New Zealand Markets 13 August 2001

New Zealand Markets 13 August 2001

NZD: The Desk View

- The break of 0.4220 was confirmed as the NZD rapidly moved up to 0.4272. Only the AUD capitulation stopped it from breaking higher.

- Our thoughts are that in absence of any data this week (excluding FPI), the NZD will grind higher into Wednesday’s RBNZ MPS.

- There is now important support at 0.4220 and then at 0.4140. Resistance is now up around 0.4290 with major resistance at 0.4320.

- The US dollar is still looking weak against most currencies and we expect this to continue. This week, the US prints retail, confidence and CPI data.

- At one point the NZD/AUD appreciated to 0.8320 last week. At those levels we think it was well overdone and we would not expect to see those levels again for some time to come.

One week range: 0.4140/0.4290

One month range: 0.4000/0.4320

New Zealand Exchange Rate Forecasts

13 Aug 3M 6M 12M

NZD/USD 0.4255 0.44 0.46 0.48

Source: Deutsche Bank

NZD/USD and NZD/AUD - Last 2 Weeks

Source: DB Global Markets Research

Fixed Interest

- The RBNZ is expected to leave the Official Cash Rate (OCR) at 5.75% this week. However, we think the Bank will conclude that the near-term risks to the growth and inflation outlook are weighted to the downside.

- We continue to favour the trade of buying the Dec01 contract against the Mar 02 contract. Confirmation that the RBNZ retains only a modest easing bias should underline the expectation that the OCR/Fed funds spread is heading to 225bps and possibly wider.

- The rally in US Treasuries and the sharp labour market inspired rally in ACGBs saw NZGB’s along for the ride, with yields falling to our 3mth target.

- We think the fundamental pressure on spreads is still for them to widen further. However, a sustained upturn in the NZD (downturn in the USD) could see reasonable investment flows into NZ, preventing interest rate spreads from widening as much as expected. We think the possibility of such a development is something that investors should be aware of.

New Zealand Interest Rate Forecasts

13 Aug 3M 6M 12M

Official Cash Rate 5.75 5.75 5.75 6.25

10 Y Bond Yield (11/11) 6.47 6.50 6.75 7.25

Source: Deutsche Bank

90 Day Bills and 10Y Bond Rate - Last 2 Weeks

Source: DB Global Markets Research

Dollar Bloc Economic Diary

Mon 13 August Aus RBA Quarterly Statement on Monetary Policy

NZ Food Price Index (Jul) [DB 0.0% mom/5.5% yoy; market 0.2% mom/5.7% yoy; previous 0.8% mom/5.7% yoy]

Tue 14 August US Retail Sales (Jul) [DB -0.1% mom; market -0.3% mom; previous 0.2% mom]

US Retail Sales ex autos (Jul) [DB 0.2% mom; market 0.1% mom; previous -0.2% mom]

Aus NAB Business Survey (Jul) [Previous: Conditions -3]

Wed 15 August US Business Inventories (Jun) [DB -0.6% mom; market -0.2% mom; previous 0.0% mom]

US Industrial Production (Jul) [DB -0.3% mom; market -0.3% mom; previous -0.7% mom]

US Capacity Utilisation (Jul) [DB 76.5%; market 76.5%; previous 77.0%]

Aus Wage Cost Index (Jun Qtr) [DB; 0.6% qoq/3.7% yoy; previous 1.0% qoq/3.7% yoy]

Aus Westpac Melbourne Institute Leading Index (Aug) [Previous: 4.1% ann.]

NZ Monetary Policy Statement and Official Cash Rate Review [DB expects no change, OCR to remain at 5.75%; market expects no change]

Thu 16 August US CPI (Jul) [DB 0.2% mom; market -0.1% mom; previous 0.2% mom]

US CPI (core) (Jul) [DB 0.2% mom; market 0.1% mom; previous 0.3% mom]

US Housing Starts (Jul) [DB 1650m; market 1628m; previous 1658m]

US Building Permits (Jul) [DB 1575m; previous 1587]

US Philly Fed Survey (Aug) [DB -5.0; market -8.5; previous -12.2]

Aus AWOTE (May Qtr) [DB 1.1% qoq/4.2% yoy; previous 0.8% qoq/4.6% yoy]

Aus RBA Bulletin (Aug) [Table H4 to show any intervention in FX markets]

Aus International Merchandise Imports (Jul) [DB AUD10.1 bn; previous AUD9.5 bn]

Fri 17 August US International Trade (Jun) [DB -USD30.0bn; market -USD29.8bn; previous-USD28.3bn]

US Michigan Consumer Sentiment (prelim) (Aug) [DB 91.0; market 93.0; previous 92.4]

NZ Balance of Payments (year ended March 2001) [Current estimate; -NZD5.3bn ann.]

NZ International Investment Position (as at 31 March 2001) [Current estimate; -NZD86.5bn]

Local data releases: The key event this week is the RBNZ Monetary Policy Statement and OCR Review. As the data has emerged (see article below), the consensus has gradually shifted from a 50% chance of easing towards our view that the RBNZ would refrain from easing further at this juncture. That said, a rate cut cannot be ruled out - we assess the probability of an easing to be 20%. At the very least, we expect the RBNZ to continue to note the presence of risks to the global economy and the possibility that lower rates may be needed if signs emerge that the domestic economy is running out of steam. In other data this week, lower fruit and vegetable prices are expected to offset rises elsewhere in the July Food Price Index, especially for general grocery foods, leading to a flat result overall. The week closes with annual revisions to Balance of Payments and International Investment Income data for the year to March 2001. Given earlier revisions, these are likely to be minor and, therefore, attract little market interest.

International Themes

United States: Although the stock market viewed last week’s news with dismay, we see enough reason for hope that we are maintaining our forecast of modest growth in H2. One more Fed rate cut this month seems assured, and with growth then beginning to show signs of picking up, that should end the easing cycle. We acknowledge the possibility of another “insurance” rate cut this fall, but think that any appreciable further easing would likely come only if some of the downside risks to our baseline forecast materialize. Corporate bond spreads have narrowed dramatically relative to Treasuries, reflecting more sanguine views of credit risks. However, a widening in high-yield spreads from April to early June suggested some concern among investors that the second-half economic rebound would prove meager. Those concerns have not dissipated, but spreads have narrowed considerably recently in what appears to have been a tendency for refugees from the stock market to reach for yield in the fixed-income sector.

Euroland: According to the August Monthly Bulletin the ECB sees more risks with growth but remains concerned with money supply. The question is, which factor will prevail? German GDP figures on August 23 will be the next important data to watch, followed by M3 data at the end of the month. If the growth numbers are in negative territory and M3 growth slows, we might see a 25bp rate cut in August.

Australia: The monthly employment data again indicated a large fall in hours worked, with the decline in hours worked now near recession levels. This implies that, outside of the export sector and leading housing indicators, the Australian economy continued to struggle in Q2-01. Combined with a global environment that continues to deteriorate this suggests to us that the RBA will retain a strong easing bias. Despite this the RBA’s quarterly monetary policy statement (released 11.30am AEST Monday) is likely to reiterate, and even strengthen, the previous statement’s position that expansionary policy settings, and signs of domestic recovery, means that any near term easing is unlikely. Such a strong “on-hold” statement is likely to be seen as “hawkish” relative to current market pricing.

Commentary: Domestic data bolsters case for no cut in the OCR this week

The RBNZ faces a dilemma. On the one hand, the domestic economy shows unmistakable signs of strengthening from a starting point where the economy is already operating at, if not beyond, its sustainable capacity. This was further emphasised by last week’s key economic data:

- Retail sales volumes rose 1.3% in Q2, a little stronger than the median market expectation, following a 1.5% qoq surge in Q1. As we have argued for some time, household spending was always likely to benefit from a combination of robust consumer confidence, strong growth in employment, rising wage settlements, rapid growth in farm incomes, lower interest rates and a gradual recovery in the housing market.

- The previous week’s stronger than expected Quarterly Employment Survey was confirmed By the Household Labour Force Survey, supporting our contention that GDP growth has rebounded sharply in Q2 following a flat Q1. The HLFS indicated a 0.9% qoq rise in employment and a 0.3% qoq rise in hours worked. The unemployment rate fell to a fresh 13 year low of 5.2%. The latest ANZ survey showed job ads rising to yet a new record high in July, suggesting that the momentum of employment growth has carried over into Q3.

However, on the other hand, aside from in Australia, global data remains very mixed and the forecast recovery remains just that - a forecast. This poses potential downside risks to economic activity and inflation at some point in the future. According to the most recent issue of Consensus Forecasts, New Zealand’s 14 largest trading partners will report (trade weighted) growth of just 2.0% in 2001, down 0.3pps from the previous month’s expectations, reflecting sharp downward revisions to growth prospects in Asia and Europe. Growth expectations for 2002 have been revised down to 3.3% yoy from 3.2% yoy previously. Growth in non-primary exports has also remained disappointing, hampered by cutbacks in global capital spending, thus failing to alleviate the concerns raised by the RBNZ in its 4 July statement. Given that Australia is the key destination for New Zealand’s manufactured exports, it is possible that non-primary export growth will record a lift over coming months, even as overall trading partner growth slows. If so, this will help to reinforce a buoyant commodity sector that continues to benefit from increased volumes and prices that, although having eased slightly over the past two months, remain at levels that are quite atypical for this stage of the global cycle

On balance, we think that the RBNZ will give greater weight to the concrete evidence from strong domestic data and the consequent inflation risks, and therefore refrain from easing further on 15 August. With two further opportunities available this year to shift rates downward if needed, we see little imperative to ease policy at this point. We think that the chance of a further 25bps cut on 15 August is now around 20%, with the latest Dow Jones survey indicating that no market economists now expect a cut (half had expected a cut just a fortnight ago). While concerns about the global economy will likely dominate the Bank’s risk assessment, upside inflation risks due to rapid growth in unit labour costs should receive greater attention in the Monetary Policy Statement.

Retail Volumes and Consumer Confidence Employment and Unemployment Rate

Source: DB Global Markets Research, Statistics NZ, Colmar Brunton Source: DB Global Markets Research, Statistics NZ