

Money supply and bank lending

0

5

10

15

20

25

30

00 01 02 03 04 05

% ch. from year earlier

M2

Bank loans

Merchandise trade balanceProducer and consumer prices

-4-202468

10

00 01 02 03 04 05

% ch. from year earlier

Producer prices

Consumer prices

Exports and imports

0

10

20

30

40

50

00 01 02 03 04 05

% ch. from year earlier(6-mth moving avge)

Imports

Exports

0

10

20

30

40

50

60

00 01 02 03 04 05

US$bn (annual moving total)

economics@

17

Asian leading economic indicator also pointing to regional growth slowdown Asian leading economic indicator also pointing to Asian leading economic indicator also pointing to regional growth slowdown regional growth slowdown

-10

-5

0

5

10

15

20

00 01 02 03 04 05

% change from year earlierIndustrialproduction(excl. Japanand China)

Asian composite leadingindicator (6 mths forward)

East Asian IP and the composite leading indicator

l The Asian LEI is a weighted average of the LEIs published for Korea, Taiwan, Thailand and Malaysia – it leads the IP (ex China & Japan) cycle by around 6 months

l This LEI has declined in 8 of the past 9 months and is signalling a clear slowdown in growth during 2005

Sources: OECD; Datastream; Economics@ANZ.

Asian LEI – monthly changes

-1.5-1.0

-0.50.0

0.51.0

1.52.0

03 04 05

% change from previous month

economics@

18

East Asian trade flows are slowing, another pointer to slower overall economic growth East Asian trade flows are slowing, another East Asian trade flows are slowing, another pointer to slower overall economic growth pointer to slower overall economic growth

East Asian exports East Asian imports

Note: ‘East Asia’ excludes Japan.Sources: Datastream; Economics@ANZ.

-20

-10

0

10

20

30

40

00 01 02 03 04 05

% change from year earlier(3-mth moving average)

Total

Excluding China

-20

-10

0

10

20

30

40

00 01 02 03 04 05

% change from year earlier(3-mth moving average)

Total

Excluding China

economics@

19

Investor risk aversion has risen noticeably over the past six weeksInvestor risk aversion has risen noticeably over Investor risk aversion has risen noticeably over the past six weeksthe past six weeks

* Index of volatility of options on S&P500 index futures. Source: Datastream.

US S&P 500 index US 10-year bond yield

3.75

4.00

4.25

4.50

4.75

5.00

31-Dec

31-Mar

30-Jun

29-Sep

29-Dec

31-Mar

30-Jun

% pa

95

100

105

110

115

31-Dec

31-Mar

30-Jun

29-Sep

29-Dec

31-Mar

30-Jun

Re-based to 31 Dec 2003 = 100

VIX index*

1012141618202224

31-Dec

31-Mar

30-Jun

29-Sep

29-Dec

31-Mar

30-Jun

Index

US corporate bond spreads

100120140160180200220

31-Dec

31-Mar

30-Jun

29-Sep

29-Dec

31-Mar

30-Jun

Basis pointsBB over AAA

economics@

20

0.80

0.90

1.00

1.10

1.20

1.30

1.4000 01 02 03 04 05 06

US$ per € (inverted)

012345678

00 01 02 03 04 05 06

% pa

US

Euroarea

US$ may not be far from bottoming against the euro and other free floatersUS$ may not be far from bottoming against the US$ may not be far from bottoming against the euro and other free floaterseuro and other free floaters

Sources: Datastream; Economics@ANZ.

US and Euro 3-mth rates l The weakness in the US$ vs the euro has not been due to any compelling case for the euro on fundamental grounds, but rather to the US’ large and growing current account deficit and the low interest rates on offer to those willing to finance it

l US short rates ‘crossed over’ euro area rates in December for the first time in nearly 4 years

l The US-euro area 3-month interest rate spread will widen to over 200 bp by September, and 250 bp by March next year – which should make financing the US current account deficit easier

US dollar vs euroUS and Euro 3-mth rates

economics@

21

Australia’s economy has reached the point in the business cycle where things typically ‘go wrong’Australia’s economy has reached the point in the Australia’s economy has reached the point in the business cycle where things typically ‘go wrong’business cycle where things typically ‘go wrong’l The Australian economy has now reached the point in the

business cycle (no, it hasn’t been abolished) from which every recession in Australia’s post-war experience has sprung

l Output growth is now being impeded by capacity constraints, productivity growth has slowed sharply), demand is running at a substantially faster rate than supply, the current account deficit is widening rapidly, and anecdotal (though as yet not hard statistical) evidence of cost-price pressures is becoming more commonplace

l At this point in every previous business cycle, the Reserve Bank has waited too long to begin raising rates (because it has needed the permission of the Treasurer to do so), so that cost-price pressures have become more entrenched, ultimately requiring recession-inducing rate increases to control it

l For now, we’re saying ‘this time it will be different’ -– deregulation/privatization/internationalization of the economy

makes it less likely that cost-price pressures in a few sectors will spread rapidly across the entire economy

– the RBA no longer needs politicians’ permission to raise interest rates

economics@

22

Current account deficit the worst in over 40 years despite terms of trade being the best in 30 years Current account deficit the worst in over 40 years Current account deficit the worst in over 40 years despite terms of trade being the best in 30 years despite terms of trade being the best in 30 years

Current account balance

Current account deficit larger than 7% of GDP for first time

since 1952-53

Terms of trade more favourable than at any time since mid-1970s

commodities boom

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

60 65 70 75 80 85 90 95 00 05

% of GDP

Real

*The ‘terms of trade’ is the ratio of export to import prices. Source: Australian Bureau of Statistics.

Terms of trade*

80

90

100

110

120

130

140

60 65 70 75 80 85 90 95 00 05

2002-03 = 100

Real

economics@

23

0

100

200

300

400

500

600

700

US

Spain

UK

Australia

Italy

Turk

ey

Portu

gal

Hungary

Mexico

Gre

ece

NZ

US$ bn

Australia’s current account deficit is one of the largest in the worldAustralia’s current account deficit is one of the Australia’s current account deficit is one of the largest in the worldlargest in the world

Current account balances, 2004Current account balances, 2004Current account balances, 2004

In US$ billions

In absolute terms, Australia’s current account deficit was the 4th largest in the world in 2004 (or the 3rd

largest if the euro-zone is treated as a single entity)

Note: % of GDP chart refers to OECD countries only.Sources: IMF, World Economic Outlook April 2005; OECD Economic Outlook December 2004; Economics@ ANZ.

0

1

2

3

4

5

6

7

8

9

10

Hungary

Iceland

Czech

Rep

.

Australia

NZ

Portu

gal

Greece

US

Turk

ey

Spain

%

As a % of GDP

economics@

24

Financing Australia’s deficit has thus far been quite easy – largely because of our high rates Financing Australia’s deficit has thus far been Financing Australia’s deficit has thus far been quite easy quite easy –– largely because of our high rates largely because of our high rates

Source: ABS; US Bureau of Economic Analysis; Datastream; Economics@ANZ.

Government borrowing

0

1

2

3

4

5

6

7

8

9

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

% pa

Australia

US

90-day interest rates

Foreign investors receive a substantial interest rate

premium for the risks associated with financing

Australia’s current account deficit (though this is set to

narrow in 2005)

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

92 93 94 95 96 97 98 99 00 01 02 03 04 05

% of GDP (4-qtrmoving average)

Australia

US

economics@

25

0.45

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

01 02 03 04 05 060

50

100

150

200

250

300

350

400

450

500US¢Australia-US90-d interest

rate spread (right scale)

Basis points

A$-US$(left scale)

Interest rate spreads

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

01 02 03 04 05 0690

100

110

120

130

140

150

160

170

180US¢RBA US$ commodity

price index (right scale)

2002-03 = 100

A$-US$(left scale)

However financing the deficit is likely to become more difficult later this year and in 2006However financing the deficit is likely to become However financing the deficit is likely to become more difficult later this year and in 2006more difficult later this year and in 2006

Sources: Datastream; Economics@ANZ.

Commodity prices

Traditional ‘fundamentals’ and the A$Traditional ‘fundamentals’ and the A$

This spread willnarrow as US rates

rise more quickly than Australian rates

Commodity prices expected to

ease moderately during 2005-06

economics@

26

0.45

0.50

0.55

0.60

0.65

0.70

0.75

0.80

01 02 03 04 05

10

15

20

25

30

35

40

US¢

VIX index (right scale)

Index (inverted)

A$-US$(leftscale)

Any increase in ‘risk aversion’ on the part of global investors would also weaken the A$ Any increase in ‘risk aversion’ on the part of Any increase in ‘risk aversion’ on the part of global investors would also weaken the A$ global investors would also weaken the A$

Note: The VIX index is a measure of US stock market volatility based on prices of options on S&P500 futures. Sources: Datastream; Economics@ANZ.

Equity market volatility

0.45

0.50

0.55

0.60

0.65

0.70

0.75

0.80

01 02 03 04 05

50

100

150

200

250

300

US¢

Spread betweenyields on A-ratedcorporate and3-5 year US Treasury bonds(right scale)

Basis points (inverted)

A$-US$ (left scale)

Credit market spreads

Measures of investor risk aversion and the A$Measures of investor risk aversion and the A$

economics@

27

Despite the sharp fall in consumer sentiment in March, consumer spending seems to be OKDespite the sharp fall in consumer sentiment in Despite the sharp fall in consumer sentiment in March, consumer spending seems to be OKMarch, consumer spending seems to be OK

Sources: Westpac/Melbourne Institute; ABS; First Data International Australia.

Retail sales

Retail sales and cashcard index

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

03 04 05

% ch from previous month

Trend

02468

101214

01 02 03 04 05

% ch. from year earlier

Retail sales

Cashcard index

Consumer sentiment

80

90

100

110

120

130

00 01 02 03 04 05

Ratio of optimiststo pessimists (%)

ActualTrend

New motor vehicle sales

0.6

0.7

0.8

0.9

1.0

1.1

00 01 02 03 04 05

Millions (annual rate)

Actual

Trend

economics@

28

The slowdown in housing triggered by the late 2003 rate rises has clearly bottomed outThe slowdown in housing triggered by the late The slowdown in housing triggered by the late 2003 rate rises has clearly bottomed out2003 rate rises has clearly bottomed out

Housing finance commitments

23456789

00 01 02 03 04 05

$ bn per month Owner-occupiers*

Investors

Lower house prices are enticing 1st home buyers back into the

market

Local council approvals also bottoming out

Residential building approvals

100

120

140

160

180

200

00 01 02 03 04 05

'000s (annual rate)Actual

Trend

Bottoming out after

falling through

2004

1st home buyer finance

15

20

25

30

35

00 01 02 03 04 05

% of ex-refi total

* Excl. re-financing. Sources: ABS; Westpac/ Melbourne Institute; Economics@ANZ.

Home-buying sentiment

75

100

125

150

175

00 01 02 03 04 05

Ratio saying "good time" to saying "bad"

This series has been a good leading indicator of trends in house prices

economics@

29

The labour market has been incredibly strong for an economy that is supposedly slowingThe labour market has been incredibly strong for The labour market has been incredibly strong for an economy that is supposedly slowingan economy that is supposedly slowing

5.0

5.5

6.0

6.5

7.0

7.5

00 01 02 03 04 05

% of the labour force

Actual

Trend

Unemployment rate

8090

100110120130140150160

00 01 02 03 04 05

'000

Job vacancies

Employment

-40

-20

0

20

40

60

80

02 03 04 05

Change from previousmonth ('000s)

Actual

Trend

63.063.263.463.663.864.064.264.464.6

00 01 02 03 04 05

% of the labour force

Actual

Trend

Labor force participation rate

Lowest since Nov 1976

Highest in 26-year history of

this series

Recordhigh

Source: ABS.

economics@

30

So does the Reserve Bank’s decision to leave So does the Reserve Bank’s decision to leave rates on hold in April mean they’ve now peaked?rates on hold in April mean they’ve now peaked?

Why rates might have peaked

l The economy may already have peaked before the March rate increase – raising rates again would risk an unnecessary slowdown

l The sharp fall in consumer confidence following the March rate hike suggests that this move will have a significant impact on household spending

l Rising retail petrol prices are equivalent (in terms of their impact on discretionary spending) to a further rise in interest rates

l There’s still no convincing evidence that wage or price inflation have begun to rise, or will rise in the near future

Why at least one further rise is still more likely than not

l Demand is still expanding at a 4% pace, too fast for an economy in which the ‘supply side’ is increasingly being held back by capacity constraints

l The allegedly much greater sensitivity of household finances to interest rate increases has been much exaggerated, while the greatly diminished sensitivity of the corporate sector (and hence employment) to rate rises has been almost completely ignored

l The pending sharp decline in the A$ will turn import prices from a dampening influence on inflation to an additional source of price pressures

l Credit growth is still running well in excess of what the RBA regards as ‘sustainable’

We lean towards this view

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31

As the A$ turns around, import prices will cease to offset domestically generated cost pressuresAs the A$ turns around, import prices will cease to As the A$ turns around, import prices will cease to offset domestically generated cost pressuresoffset domestically generated cost pressures

Excluding GST impact in 2000-01.Sources: ABS; Economics@ANZ.

Producer prices

-15

-10

-5

0

5

10

97 98 99 00 01 02 03 04

% change fromyear earlier

Domesticallyproduced

Imported

Consumer prices*

-1

0

1

2

3

4

5

97 98 99 00 01 02 03 04

% change from year earlier

'Non-trade-ables'

'Tradeables'

l As a rough rule of thumb, every 10% (US 7½-8¢) rise (fall) in the A$ subtract (adds) about ½ pc pt from (to) inflation over the following year

l The rise in the A$ over the past two years has helped to keep ‘underlying’ inflation in the lower half of the Reserve Bank’s 2-3% target band

l However with the A$ set to fall by as much as 20% by end-2006, import prices will no longer be providing an offset to domestic cost pressures

l Domestic price pressures are expected to escalate gradually as firms seek to pass on higher materials and labour costs

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0

5

10

15

20

25

00 01 02 03 04 05 06

% change from year earlier over 3 mthsat annual-ized rate

0

5

10

15

20

00 01 02 03 04 05 06

% change from year earlierover 3 mths at

annualized rate

0

5

10

15

20

00 01 02 03 04 05 06

% change from year earlier

over 3 mths atannualized rate

0

5

10

15

20

25

00 01 02 03 04 05 06

% change from year earlier

* incl. securitizations

over 3 mths atannualized rate

Credit growth still exceeding what the Reserve Bank regards as a ‘sustainable’ paceCredit growth still exceeding what the Reserve Credit growth still exceeding what the Reserve Bank regards as a ‘sustainable’ paceBank regards as a ‘sustainable’ pace

Source: Reserve Bank of Australia;Economics@ANZ forecasts.

Housing credit*

Other personal credit

Business credit

Total credit

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4.0

4.5

5.0

5.5

6.0

6.5

01 02 03 04 05 06

% pa

90-day bill yield

Cash rate

Interest rates

It’s hard to believe the concerns raised in the RBA’s SoMP* have been allayed by one ¼ pt riseIt’s hard to believe the concerns raised in the It’s hard to believe the concerns raised in the RBA’s SoMPRBA’s SoMP** have been allayed by one ¼ pt risehave been allayed by one ¼ pt rise

* Statement on Monetary PolicySources: ABS; RBA; Economics@ANZ.

It’s hard to imagine a single ¼ pc pt

rate increase will fully alleviate all the

RBA’s concerns about risks to the inflation outlook

RBA inflationtarget band

0

1

2

3

4

5

6

7

01 02 03 04 05 06

% pa

Excluding GST and'volatile' items

'Headline'

Inflation is headed for the upper half of the Reserve Bank’s

2-3% target band

Inflation

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0

50

100

150

200

01 02 03 04 05 06

Basis pointsAustralia-US10 year

-100

-50

0

50

100

150

200 Basis points

90 days-10 years

Sense that there is only limited upside for short rates will see Australian bond spreads narrowSense that there is only limited upside for short Sense that there is only limited upside for short rates will see Australian bond spreads narrowrates will see Australian bond spreads narrow

Sources: Datastream; Economics@ANZ.

10-year yields Spreads

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

01 02 03 04 05 06

% pa

US

Australia

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-1

0

1

2

3

99 00 01 02 03 04 05 06-2

-1

0

1

2% ch. %

Output gap (RHS)

GDP (LHS)

NZ economic growth remained strong through end-2004 although a turning point may be closeNZ economic growth remained strong through NZ economic growth remained strong through endend--2004 although a turning point may be close2004 although a turning point may be close

Sources: Stats NZ, ANZ National Bank, NZIER

Economic growth & ‘output gap’

Capacity utilisation rate

• The December quarter GDP outturn was relatively benign at 0.4 percent (3.9 percent annual)

• Various one-off factors pushed the quarterly result lower and consequently, the March quarter outturn is expected to show some bounceback. Capacity utilisation remains just off its all-time highs

• However, even with expectations for a solid start to 2005, leading indicators suggest the economy is close to a turning point

82

84

86

88

90

92

94

87 90 93 96 99 02 05

%

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0

10

20

30

40

50

92 95 98 01 04 07-1

0

1

2

3

4

5net balance % ch. from yr earlierInflation

(RHS)

Pricing intentions (LHS)

0.5

1.01.5

2.0

2.5

3.03.5

4.0

95 98 01 04 07

%

RBNZ Scenario 1:Continued monentum with a

weaker exchange rate

CPI InflationANZ Forecasts

NZ inflationary pressures remain intenseNZ inflationary pressures remain intenseNZ inflationary pressures remain intense

Sources: Stats NZ, RBNZ, National Bank, ANZ National Bank

Inflation & pricing intentions

Inflation

• The combination of lower output in Q4 and strong employment growth raises the output gap, increasing inflationary pressures – as also evidenced by our quarterly business opinion survey

• Although the March quarter CPI rose 0.4%, below the expected 0.6%, this was largely due to a seasonal fall in air fares (which subtracted 0.3 pc pts from the overall result)

• Contributing further to inflation pressures in coming months is the recent depreciation of the NZ$, which will raise tradables prices and has the potential to send CPI inflation through the top of the 1 to 3 percent target band this year.

• Our forecasts put CPI inflation at 3¼ percent by the September quarter.

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4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

95 98 01 04 07

%

Average of models andrange of scenarios

90-day interest rate

Market Pricing

RBNZ monetary policy will remain in a restrictive stanceRBNZ monetary policy will remain in a RBNZ monetary policy will remain in a restrictive stancerestrictive stance

Sources: Reuters; ANZ National Bank

Seven models of interest rates• The movement in the CPI will

keep the RBNZ on tenterhooks over the coming six months. This will keep the risk profile for interest rates skewed upwards.

• However, the RBNZ will be reluctant to pull the interest rate trigger - largely because the economy is at a turning point and raising interest rates again risks slowing the economy further

• This view is consistent with various formal interest rate models and market pricing

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0.9

1.0

1.1

1.2

1.3

1.4

1.5

90 92 94 96 98 00 02 04 06

A$/NZ$

Average

Notwithstanding recent persistent NZ$ strength vs the A$ the kiwi is still expected to weakenNotwithstanding recent persistent NZ$ strength Notwithstanding recent persistent NZ$ strength vs the A$ the kiwi is still expected to weakenvs the A$ the kiwi is still expected to weaken

A$/NZ$

Sources: Reuters; ANZ National Bank forecasts

l A stronger US$ is expected to pull both the A$ and NZ$ lower over the remainder of 2005

l In the near term, the 125bp interest rate spread between NZ and Australia is expected to favour the NZ$ over the A$

l Over longer periods, the A$-NZ$ shows a strong tendency towards ‘mean reversion’

l Other factors arguing for a decline in the NZ$ vs A$ are -

– stronger growth in Australia than in NZ (though slower in both)

– continued widening in NZ’s current account deficit cf. some narrowing in Australia’s

– eventual narrowing in interest rate spread in favour of NZ as RBA lifts rates again and RBNZ begins to ease sooner

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0

4

8

12

16

00 01 02 03 04 05 06

% change from year earlier

0

3

6

9

12

15

00 01 02 03 04 05 06

% change from year earlier

02468

10121416

00 01 02 03 04 05 06

% change from year earlier

0

5

10

15

20

00 01 02 03 04 05 06

% change from year earlier

Higher interest rates and slowing economic growth will slow NZ credit growth over 2005-06Higher interest rates and slowing economic Higher interest rates and slowing economic growth will slow NZ credit growth over 2005growth will slow NZ credit growth over 2005--0606

Source: Reserve Bank of New Zealand;ANZ National Economics forecasts.

Housing credit*

Other personal credit

Business (incl. agriculture)credit

Total credit