Surging income growth in the export sector is driving the NZ economy onto a respectable growth path – one that we think will be sustained over the next few years as consumer spending and business investment join in.
Growing pressures on inflation will keep the RBNZ working towards normalising monetary policy settings, while high export commodity prices and a directionless USD support our view of a higher NZD by year-end.
Recent data shows that New Zealand’s economic recovery has continued at a steady but unspectacular pace.
GDP expanded by 0.6% in the March quarter, softer than the 0.9% recorded in the December 2009 quarter, but broadly in line with forecasters’ expectations.
A two-speed economy is now clearly evident: global demand for commodities and Australian demand for manufactured goods is leading a surge in goods exports while stagnant real wages and the soft housing market have resulted in weak growth in most of the service industries, including a 0.8% fall in retail trade.
Still, a year after the recession officially ended, GDP has expanded by almost 2%. That is about average compared to the major recessions in New Zealand’s post-war history.
Growth typically accelerates in the second year after a recession, and we think that’s achievable this time as the recovery becomes more broad-based.
Our forecasts see GDP growing by close to 3% in calendar 2010, with exports leading the charge. In calendar 2011, we expect growth to accelerate to an above trend pace of 4.4%, as strong income growth brings consumers out of hibernation and a solid investment cycle (both residential and business) gets under way.
Thereafter, we forecast growth to ease back toward 3.5%.
The risks to this view are many and varied. Internationally, European sovereign debt woes and talk of a double-dip in global growth are key sources of concern.
Back home, the major sticking points centre around the weakness in the housing market and ability of the consumer to pick up the pace of spending when faced with falling house prices and high household debt.
As was widely expected, the RBNZ was confident enough in the recovery’s progress to begin lifting interest rates in June, and quickly followed that up with a further 0.25% increase in July.
The accompanying Statements by the RBNZ have made it clear that these hikes are the first in what will likely be an extended tightening cycle.
Indeed, the interest rate projections in June Monetary Policy Statement were consistent with the cash rate rising to 5.5-6.0% over the next couple of years. And, while the July Statement was a little less emphatic about the pace and extent of tightening (implying that the end point may be lower and/or there could be some pauses along the way), our view remains that the RBNZ will continue to work its way towards a peak in the OCR of 6% by early 2012.
The key reason for an extended tightening cycle is that underlying inflation pressures are gathering momentum along with the rest of the economy.
Annual inflation is expected to peak at 5.2% in the middle of next year, with a range of government charges – e.g. GST, the Emissions Trading Scheme – adding 2.8 percentage points to the annual rate at their peak.
The RBNZ is able to look through the direct impact of these charges, and is assuming that the pass-through into wage and price setting behaviour over the medium term will be minimal.
But excluding these charges, underlying inflation is still expected to return to the upper region of the 1-3% target range by next year – and that’s even under the assumption of an extended series of rate hikes.
The escalation of concerns around sovereign debt in Europe and the emergence of fears over a double-dip in global growth, sent markets into a panic through late April early May, with sharp declines in equity markets, commodity prices and risk currencies such as the NZD.
A renewed financial crisis would undoubtedly undermine global investor confidence, de-rail the global recovery, and hit our commodity prices and the NZD hard.
However, we put low odds on such an outcome.
As such, we continue to see the New Zealand dollar rising through this year, reaching around USD0.74 by year end and around 0.76 in early 2011.
Our expectation of a stronger US dollar through the remainder of 2011 will see the NZD ease back slightly later in that year.
