The activity of the services sector is falling – a threat to GDP in the second quarter

A long-running study shows that activity in New Zealand’s services sector, which accounts for about two-thirds of the country’s GDP, has fallen sharply.

BNZ – BusinessNZ Services Performance Index (PSI)which has been ongoing since 2007, saw the lowest level of activity since the month of the non-Covid-19 lockdown.

An index level below 50 means the contracting services sector, above 50 means its development. The latest monthly score was 43, down about 3.6 points over the month.

This is further evidence that the Reserve Bank’s efforts to tamp down inflation are really starting to have a lethal effect on the economy.

While March quarter GDP results are due this week and it is a toss-up whether they will show a contracting or (slightly) growing economy, this reading of the services sector index potentially carries a very bad prognosis for the June quarter GDP result, which will end in less than two weeks.

“It’s weak and then it’s very weak,” said BNZ senior economist Doug Steel.

He said the index’s latest reading is lower than the low of 44.9 reached during the global financial crisis.

“This shows the reverse momentum of the services sector,” Steel said. He said the latest index reading “extends the rapid decline from February’s approximately 52.4.”

“The speed of the decline is as concerning as the magnitude of the decline over the past three months.”

BusinessNZ chief executive Kirk Hope said May’s result “was as bad as it can get for the sector”, reaching a level of decline worse than during the 2008-09 global financial crisis.

Steel reported that all major service performance (PSI) components declined this month. This puts them all further back and “well below average.”

“Business/Sales was a total weak spot in May at 40.9. That’s a massive 13.6 index points below the long-term norm, a comparison only bettered by the new orders/business index, which has fallen to 42.6 and about 14.5 index points below normal. Demand has dropped,” he said.

“Most industries are in retreat, with the retail PSI of 33.8 the weakest of all and the lowest on record for May. As one PSI respondent put it, there was a “sudden drop in sales” and a “significant drop in average order size.” Another noted, “Market redirection of products that customers buy. Lower value products are in higher demand.”

“This sentiment is consistent with last week’s sentiment data on electronic card transactions for May. Seasonally adjusted data showed that the value of retail transactions decreased by 1.1% m/m, compared to a decrease of 2.6% a year earlier. The average transaction value was 2.2% lower than a year earlier,” Steel said.

He said all this points to a “downside risk” to GDP in the second quarter.

Steel said the combination of the “very weak” PSI and last week’s “soft” PSI Manufacturing index performance produces a composite indicator “that shows GDP falling by more than many would believe.”

“Even if this week’s Q1 GDP numbers are close to zero, as we believe on an annualized basis, the PSI and PMI indicators suggest a bigger downside than we already predict for Q2.

“They raise the risk of much weaker annual GDP growth in the second quarter than that published in the RBNZ’s May MPS (monetary policy statement),” Steel said. The RBNZ forecasts that GDP will grow by 0.1% in the June quarter.

“New Zealand’s PSI and PMI also appear weak compared to other countries. Indeed, both local rates are lower than their counterparts in the main comparators we look at in Australia, China, Europe, Japan, the UK and the US,” Steel said.