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OFFICIAL CASH RATE & WESTPAC COMMENTARY

REVIEW DATES
2011

Retail sales volumes fell 0.4% in the
December quarter, a slightly larger
drop than we expected. Excluding the
auto-related sectors, sales were flat
for a second quarter in a row, ending
a five-quarter growth streak since the
recession officially ended in June 2009.

While there are some caveats to this
survey that we'll discuss shortly, it tells
the general tale of the consumer over
the course of last year. The recovery in
activity stalled in the middle part of 2010;
employment prospects dimmed, and
house values began to fall again as tax
changes reduced the benefits of property
investment. With no income growth or
perceived wealth increases to speak of,
households reined in their spending
accordingly.

Part of the December quarter decline can
be chalked up to one-off factors. First, the
increase in GST on 1 October saw some
purchases of big-ticket items - furniture,
electrical goods, hardware and vehicles
- pulled forward into September, with a
consequent dip in sales in the following
months. The second factor was a drop
in spending in the Canterbury region
following the September earthquake.

The regional breakdown suggests that
spending in the region was running
behind the rest of the country for the
quarter as a whole, although it was
stronger in the December month, which
might reflect replacements of damaged
household items.

Partly offsetting the weakness in bigticket
purchases, there was a 1.9% rise in
supermarkets and grocery stores, and a
2.3% rise in clothing. Recreational goods
(of which books make up about a fifth)
saw a 0.8% rise in volumes. Auto-related
spending was weaker on balance, with a
6.4% rise in fuel volumes but an 8.2% drop
in vehicles and parts.

There's a keen interest at the moment as
to whether the economy contracted again
in Q4, fulfilling the technical condition for
a "double dip recession" in the second half
of last year. The retail figures certainly
won't hurt the case, although we can't
take them entirely at face value. The retail
survey was overhauled in October, leading
to some dramatic changes in its coverage
and history - for example, the 0.7% rise
in Q3 sales volumes under the old survey
design has become a 0.4% decline under
the new one. However, the retail
component of GDP will still be based
off the old survey design for a while
longer.

A look through the details suggests
that, if anything, measured spending
may have been even weaker under
the old design. But at least part of
that could be due to reclassification
to and from other sectors such as
manufacturing, wholesale trade and
services - we won't get the indicators
for these sectors until early March.
We'll hold fire on our GDP forecasts
for now, but we are looking at weakly
positive growth at best for Q4.

On the subject of sectoral indicators, the
Business NZ manufacturing PMI suggested
that the pickup in activity in Q4 gathered
a little more pace in January. The overall
index rose to 53.7 (a reading above 50
indicates growth), the highest reading
since June last year. By region, Canterbury
has been in mild contraction since the
September earthquake, but the other main
centres reported faster growth.

Producer prices saw relatively small gains
in the December quarter, a break from the
strong gains through the rest of 2010 and
in contrast to the growing price pressures
that have been evident in the Northern
Hemisphere. However, in New Zealand
at least, producer prices are not really a
precursor of domestic inflation pressures
- the index is heavily weighted towards
dairy products and other commodities
that are produced here and exported.

The small 0.2% rise in output prices
largely reflected a 6% fall in prices
received by dairy processors. That in
turn was the result of price contracts that
were agreed around the middle of 2010,
when world dairy prices were temporarily
weaker. We calculate that this will only
affect the December quarter, and will be
a similar-sized drag on the terms of trade
(to be published on 1 March). That said,
we still expect a small gain in the overall
terms of trade, thanks to a mix of higher
prices for other commodity exports and
lower prices for manufactured imports.

The outlook for dairy export earnings in
2011 has continued to brighten. Dairy
prices in Fonterra's fortnightly auctions
rose on average by 11% through February,
reaching the highest levels since March
2008. Global prices are being squeezed
higher by a mix of rising demand in
emerging markets and limited growth
in supply - New Zealand's production of
milksolids is running slightly behind last
season, and drought has affected feed
costs in other parts of the world.
This week's data calendar is fairly low-key,
although we will be watching the RBNZ's
survey of inflation expectations (Tues).

With annual inflation now officially above
4% as a result of one-off government
policy changes, and rising food and fuel
prices increasingly on people's minds,
this is probably the first time that their
perceptions of inflation will really be
put to the test. However, the RBNZ's
real concern will be whether any rise in
inflation expectations can be translated
into action; the large degree of spare
capacity in the economy right now should
give it some comfort on that front.
Fixed vs. floating: The RBNZ's more
cautious stance suggests that floating
rates will remain on hold for several more
months. Fixed-term rates could rise in
that time, but only if there is a substantial
turnaround in sentiment on the global
economy. As a result, there is no urgency
to fix right now.

Key Data Previews

Source Brendan O'Donovan Westpac Weekley Commentary 21 February 2011