already upbeat outlook for Hawaii's economy has improved during the first part
of the year. The housing market has been hot, and the visitor industry is poised
for another record year. Personal income figures for 2004 came in stronger than
expected, setting the stage for additional healthy gains this year. We continue
to expect gradual slowing of the economy as capacity constraints begin to bite.|
The year so far has seen a continuation of the broad strength experienced in 2004. Tourism has exceeded expectations in the first part of the year, and job growth remains buoyant. Among key developments are:
o Arrivals have been very strong, rising impressively over last year's very good performance. The mainland U.S. visitor count rose 13.3 percent in the first quarter. Japanese arrivals gained 11 percent over a weak first quarter in 2004. Overall arrivals, which include the various smaller markets as well, rose 12.3 percent in the first quarter. Total visitor days were up by a similar 11.8 percent.
o The biggest surprise in the first quarter was a huge surge in visitors to the Big Island. Hawaii County visitor arrivals surged ahead more than 25 percent, to their highest quarter ever. The opening of the Sheraton Keauhou Bay Resort in October 2004, with more than 500 rooms, played a role in these robust numbers, but Big Island tourism apparently also benefited from the very high occupancy rates on the other islands.
o Job growth also continues at a brisk pace. The number of non-farm payroll jobs rose by 2.8 percent in the first quarter. Employment (which includes self-employed persons) rose 2.4 percent in the first quarter, and surged ahead a surprising 5.6 percent on the Neighbor Islands. While it seems likely that the employment figures will be revised downward in the future, this nevertheless reinforces the very tight nature of the local labor market. The state's unemployment rate dropped to 2.8 percent in March, its lowest level since October 1991.
o The strongest job gains continue to be in construction and the transportation and utilities sectors. Trade and service areas are also strong.
o Real-income figures for the final quarter of the last year became available in April, and there were substantial upward revisions to previously released third-quarter data. There was a clear pattern of acceleration over the course of the year, with real (inflation-adjusted) personal income growth rising from a 2.5 percent pace at the beginning of 2004 to 4.7 percent in the fourth quarter.
o Finance, insurance and real estate income was adjusted up sharply for the third quarter and rose at a 10 percent inflation-adjusted rate in the fourth quarter. Accommodations and food service also saw substantial upward revision and grew at an 8- to 9-percent rate in the second half. Other service income was also adjusted upward. On the flip side, there were downward revisions to government employee and military earnings going back to 2002.
o The housing market is hot, hot, hot. In the first quarter, the median Oahu single-family home price hit $529,000, up 25 percent from the first quarter of 2004. Median prices have been rising at a better-than-20 percent rate for five quarters, and they have nearly doubled since the beginning of 2001. (Data from Prudential Locations Real Estate Sales & Research.) Volume remains strong, with the largest number of first-quarter sales (1,019) on record. Recent price gains have been even bigger on Kauai and the Big Island.
o The government fiscal condition continues to look very good. For the first nine months of the current fiscal year, General Fund revenues are running 15.5 percent above 2004 levels. Personal income tax revenues rose 17.2 percent and transient accommodation tax revenues grew by a healthy 9.2 percent during the same period. General excise and use taxes were up a strong 13.6 percent for the fiscal year through January, a reflection of strength in the broader economy.
o Oil prices have stayed at very high levels, and gasoline prices have been averaging at or above $2.50 per gallon statewide. Shelter costs are probably a bigger concern for Honolulu inflation going forward, as home prices continue to surge upward. Last year, the Honolulu CPI rose 3.3 percent.
Updated Forecast for 2005-2006
The first-quarter surge in visitors demonstrates that even in a period of high occupancy there is room for additional growth. Together with the recent strong growth in income and employment, this leads us to upgrade somewhat our forecast for the Hawaii economy for 2005. A continuation of healthy growth is expected in 2006, although labor and capacity constraints are evident.
The external environment looks fundamentally sound, although the outlook for Japan has softened somewhat. Data for the fourth quarter showed only anemic growth in Japan, and data revision indicated that the economy passed through a recession mid-year. A portion of the reduced growth estimates can be attributed to a statistical change from fixed-weight to chain-weighted price indexes, but there is no denying that growth has weakened. Notwithstanding a surprise pickup in preliminary data for the first quarter, we now expect only a modest 1.3 percent growth in real Gross Domestic Product for the year as a whole, strengthening to 2.4 percent in 2006.
At the same time, the yen is expected to remain strong, helping to bolster Japanese purchasing power in the islands. Indeed, first-quarter Japanese arrivals rose a healthy 11 percent statewide, in line with our previous forecast. Moderate improvement of the Japanese economy and the strong yen should be sufficient to support a continuation of the market's recovery.
Our outlook for the U.S. economy continues to see growth in the 3.4- to 3.5-percent range for the next two years, just at or below potential output growth for the American economy. Notwithstanding risks from further oil price increases, this should provide adequate support for a continued vigorous U.S. visitor demand in the Islands.
The very strong first-quarter visitor performance appears to have carried over into the spring. The year-on-year numbers for the second quarter will not look quite as impressive, since last year's second quarter was an excellent period, but we continue to see evidence of substantial year-on-year growth for both domestic and international visitors. With every sign of a very good summer on the way, we now expect overall visitor arrivals growth to approach 7 percent for the year as a whole. U.S. arrivals will rise 6.4 percent, and Japanese arrivals will rise 8.4 percent.
It remains the case that occupancy rates are now very high by historical standards, and so gradual slowing of expansion must occur over the next several years. We expect U.S. arrivals growth to decelerate to just under 1 percent annual growth in 2006. Japanese arrivals will slow to 3.6 percent in 2006. Occupancy rates will remain in the 78- to 79-percent range.
There is no respite in sight for the extremely tight labor market. In-migration will occur, but labor constraints will cause gradual slowing of job growth over the next few years. This year will see a 2.2 percent gain in jobs, declining to 1.6 percent in 2006. On the basis of recent gains, employment (which includes self-employed persons) will also post a 2.2 percent rise this year before decelerating. We now believe that Hawaii's unemployment rate, which dropped to 2.8 percent in March, will remain at or near this low level for the next year or two, before edging up as hiring rates slow and labor-force participation rises.
The residential real estate cycle is becoming a bit more worrisome with every month of 20 percent-plus year-on-year price increases. Where two years ago we were celebrating the positive wealth effects of higher home prices, today we are somewhat more concerned about speculative behavior and adverse effects on the cost of living. We continue to believe that the market will cool over the next couple of years as the effects of declining affordability and (eventually) higher interest rates are felt. Barring a sharp price correction, however, housing construction will continue to be a healthy sector.
Areas of strong job and income growth in 2005 will be construction (6.7 percent growth expected), wholesale and retail trade (2.6 percent), health-care (up 2.9 percent) and other service areas (up 2.3 percent). Accommodations and food services will expand by 2.5 percent. The finance, insurance and real estate sectors will see slower 1.7 percent growth. Reflecting recent losses, we expect government jobs for the year to decline 0.5 percent.
We noted above that income growth accelerated as 2004 progressed, and the resulting high starting point for 2005 will result in about 3 percent growth in real income this year. Income growth will slow to 2.3 percent in 2006.
The pickup in inflation will only gradually abate. While with luck oil prices may have seen their highest levels of the year, there is still plenty of room for pass-through of high home prices to housing costs. We expect inflation to peak at 4 percent this year and remain above 3.5 percent in 2006.
Concluding Remarks and Forecast Risks
The Hawaii economy looks to be on firm footing. In some respects, it is over-performing. Visitor arrivals continue to post impressive year-on-year gains, and employment growth actually strengthened over the course of last year. Construction activity remains strong and housing prices are soaring.
These influences are generating robust growth this year, and there is no indication of marked slowing heading into 2006. Still, the constraints to growth that we have mentioned in the past are now clearly evident. With occupancy rates near record levels, tourism growth must slow, even if a high level of activity is sustained. With the aggregate unemployment rate below 3 percent, there is only so much more room for additional job gains. Local firms will need to compete more aggressively for workers and labor costs will edge up, particularly for skilled laborers.
We are less concerned than some observers by the risk of a housing price bubble. Even with their recent gains, housing prices relative to an affordability benchmark are nowhere near as high as they were in 1990 at the peak of the Japanese-driven bubble here. Rising housing costs are more likely to cause a gradual slowing of construction activity than an abrupt market correction. Of more concern is the impact on the cost of living for households of modest means.
The biggest risk at present appears to be higher inflation related to high oil prices. Even if energy prices have now peaked, housing costs are still surging upward. Labor costs are certain to pick up as well. Based on the behavior of Hawaii prices over past business cycle expansions, there is some risk that inflation will exceed our forecast by as much as a percentage point. Higher-than-expected inflation could cut into real-income gains and further aggravate affordability concerns in an otherwise healthy local economy.
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