New Zealand’s terms of trade rose 1.3% in the second quarter.
This was against market and our expectations of a reasonable fall.
Despite being a sizeable upside surprise on the day, we would not overstate its significance.
The terms of trade is the ratio of export prices to import prices.
A lot of the surprise, to us at least, was higher export prices in the quarter.
But it looks to be more an issue of timing than substance.
Export prices rose 2.1% in the quarter, underpinned by a 6.0% increase in dairy prices.
The latter appears to be associated with a short and sharp dairy price spike earlier in the year, which rapidly reversed course over the following months.
That unwind will show up in the terms of trade statistics in the third quarter and, to a lesser extent in the fourth quarter.
Purchasing power down
This is despite the positive bounce in the mid-August dairy auction and the decent follow up gain we expect in the next auction.
While we are constructive on dairy prices over the year ahead from their current very low levels, any gains, if they indeed occur and are sustained, will only fully show up in the statistics in 2016.
Despite the quarterly jump, export prices overall were 8.1% lower than a year ago. A lower terms of trade represents a reduction in the nation’s purchasing power.
That is clear on the export side. Lower prices equal lower incomes. But the reduction in purchasing power over the past year is not only confined to exporters.
A lower terms of trade is often associated with a weakening currency.
That has certainly been the case this time around with the New Zealand Dollar down 15% over the past year or so on a TWI basis, including a full 44% against the generally stronger US Dollar. While a lower New Zealand currency helps support exports, it also adds general upwards pressure to import prices.
Higher import prices are a drag on domestic purchasing power. Import prices did rise 0.7% in Q2, but were still 3.9% lower than a year ago.
The annual decline more than accounted for by the massive drop in international oil prices over that period.
We remain of the view that the terms of trade will deteriorate into year’s end.
Rapidly eroding business and consumer confidence over recent months add support to the idea that the terms of trade is weakening into the second half of 2015 after its first half fillip.
They also add to the case to nudge interest rates lower.
Looking into 2016 we anticipate both export and import prices to rise, as the lagged effects of a lower New Zealand Dollar filter through (and international commodity prices find some support). This is important from an inflation perspective.
The general economic support and inflationary pulse that the lower currency offers is one reason we are a bit cautious in how far the Reserve Bank of New Zealand (RBNZ) may actually cut the Official Cash Rate (OCR).
We should not get too downbeat on the terms of trade either.
Even if our weak second half 2015 story pans out, the index would still be only 12% down from what was a 41 year high in the middle of 2014.
The ongoing, and broadening, strength in residential property prices is another reason for the central bank to be at least a little cautious on cutting the OCR aggressively.
Today’s QV data is the latest to not only affirm strong annual house price inflation, at 11.3% y/y on this measure, but also the growing tendency of house prices to be inflating outside of Auckland and Canterbury.
Take Hamilton for example. Its annual house price inflation picked up to 10.3% in August, based on a 5.7% increase over the last three months alone. This is all the more interesting given Hamilton is the capital of Waikato, an area overweight the (distressed) dairy industry.
Such Auckland spill-over effects are probably being encouraged by investor money beginning to tilt away from Auckland (where investors are becoming subject to a 30% deposit minimum, essentially up from the 20% minimum that’s been in place since late 2013).
With this, there are signs the Auckland market may be losing some of its fervour, although it is not yet conclusive in the anecdote. And certainly not from the latest QVNZ numbers, which had Auckland’s house price inflation up to 20.4%, from 18.8% in July.
South goes north
What we can probably say with some confidence now is that housing price pressures in Canterbury have largely peaked. This is as high home-building activity begins to get on top of the big supply squeeze, post quakes. Not only are home prices broadly flattening off, even easing a bit, but rents are following a similar pattern.
But when we step back, and add it all up, we have to wonder what has changed over recent months to have given house price inflation such a further nudge, overall, especially with increasing talk of recession risk?
Lowering lows in interest rates would seem to fit the bill.
Stephen Toplis is Head of Research at BNZ, the Title Sponsor of the Indian Newslink Indian Business Awards 2015 and Sponsor of the ‘Best Large Business’ and ‘Supreme Business of the Year.’