NZ QUARTERLY ECONOMIC REPORT
[from an email - no link]
After the rush
Wednesday, March 24, 2004 _______________________________________________________________
SUMMARY
* The NZ economy is coming to the end of a strong multi-factor demand phase
* A phase that has left local economic resources stretched
* A lower growth rate is expected over the next year or two
NZ is on a sustainable growth trend of around 3% p.a. But, as always, cyclical factors will apply. In any five-year period the probability of a recession is over 50%. A recession is not forecast for 2005 but it is this risk that is becoming greater. At the very least the NZ economy and the banking sector appear about to enter a year or two of below average growth. No one event has occurred to bring a possible recession closer but rather the growth phase is coming up against resource constraints and imbalances have developed.
At the same time there are mixed and changing demand influences:
* Global economic growth is improving and is creating greater demand in some sectors of the economy (e.g. tourism, dairy, our two largest export sectors);
* But a higher NZ dollar is also putting pressure on local competitiveness and exporters' incomes;
* And a global slowdown is a distinct possibility beyond 2004, especially given the debt levels in a number of countries;
* Locally, net immigration is slowing but will likely
stabilise after a 1-2 year transition period (to new residency approval rules);
* Interest rates are rising and will face upward pressure from similar moves offshore in the next year or two;
* And fiscal policy will be loosened over 2004-2006.
In other words, the strong local demand push resulting from,
in chronological order, higher export incomes, higher immigration, and lower interest rates is changing into what is hoped to be a more balanced demand structure. This is yet to be tested.
As usual, the NZ dollar is likely to have a strong influence
on the economy and on interest rates. The upward trend is probably not complete yet - this will both dampen growth prospects for 2005 and 2006 and cap any Reserve Bank of New Zealand (RBNZ) rate hikes.
However a return to average exchange rates (and probably
lower) is expected over 2005 and 2006 as the US dollar
rebounds from what are already low levels and as the widening NZ current account deficit impacts. This depreciation, in turn, will set the export sector up for a brighter period in the second half of a 5-year forecast horizon.
It may well also trigger an inflation rate breach of the 3% upper limit, hence reducing the RBNZ's ability to ease in the face of slower growth.
INTERNATIONAL ECONOMIES
* Global growth moving from explosive stage to more modest but hopefully more balanced phase
* US dollar probably faces more downside pressure but now near sustainable levels
Growth in a number of economies has recently picked up, following recessions in 2001. The IMF, for one, predicts a period of relatively high global growth over the next few years. The initial growth phase is marked by two sources of strong demand: from the US and from China. In both economies the explosive stage of the growth phase has probably passed. The issue now is whether these economies can kick on with high growth in light of imbalances that have emerged. And whether other economies can accelerate to bring more balance to the global growth phase. This presents a number of challenges and raises the uncertainty around growth rates in 2005 and beyond.
* The US economy accelerated sharply in 2003.
* Forecasters, on average, put the growth rate at or above 4% p.a. for each of the four quarters of 2004 (and around 3% p.a. beyond that).
* But there are some worrying aspects to the current growth phase - it is heavily dependent on fiscal and monetary stimuli and hence debt.
* 2005 could prove difficult as these stimuli are unwound (especially after the Nov-04 elections).
* Activity has picked up lately in the other two major economies but 2004 growth rates are expected to be modest.
* A moderate 3% p.a. growth rate is, on average, forecast for Australia.
* Meanwhile China is growing at a breakneck 8% p.a. and more (India slightly less).
* This is creating considerable demand pressure in some
markets (e.g. oil, coal, shipping).
* And also considerable supply competitiveness in other
sectors (e.g. textiles).
* Again, though, cracks are emerging and recent policy has aimed to dampen growth slightly, particularly in the face of rising food prices.
* Less explosive US and Chinese demand growth should, in general, cap commodity prices.
* Although each market will differ (dairy prices are probably already near a peak due the potential for greater supply).
* Tied in with higher commodity prices has been the weaker US dollar (down 26% since a early 2002 peak in trade-weighted terms).
* The decline should be seen in the context of the rapid USD appreciation of the late 1990s - the USD has now returned to earlier levels.
* The widening US current account deficit has created the supply of dollars, low interest rates has dampened the demand. There are hints of both changing but it appears some months before either trend is convincing.
* On balance the forces suggest the USD will probably stop depreciating in the next 12 months, but the subsequent appreciation will probably be moderate (relative to the
decline) and, in the meantime, the USD remains prone to over-shooting (i.e. falls to fresh lows).
THE NEW ZEALAND ECONOMY
* Local growth rate decelerating as various demand impulses pass
* A gathering fiscal impulse will help but tight local resources could prove the constraint
The key themes for the NZ economy appear to be the changing demand factors including the removal of growth impulses (most recently migration and soon interest rates as well), the emergence of negative demand forces (lower export incomes and potentially migration) but a large fiscal impulse to come, all set in the environment of very tight resource markets.
* The rate of net immigration peaked last year (net permanent
& long-term arrivals +42,000 in May 03/04 year or 1.1% of the population, plus an excess of short-term arrivals).
* Net PLT arrivals are likely to be around 10-20,000 in the next couple of years.
* Still a net inflow (unlike in 70s, 80s and 90s).
* But, at the margin, the lower number does reduce demand pressure in the housing market.
* At a time that supply is increasing rapidly.
* A period of flat house prices (on average) and declining dwelling construction (down around 10-15% after a 55% rise over 2 years) is envisaged. This would reduce GDP by 1% over a couple of years.
Export incomes are also declining. The lower dairy payout predicted for the May 04/05 year alone will probably knock $500m off local demand (0.4% of GDP).Some offset to these demand checks will come from a loosening of fiscal policy (including Budget 2004). There are large uncommitted funds forecast and both Labour and National have advocated policies that would see these surpluses reduce.
However the ultimate constraint is likely to come from a lack of resources, an issue that will manifest itself as higher wages and prices.
At present the inflation rate is well within the 1-3% p.a. average target. But the present modest headline rate conceals the dichotomous influences at work.
Tightness in local input markets - including labour - is showing as rising prices for non-tradable sector goods and services, a situation to persist well into 2005. Falling prices in the currency-exposed tradable sector is providing a large offsetting influence but this could disappear should, as expected, the NZ dollar depreciate during 2005. There is a significant probability that the inflation rate will breach the 3% upper target.
INTEREST RATES AND EXCHANGE RATES
* Modest NZ interest rate increases this year
* Prospect for lower rates next year to be limited by a
falling NZ dollar by then
Interest rates are responding in large to two forces:
* a gradual decline in level, as low inflation - and with it the threat of deflation - become more the norm;
* and movements up and down as near-term inflationary risks alter.
The second force should show as higher interest rates globally in the next two years as monetary stimuli are unwound in light of higher global growth.
The first force should show as a lower peak to interest rates in this cycle (including a NZ OCR peak below 8%) and probably a lower NZ (and Australian) low during the next severe recession (OCR as low as 3%).
* On average, a cash rate centred on 5.75% is forecast over
the next 5 years (near the mid point of current estimates of the neutral rate).
* The forecast 90-day profile (see opposite and below) is relatively flat, reflecting the mixed forces that are likely (rising NZ dollar limiting RBNZ hikes this year, high CPI and falling NZD limiting easings in 2005-2006). Undoubtedly further shocks will exaggerate moves in either/both directions.
* In the near-term the combination of a difficult-to-stop spending momentum and strong domestic inflationary pressures is expected to prompt 2-3 more cash rate hikes this year.
* Longer-term yields are expected to follow a similar
near-term profile but with the major driving force being, as usual, changes offshore.
* US bond yields are expected to return to around 5% this
year. NZ rates should follow.
* Albeit at a more gradual pace, evident as a narrowing of the NZ-US 10-year bond yield premium to earlier levels of 1%.
* But the US bond trend are also expected to remain choppy. In particular doubts are likely to be raised about US growth in 2005 and 2006, which could see bond yields decline again. On average local bond yields should average 6% over the next few years.
The NZ dollar will continue to evolve on the basis of USD direction, AUD direction and local asset prices. The current appreciation is seen as largely cyclical on all three fronts - a return to the post-float averages of 56c (US) and 81c (Aust) is expected, probably over 2005 and 2006.
In the meantime further USD weakness (see p2) could see the
NZD over 70c again while an RBNZ tightening bias is likely to see the NZD/AUD remain near 90c for some months. |
