Services sector recovery could be stung by rising interest rates, strong currency, BNZ says

New Zealand's services sector was "significantly more optimistic" in November than it was a year ago, although prospects of better times ahead come with a sting in the tail in the form of rising interest rates, BNZ head of research Stephen Toplis said following the release of the BNZ Capital-Business NZ Performance of Services Index (PSI). The PSI recorded a score of 56.0 in November, indicating an expansion of activity in the sector from an October PSI of 49.9. A PSI above 50 represents an expansion of activity, while a score below 50 represents contraction. Business NZ CEO Phil O'Reilly said the pick-up in activity during November did not come as a complete surprise, as the PSI is not yet seasonally adjusted. However, the PSI was still at its highest level since November 2007 (62.6), and up from a contractionary 47.3 a year ago.

"Whether the data is broken down by sub-index, region or size of business, there is a consistent message of expansion across the board with levels not seen in many categories since late 2007/early 2008. The sub-indices of activity/sales and new orders/business continue to dominate the extent of expansion, as the traditional Christmas rush for orders and sales occurs due to customers wanting tasks completed by the end of the year," O'Reilly said. Toplis noted that the services sector had become, in aggregate, "unequivocally upbeat about the future". The PSI, along with its sister PMI (Performance of Manufacturing Index) series, were consistent with BNZ's expectation of the economy growing 2.5% during 2010, Toplis said. However, Toplis quickly moved to warn of a "potentially very nasty sting in the tail" by way of rising interest rates. A strengthening economy, coupled with rising interest rates, tends to be associated with a rising currency, Toplis said, and this would be capped off by a cash-constrained government turning off its fiscal stimulus:

The resurgence in the PSI is consistent with other domestic leading indicators (including the sister series the PMI) and significantly improved hope for global economic activity. They are also consistent with our own expectation that the economy grows 2.5% in calendar 2010 and 3.4% in 2011. While this is all good news, and we don't want to pour cold water on Christmas cheer, we warn that the prospect of better times comes with a potentially very nasty sting in the tail. That sting comes by way of rising interest rates. The prospect of this was clearly laid out in last week's December Monetary Policy Statement in which the Reserve Bank cautioned that the time for higher interest rates is fast approaching. Just three months ago the RBNZ had said there would be no rate hikes until December 2010 at the earliest. Now it is intimating June is the most likely starting point with April, or even March, well within the realm of possibilities. ...As if all this wasn't bad enough a strengthening economy coupled with rising interest rates tends to be associated with a stronger currency. The New Zealand dollar's upward response to last week's monetary policy statement is symptomatic of this. In aggregate, then, monetary conditions will be tightening and, in turn, constraining economic activity. To cap things off, a cash-constrained Government will also be turning off its fiscal stimulus further restricting the economy's growth path. In our opinion, these developments are not to be feared. In fact, to an extent, they are to be welcomed with open arms. After all, interest rates and the currency will only be forced higher if the economy is on the improve. Another recession, in contrast, would see both fall but would hardly be considered as the optimal outcome.

Here is the release from Business NZ:

The service sector is showing solid activity as Christmas approaches, according to the BNZ Capital - Business NZ Performance of Services Index (PSI). The PSI for November stood at 56.0, 6.1 points up from October, and the highest level of activity since November 2007. In comparison with previous years, the November result was 8.7 points up from November 2008, but 6.6 points down from 2007. A PSI reading above 50.0 indicates that the service sector is generally expanding; below 50.0 that it is declining. The average PSI value for 2007 was 58.1, while for 2008 it was 49.1. So far for 2009, the average score has been 48.3. Business NZ chief executive Phil O'Reilly said the pick-up in activity does not come as a complete surprise, given the survey is not yet at the stage of taking out seasonal factors. However, the make-up of the lift is encouraging. "Whether the data is broken down by sub-index, region or size of business, there is a consistent message of expansion across the board with levels not seen in many categories since late 2007/early 2008. The sub-indices of activity/sales and new orders/business continue to dominate the extent of expansion, as the traditional Christmas rush for orders and sales occurs due to customers wanting tasks completed by the end of the year. "On the negative side, comments from some respondents continue to focus on key phrases such as "˜recession', lack of demand' and "˜smaller margins'. There are still many businesses that will experience another quiet Christmas like 2008 and can only hope that 2010 will bring better fortunes with improving consumer confidence translating into increased sales." Bank of New Zealand's Head of Research, Stephen Toplis, said that "Businesses have every justification to be guardedly optimistic going into calendar 2010. The PSI is consistent with the BNZ's own view that the economy will expand 2.5% through 2010." However, he warns that "such growth is likely to be accompanied by rising interest rates and further upward pressure on the NZD so businesses would be well advised to adopt conservative debt and foreign exchange rate management tactics." The current month was the first time since February 2008 that all sub-indices were in expansion mode. The two major contributors to the increase in overall activity came from a 10.3 point lift in activity/sales (58.7) and an 8.5 point lift in new orders/business (61.1). Employment (51.2) continued to edge up higher, while stocks/inventories (50.6) and deliveries (54.3) recorded their highest values since November 2008 and November 2007 respectively. Activity was positive for all four main regions during November, with the Otago/Southland region (59.4) leading the way with its highest results since February 2008. This was closely followed by the Central region (59.3), which had broken free of a tight band of results during the previous three months. The Canterbury/Westland region (56.0) continued to build on previous results, while the Northern region (54.8) returned to similar expansion levels experienced in September.