Strong economy sees first signs of slowing
Prospects for the Hawaii economy continue to look very good for the remainder of the year. A slow start for tourism and limited airline capacity through the summer make us a bit less optimistic than before about the annual visitor numbers. At the same time, 2005 job growth was revised upward and that strength has carried over into 2006. As expected, there are now signs that slowing has begun to occur, particularly in Neighbor Island economies. In the face of a very tight labor market, further slowing is expected over the next several years.
Hawaii’s Recent Economic Performance
Visitor arrivals were weaker than expected in the first quarter of the year. The mainland U.S. visitor count rose by just 0.5 percent, partly reflecting the shift of the Easter holiday from March of last year to April of this year. More worrying, Japanese visitor arrivals fell 7.5 percent, accelerating a decline that began in the second half of 2005. Overall arrivals, which include the various smaller markets, declined by 0.5 percent in the first quarter. With some strengthening of the length of stay, total visitor days rose a scant 0.2 percent.
Not surprisingly, Oahu suffered the most from the dismal Japanese arrivals; Oahu arrivals fell 3.5 percent from a year earlier. All Neighbor Islands saw positive growth. Visitors to Kauai were up 8.8 percent, while Maui and the Big Island saw 4.5 percent and 4.1 percent growth, respectively.
|Hawaii Economic Indicators
(Annual Growth Rates by Percent)
|U.S. Visitor Arrivals||7.3||7.0||3.1||1.8|
|Japan Visitor Arrivals||10.6||2.7||0.5||1.5|
|Inflation Rate, Honolulu MSA*||3.3||3.8||3.8||3.2|
|Real Personal Income||4.6||3.1||3.0||2.2|
|*level of series
source: uhero. figures for 2006 and 2007 are forecast
Job growth continues at a very brisk pace. Figures for 2005 were revised upward to 3.2
percent growth, compared with 2.8 percent growth in 2004. The number of non-farm payroll jobs rose a solid 3.5 percent in the first quarter of this year. Employment (which includes self-employed persons) surged ahead 3.7 percent in the first quarter. The state’s unemployment rate remained at a very low 2.6 percent, seasonally adjusted rate in March.
The strongest job gains continue to be seen in construction and the transportation and utilities sectors. There was moderate acceleration of job growth in trade, accommodations and food services, and real estate and renting sectors in the first quarter. Unfortunately, because of changes in state data reporting, we do not yet have any job figures at the county level for 2006.
Unlike jobs, there was a clear pattern of slowing in income growth over the past year. Real (inflation-adjusted) personal income growth slowed from a 5.4 percent pace at the beginning of 2005 to 0.7 percent in the fourth quarter. This brought real income growth for the year to 3.1 percent, considerably slower than the 4.5 percent seen in 2004. Considering the strong job growth, it is likely that this figure will be revised upward.
Construction saw stellar real income growth of 19 percent in 2005, part of this due to expanding employment and part due to rising pay rates. Transportation and warehousing real income grew by 9 percent over the same period. Administrative and waste service, health care and social assistance, and professional and technical services all saw robust growth above 5 percent. Other major sectors (retail trade, real estate and rental and leasing, accommodation and food services) grew by more than 4 percent.
Housing market activity continues at a high level, but with some signs of cooling. The median Oahu single-family home price stood at $626,000 in the first quarter, up 19 percent from the first quarter of 2005. This compares with an average price gain of 28 percent in 2005. The volume of resales on Oahu slowed significantly, falling more than 10 percent in the fourth quarter of last year and about 3 percent in the first quarter of this year. Maui saw a large, 21 percent decline in resales in the fourth quarter, with significant declines also on Kaua‘i and the Big Island. (Information courtesy of the Honolulu Board of Realtors and Prudential Locations Real Estate Sales & Research.)
The government fiscal condition continues to be robust, although the pace of revenue growth is slowing. General Fund revenues rose 6 percent in the first quarter of this calendar year, compared with a 15 percent growth in 2005. Individual income taxes have slowed the most, from about 25 percent growth in the first half of last year to 5.1 percent growth during the first quarter of this year.
The Honolulu Consumer Price Index (CPI) rose 4.5 percent in the second half of 2005, accelerating from 3.3 percent in the first half of the year. Core inflation (all items less food and energy) rose 3.5 percent over the same period, up from 2.5 percent in the first half of 2005. More than half of measured inflation came from shelter cost increases. Fuel prices, while rising nearly 18 percent from the previous year, contributed a much smaller amount to inflation, because fuels represent a relatively small share of the total spending of a typical Honolulu household.
The UHERO Hawaii Forecast
Conditions continue to look favorable in the key external economies that underpin Hawaii’s economic activity. U.S. real GDP grew at an annual rate of 4.8 percent in the first quarter of 2006, rebounding from a slow fourth quarter. Spending continued at a fairly healthy pace in April, although much of this was due to higher spending on gasoline. The labor market created fewer jobs in April than expected, but the unemployment rate remained unchanged at 4.7 percent.
The national housing market is cooling. In March, permits fell 6 percent and starts fell 8 percent. Permits, starts, existing-home sales and new-home sales are all below the peaks they attained last year. Rates on 30-year, fixed-rate mortgages have risen almost half a percentage point since January.
Inflation and uncertainty about the Federal Reserve’s response continue to be concerns. Inflationary pressure intensified in the first quarter, with consumer prices increasing at a seasonally adjusted annual rate of 4.3 percent. This compares with an increase of 3.4 percent for all of 2005. With the recent surge in oil prices and high capacity utilization rates, inflation risks have clearly increased. This raises the prospect of continuing Fed interest-rate increases, which could put a damper on spending.
All in all, the overall outlook for the U.S. economy remains sound. We expect growth to slow from the strong first quarter number, so that annual growth will come in a bit lower than we have seen over the past two years. After expanding by 3.5 percent last year, we expect the U.S. economy to grow by 3.2 percent this year, and 3.1 percent in 2007.
Japan’s economy slowed somewhat in the first quarter of the year. Real GDP expanded at an annual rate of 1.9 percent, following 5.4 percent growth in the fourth quarter of 2005. Private demand was fairly strong, but a cut in public investment restrained growth.
|U.S. Visitor Arrivals|
Forward-looking indicators continue to send a positive signal. Both capacity use and employment conditions as perceived by firms continued to tighten in the March Tankan survey. Japanese consumer sentiment is also improving. This suggests that consumption will continue to support economic growth in the months ahead.
There are now more encouraging signs of price recovery. The inflation rate was positive for each of the first three months of the year. In March, the general inflation rate was 0.3 percent and the core inflation rate was 0.5 percent.
Reacting to the more widespread evidence of economic health and signs that deflation may be finally ending, the Bank of Japan decided in March to end its quantitative easing policy. While interest rates have not yet been raised, this sends a signal that the zero-interest-rate era may be ending.
In sum, we believe that Japan’s economy is well-positioned to continue its current expansion. After 2.7 percent real GDP growth in 2005, we expect 3 percent growth this year. Growth will slow to 2 percent in 2007, as the business cycle expansion matures.
While external conditions remain favorable, we now expect somewhat weaker Hawaii visitor arrival growth than we forecast earlier in the year. In part this reflects the weak first quarter, but also limited airline capacity over the next several months. According to the state of Hawaii Department of Business, Economic Development and Tourism (DBEDT), scheduled air seats for the May to July period are up just 0.4 percent from a year ago; they are down 14 percent on flights from Japan.
As a result, we now expect 2.8 percent overall visitor arrival growth this year. U.S. mainland arrivals will grow by 3.1 percent, and Japanese arrivals will be essentially flat, rising 0.5 percent. U.S. visitor growth will be 1.8 percent in 2007, and Japanese arrivals will be about 1.5 percent. There will be somewhat stronger growth in the non-Japanese international category, so overall arrivals will expand by about 2 percent in 2007.
With still-healthy tourism numbers and little near-term capacity growth, occupancy rates will remain high, in the 80-percent range statewide. A number of visitor projects are expected to add to the room stock over the medium term, primarily in timeshares and condo hotels.
Given the tight capacity and rising tourism prices, we expect to see some additional decline in the length of stay. As a result, the number of visitor days will grow a bit more slowly than visitor arrivals, about 1 percent per year.
|Japanese Visitor Arrivals|
All in all, the visitor picture continues to look very positive. While additional growth in visitors will be slower than in recent years, tight conditions will support further gains in hotel room rates and overall visitor-industry revenues.
The local labor market has continued to tighten in recent months. The statewide unemployment rate last year was 2.8 percent, and it averaged 2.5 percent for the first quarter of 2006. Unemployment rates are low in all four counties, and there is anecdotal evidence that the actual rate in some communities is even lower than this. Labor shortages are now the talk in most industries.
With the unemployment rate approaching the 2.4 percent seen at the height of the 1980s Japanese bubble, labor constraints will act to slow growth going forward. Job slowing is already evident in Neighbor Island economies. Between 2004 and 2005, job growth on Maui slowed from 3.9 percent to 3.1 percent; on Kauai it slowed from 3.8 percent to 2.9 percent. Oahu and the Big Island have not yet shown significant slowing, but that is sure to come.
Notwithstanding the strong job growth reported in the first quarter, we expect a decline from last year’s 3.2 percent job growth to 2.5 percent this year and 1.3 percent in 2007. The statewide unemployment rate will remain at or below 2.5 percent for the next two years.
The recent fall in residential resales and slowing of home price gains are consistent with a maturing housing market. Declining affordability and higher interest rates will lead to further cooling over the next several years.
As the housing market cools, residential construction will also slow. We do not expect a significant downturn in activity, however, and military renovation projects will play a supportive role. The commercial side may also contribute, now that office vacancy rates have fallen and industrial space is extremely tight.
While the construction job growth trend is heading downward, the year has started off very strong, and we expect almost 8 percent growth for the year. This compares with about 14 percent job growth in 2005. Construction job growth will remain above average in 2007, before dropping further as the cycle closes in on its peak.
|U.S. vs. Honolulu Inflation|
Above-average job growth will also be seen in the retail and wholesale trade sector, and in the “other services” category, which includes business, administrative and professional services. We now expect a significant drop in agriculture this year, on top of a sharp downward revision of 2005 agriculture jobs. Further declines are expected, as the Del Monte layoffs occur. State and local government jobs will continue to be anemic.
We expect 2006 real (inflation-adjusted) income growth in the construction sector to be about 11 percent, following 19 percent growth in 2005. Total real income of all Hawaii residents will expand by 3 percent in 2006, with slowing to 2.2 percent in 2007.
Housing costs drove the acceleration in inflation that occurred in the second half of last year, and further feed-through of home price appreciation may yet occur. The spring surge in energy prices and the continuing labor market tightening reinforce inflation concerns. We do not yet see evidence to merit raising our inflation forecast, although this will bear careful watching in coming months. For now, we continue to forecast local inflation of 3.8 percent this year, and inflation remaining above 3 percent in 2007.
The state forecast continues to look very positive, but with clearer evidence now that slowing is beginning to occur. The greatest risks to the local economy are potential disruptions to growth in the external economy. With persistent high energy prices and accelerating U.S. inflation, it is now likely that the Federal Reserve will continue to raise interest rates in coming months. As always, this runs the risk of overreaction and a sharper-than-anticipated slowing of consumer and business spending.
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