The RBNZ has recently sent the Government a friend request, noting there's scope for fiscal policy to support the economy and the RBNZ's inflation and employment objectives. In the past, when monetary conditions are tightening, fiscal policy has been constrained by the consideration that any extra stimulus will likely end up being crowded out by higher-than-otherwise interest rates. But now, the OCR is low and going lower, the economy isn't firing on all cylinders, inflation pressures appear contained and poised to wane, and the Government has the firepower to lend a hand. So should the Government do a little more to help keep monetary policy in conventional territory? Or should it keep its powder dry just in case one of those nasty tail-end risks to the economy materialise? We think a little more wouldn't hurt, and that the Government is likely to reach the same conclusion, meaning some additional fiscal stimulus is one of the few upside risks to the outlook at present.
The QSBO survey for Q3 was very weak, adding downside risk to even our subdued growth forecasts. So what is going on? Global growth is clearly cooling, but New Zealand has been largely shielded so far - at least our commodity prices have been. But tourism is feeling it, as is business sentiment, and that's starting to hurt investment and employment. And export intentions indicate trouble. Net migration estimates are holding up, but we see some risk it could be revised lower - meaning lower net migration might have been a bigger part of slowing growth than is currently recognised. What about the supply side? Domestically, firms are still concerned about capacity constraints, but there are signs that this is easing, with some indicators suggesting labour is becoming less difficult to find and weaker demand is becoming a greater issue. Amidst all this, the household sector is still holding up. But if they seriously retrench, it's game over.
30 September 2019:Dead or just sleeping? (PDF 552kB)
Last week the RBNZ held the OCR at 1% and noted that there is scope for more cuts if necessary. The RBNZ also stated that low long-term interest rates reflect low expected inflation well into the future. Indeed they do. But what if the RBNZ (and us, and everyone else) is wrong and the story of the next decade is sharply higher inflation? This week, we explore a tail risk that no one is talking about. There are several potential catalysts for a return to a high inflation, low growth world: oil price shocks, tariffs and protectionism, or climate change. These ‘supply shocks’ could have a potent impact if they cause a rise in inflation expectations. Global central banks’ independence is steadily eroding – could the commitment to inflation targeting come into question? Our forecasts – everyone’s forecasts – are based on the status quo. But the status quo is coming under pressure.
This week we expect the RBNZ to leave the OCR on hold as it waits to see the impact of its actions so far, but by November we think they'll be cutting again. "Lower for longer" is our forecast, and most other forecasters are broadly on the same page, though not yet calling the OCR as low as we are (just 0.25% by May next year). But retail interest rates and wholesale interest rates are not the same thing, and they do not always move together, as we learned in the Global Financial Crisis. There are plausible scenarios around both global risk appetite and bank capital requirements that could see at least some retail interest rates rise, even if the economy fails to bounce back. Broad agreement amongst forecasters that the OCR is going to be low for a long time does not mean there is no upside risk to the interest rate borrowers face.
We recently revised our forecasts for the OCR to a new record low of just 0.25% by May next year. The single most important driver of this change is a downgrade to the outlook for growth in the second half this year, with the biggest revision being to business investment. But it isn't all doom and gloom by any means - parts of the economy are doing just fine. The issue is that the RBNZ needs the economy to run hot, not in the kind of spluttering fashion we expect. There are still solid supports out there which we expect will see the growth rate modestly pick up next year. But with inflation under target and inflation expectations slipping, the RBNZ will conclude it can't afford to be patient.
We now expect the OCR to hit 0.25% by mid-next year, and with the global outlook shaky, a negative OCR certainly can't be ruled out. This week we look at some of the international experiences with negative interest rates to glean insights into what it would mean. The good news for households is that they are unlikely to be directly exposed to negative interest rates on their savings accounts. But banks and cash-rich businesses do bear the costs. Ever-lower policy rates don't always mean lower lending rates, and it isn't clear that negative interest rates will be successful in boosting inflation expectations. Negative rates also severely disrupt the normal workings of the banking system. So while a negative OCR is an option in the RBNZ's toolbox, we're not at all convinced that it should be deployed.
As a small open economy, New Zealand is at the whim of global forces. Recently, the global growth outlook has deteriorated further and trade tensions have escalated dramatically. We step through three key channels which New Zealand has been impacted through; trade, financial markets, and uncertainty. So far, tourist numbers are weaker but our exports and commodity prices have been shielded by continued demand for soft commodities and favourable supply factors. The NZD is doing its job and global financial conditions are looking more fragile, but are still a tailwind. But elevated global uncertainty seems to be weighing on domestic firms' sentiment, investment and employment. Overall, the risks are all looking pretty one sided.
The OCR has already been cut 75bp this year to 1.00%. We expect a further cut to 0.75% in November, with the risks being skewed towards sooner and/or more. But there are signs that the OCR is already losing a degree of traction on bank lending and deposit rates - one of the key channels through which monetary policy affects the economy. Diminishing pass-through to bank funding costs/deposit rates (and hence lending rates) adds to the risk that interest rates in New Zealand may already be approaching the effective lower bound in terms of their impact on mortgage and other borrowing interest rates, though not via other important channels such as the exchange rate.
Aging demographics are going to pose significant challenges in the decades ahead, for New Zealand and the global economy. Favourable demographics have been a tailwind for the global economy since the 1970s, as baby boomers transitioned through the workforce. But now, the tide has turned. In some economies, the change is going to be significant - in China in particular. Looking ahead, an aging population globally implies lower GDP growth rates, lower interest rates, and greater debt burdens. In this new world, central banks need to prepare for what happens when policy rates hit zero (if they haven't already), and governments need to prepare for the fiscal burden of greater health and superannuation costs.
Last week was packed full of surprises. Globally, China allowed the yuan to depreciate through 7 to the USD, trade tensions rose, and global markets fell sharply. Amid the financial market turmoil, we added another 25bp cut for September to our forecasts, implying an OCR of 0.75% by year-end. Meanwhile, the Q2 unemployment rate unexpectedly dropped from 4.2% to 3.9%. Then came the RBNZ; they decided to load our August and September 25bp cuts into one big 50bp hit in August, cutting the OCR to 1% and signalling that it could go even lower. We still expect a November cut to take the OCR to 0.75%, but note that September remains live with this pre-emptive Committee at the helm.
It's all action this week with Q2 labour market statistics and the RBNZ's August MPS in the spotlight. We round up some of the key developments that the RBNZ will have to consider, and it's not looking pretty. The global growth outlook has worsened, overseas central banks have eased policy (putting upward pressure on the NZD), commodity prices have softened, the outlook for domestic growth has weakened, unemployment looks likely to increase, and inflation expectations are at risk of slipping further. We expect the RBNZ to cut the OCR to a new record low of 1.25% on Wednesday, and signal that an even lower OCR is likely needed.
New Zealand's trading partner growth has slowed over the past year or so. While goods exports have so far proven resilient, there are a few signs that this weakness is weighing on services exports, particularly international tourist arrivals (especially from China and Europe). However, before we go sounding too downbeat, it's important to note that capacity constraints are a factor too. Transitioning from volume-driven growth towards greater value-add is something the sector was going to have to do at some point. So long as downside tail risks to the global outlook don't materialise (spooking foreign households), international tourism should be able to weather softer global growth, particularly at the higher (less price-sensitive) end of the spectrum.
CPI inflation in the second quarter offered no surprises, coming in bang on ANZ and RBNZ expectations. But the outlook for domestic inflation is bleak, with renewed slack in the economy set to drive annual non-tradable inflation lower. And the recent dip in inflation expectations poses a key risk to the inflation outlook. While we estimate that inflation expectations will stabilise around the target midpoint of 2%, we would expect the RBNZ to react aggressively were surveyed inflation expectations to start to slide from here, so it's worth keeping an eye on this data.
Yiel22d curve inversion (long-term interest rates lower than short-term ones) is often touted as a possible precursor to economic recession. The US Federal Reserve assesses the probability of a recession using this indicator, and as at 30 June this was implying that the chance of a recession occurring in the US economy over the next 12 months is 33%. However, how much this indicator should be trusted is hotly debated. It's got a great track record, but there have been lots of weird things going on in interest rates and monetary policy this decade that may have invalidated it. Here in New Zealand, its track record isn't so good, so we aren't reading too much into the inversion that has also been seen here. But clearly there are expectations of interest rates being lower for longer. This will stimulate the economy, but as interest rates get ever lower, the offsets get stronger, including the negative impact on savers and bank margins, impacting credit availability. We expect it'll take a couple more cuts before the RBNZ is comfortable with the medium-term inflation outlook.
Global manufacturing has been under pressure for a while now as slowing global trade (on the back of US-China trade woes and waning US fiscal stimulus) has weighed on demand. While New Zealand’s export commodity prices have held up, our ex-food manufacturing sector has slowed alongside the wider domestic economy, suggesting New Zealand’s experience may not be so different. Indeed, last week’s Quarterly Survey of Business Opinion suggests slowing manufacturing activity (and the wider economy for that matter) has persisted into Q2, and that this may now be leading to reduced headcount in the sector – and hence a possible (but likely small, so far) spillover into household incomes. This week brings a scattering of monthly data releases, with a few partial Q2 CPI indicators (June food prices, rents, and our Monthly Inflation Gauge), our Truckometer, cards transactions (which isn’t very useful data), the June PMI and possibly REINZ housing market data.
The global economic outlook has deteriorated over time, but the global monetary policy landscape has changed more abruptly, with further stimulus signalled by key central banks including the US Fed. Global bond yields have dropped dramatically, and local yields have gone with them. This is an important context for the RBNZ's dovish OCR Review last week, in which they said more OCR cuts were "likely". Although the RBNZ sets the OCR for New Zealand conditions, the importance of interest rate differentials for the NZD means that what other central banks are up to matters. But that doesn't mean we need to keep pace 1:1. The RBA has more immediate work to do than the RBNZ; ANZ is forecasting policy rate cuts tomorrow and August there, whereas we expect the RBNZ to cut in August and November. We also expect two cuts from the US Fed in the second half of this year.
With the OCR at just 1.5%, it's time to acknowledge that if things were to take a decisive turn for the worse, we could end up following in the footsteps of central banks overseas, with negative interest rates and/or quantitative easing. It is far from a given that going down this path would be necessary - or wise. Fiscal policy and the NZD would be expected to do the heavy lifting. And the effectiveness of such policies abroad is debateable, with real costs and risks. But if unconventional monetary policy is risky, doing it on the fly would be riskier still, so it's time to plan ahead. This week brings the Reserve Bank OCR Review. While the domestic data has evolved broadly in line with their forecasts, the global picture has turned sourer and other central banks have turned decisively with it. How these two factors will be weighed up is uncertain. We expect a more dovish tone but stopping short of promising further cuts, but we can't rule out the RBNZ will elect to follow the crowd rather than risk upward pressure on the NZD.
Q1 GDP is out this week, so what better time to discuss the broader economic outlook? For the record, we expect economic activity expanded 0.4% q/q in Q1, which would see annual growth slow 0.1%pt to 2.2%. But even if Q1 growth surprises on the upside, it won’t change the broader theme that economic momentum is waning and that core inflation is still not quite where it needs to be. To rectify this, and given growth headwinds aren’t expected to dissipate anytime soon, we think a little extra monetary stimulus is likely to be delivered by year-end. As well as GDP this week also brings Q1 balance of payments data, which we expect to show a stable current account deficit as a share of GDP. Our Monthly Inflation Gauge for May is out today, and there’s another dairy auction on Wednesday.
The OCR, at 1.5%, is now at a record low. The RBNZ’s pre-emptive cut has been effective in easing financial conditions in New Zealand via both a lower NZD and a drop in lending rates. While this will provide a tailwind to growth, other headwinds are evident. Businesses are reluctant to spend and invest, the residential construction outlook is looking increasingly precarious, and global growth is faltering. There is also a risk that financial conditions could tighten sharply over the next year. We think that more OCR cuts will be needed to ease financial conditions further and ensure that monetary policy supports a gradual recovery in growth, inflation, and employment.
Last week was busy. The Reserve Bank’s Financial Stability Report (FSR) was released, the first Wellbeing Budget made its debut, and ANZ’s Business Outlook and consumer confidence surveys were out. “Resilience” was the theme of the week. The FSR argued the financial system was resilient but more work needed to be done given still-elevated risks. The Budget maintained a focus on fiscal resilience in anticipation of a rainy day, while boosting spending with a broader focus on what matters. Only the Business Outlook arguably didn’t rise to the occasion, with businesses seemingly not feeling very resilient at all. Global markets aren’t feeling too robust either, with a stampede for the relative safety of bonds seeing global yields fall, including here in New Zealand, where the 10-year bond yield hit record lows.
It’s Budget week. The Government’s books are in a healthy position, but a slightly softer economic outlook will likely drive a small deterioration in the fiscals from six months ago. But we think there will be enough wiggle room to accommodate that, and the forecasts will continue to show net debt at (or slightly below) 20% of GDP by 2022. Once achieved, the Government has signalled it intends to maintain net debt within a 15-25% of GDP range. This wouldn’t kick in until after the 2022 fiscal year, and is unlikely to have much impact on the 2023 fiscal year forecasts (at this stage). From a macroeconomic perspective, we don’t think the RBNZ will find much in the fiscals that suggest a stronger inflation impulse than they’ve already baked in. The RBNZ’s Financial Stability Report is also this week, as well as the ANZ Business Outlook and consumer confidence surveys.
The recently released Climate Change Response (Zero Carbon) Amendment Bill proposes to tackle climate change by committing to long-term targets, introducing an Independent Climate Commission, and ensuring the Government develops carbon budgets and policy plans to meet these. For dairy farmers, the Bill adds another layer of uncertainty to an already challenged sector. Options that may help the sector achieve the proposed targets include livestock reductions, farming more efficient stock, and technological improvements, such as using feeds that result in lower methane emissions. Coming up this week, dairy prices, overseas goods trade, and Q1 retail sales are due.
The RBNZ cut the OCR 25bp to 1.50% at the May MPS last week, citing slower global and domestic growth. But it wasn’t all guns blazing: the forecast OCR track implies only a 50% chance of a further cut (sometime next year). The RBNZ downgraded their near-term outlook substantially, with GDP growth slowing to 2% y/y by Q2 2019 (in line with our forecast), implying the hurdle is high for a further cut on domestic factors in the near term. However, beyond Q2 the RBNZ is forecasting a strong cyclical lift in annual GDP growth that looks optimistic compared to our own forecast. Accordingly, we continue to expect a further OCR cut in November, with one more cut to follow early next year. This week we’ll get another read on the housing market from REINZ and an update on migration.
The wait will soon be over for the much anticipated May Monetary Policy Statement (out 2pm Wednesday). Since the RBNZ’s dovish shift in guidance at the March OCR review, market pricing has been quite appropriately ebbing and flowing around the 50% mark for a cut in May. More analysts than not are now calling a May cut, but we’re not among them. On balance we expect the Bank to deliver a dovish hold, presenting a downward-sloping OCR track and firming up its language around the likely impending need for additional monetary stimulus. By August, we think the evidence that slowing economic momentum and waning capacity pressures will be sufficiently strong for the RBNZ to cut the OCR, but we certainly wouldn’t rule out that they’ll decide to bite the bullet next week. It’s a nail-biter. There’s also three ANZ proprietary indicators and another GlobalDairyTrade auction out this week.
In the March OCR Review, the RBNZ surprised the market with a dovish tone, explicitly referring to the risk of a higher NZD. But since then, the NZD has fallen a lot, accompanied by expectations for a lower OCR. Interest rate differentials and relative terms of trade have been important drivers of the NZD/AUD and NZD/USD crosses recently. A lower exchange rate is an important channel for the RBNZ, and recent falls should add to inflationary pressure if the RBNZ locks them in by retaining its dovish tone and showing OCR cuts are expected. To keep the stimulus from recent falls in the NZD and mortgage rates flowing, we expect the first OCR cut will be delivered in August, with two cuts to follow. This week brings the final pieces of the domestic data puzzle ahead of the May MPS, with the ANZ Business Outlook Survey on Tuesday and Q1 labour market statistics on Wednesday.
Our latest economic outlook has annual GDP growth slowing to 2% in Q2 2019. However, still-high (but easing) net migration inflows, expansionary (but not persistently) fiscal policy, low interest rates, and an elevated terms of trade should put a floor under the deceleration. Capacity pressures are poised to continue to wane and that’s going to weigh on non-tradable inflation. However, with OCR cuts expected from August, it shouldn’t be long before the economy gets the stimulus it needs to push economic activity back into inflation-building territory. It’s a pretty quiet week ahead data-wise, with ANZ-Roy Morgan Consumer Confidence for April and Overseas Merchandise Trade for March both due out on Friday.
The minimum wage went up $1.20 on 1 April to $17.70 per hour, and is now sitting at almost 71% of the median wage. And more rises are on the way; the Government intends to keep lifting the minimum wage to $20 by April 2021. This week we provide an overview of the outlook for the New Zealand labour market, and discuss how minimum wage rises are likely to impact economic outcomes. All up, we expect higher minimum wages to provide a small temporary boost to real wage growth, but higher CPI inflation than otherwise will provide a partial offset. Lower-than-otherwise hours worked will also partially offset the boost to household incomes. Speaking of inflation, this week brings the Q1 CPI release. Annual headline inflation is expected to tick down to 1.7% owing to softer tradable inflation. Non-tradable inflation is expected to tick up a touch, in line with RBNZ expectations.
New Zealand’s primary industries are an important part of the economic picture. Commodity prices are generally strong at present. However, rising costs are impacting returns, with finding skilled labour a particular challenge. There are varying conditions across segments, and this is evident in confidence levels. High debt levels in the dairy sector are curbing market sentiment, with farmers focused on debt repayment and required investment. Meanwhile, confidence in horticulture and sheep and beef industries is strong on the back of elevated returns. And so far, slowing Chinese growth is not affecting the forestry sector. That said, a slowdown in global growth is clearly evident, and there is a risk that conditions could deteriorate for primary producers, particularly if gravity comes calling for our commodity prices. Global risks are clearly weighing on the RBNZ’s thinking and they have indicated that the next move in the OCR is more likely to be down.
The Reserve Bank surprised all punters by saying that “the more likely direction of our next OCR move is down”. In response, the NZD dropped about a cent, and yields dropped sharply across the curve. We have been saying since late last year that the next move in the OCR would be down, but the RBNZ has come around to our view sooner than we had anticipated. However, acknowledging that downside risks to the growth outlook imply downside risks to the OCR is one thing; actually cutting the OCR is another. It is a line-ball call, but on balance we think the RBNZ will wait to see global and domestic risks manifest into something more concrete before actually cutting, in order to rule out the possibility of the unnecessary volatility in interest rates and exchange rates that a U-turn would engender. We have therefore brought forward our OCR rate cuts by three months to August, November and February, giving the RBNZ one more Monetary Policy Statement, in May, to assess how things lie (and introduce the new policy committee members). But between now and then lie several key data releases, and a decent disappointment in any of them could result in a cut as soon as May.
Last week’s GDP data showed growth continuing to moderate, slipping from 2.6% to 2.3% y/y. We expect the RBNZ will acknowledge this softening at the OCR Review this week but maintain an overall similar tone to the February MPS. Near-term GDP indicators point to ongoing softness and the RBNZ’s forecast for growth above 3% y/y this year is looking hard to achieve. That said, there is scope to wait and see how developments unfold. Moving forward, the RBNZ’s view on how potential output evolves – based on its assessment of capacity pressures – will be crucial for the inflation and policy outlook. Currently, the economy is coming up against constraints, but we expect that these will start to wane as headwinds build, making it difficult to sustain inflation at the 2% target over the medium term. Once that eventually becomes apparent, we expect the RBNZ will lower the OCR. We continue to pick November for the first move, though there are risks that could see this happen earlier or later than we expect.
Drivers of economic growth have shifted and this has been reflected in a changing economic landscape regionally. It’s currently a mixed picture. Auckland and Canterbury are not the engines of growth they once were. Conditions in Wellington are very favourable. Meanwhile, a number of provincial areas, like Northland, Bay of Plenty, Hawke’s Bay, Otago and Southland have been hot spots – boosted by favourable conditions in agricultural segments, strong tourism, buoyant housing markets, and population growth. However, challenges such as low confidence in the dairy industry are weighing in some areas. Despite regional divergences and strong performance in some places, businesses across a range of regions are wary about the outlook – and there is a risk that the landscape could shift from here.
Globally, manufacturing output is slowing, but New Zealand manufacturing is a clear outlier. This reflects the fact that volumes have been supported by meat and dairy production, which in the short run tends to be driven more by the weather than demand. Global demand fluctuations do turn up in meat and dairy export values, via commodity prices. But so far these have held up remarkably well to the slowing in global growth. Outside of meat and dairy, manufacturing growth has softened. Fluctuations in export demand tend to flow through to volumes, while domestic consumption of manufactures tends to be heavily influenced by construction. While it is possible that New Zealand manufacturing may continue to outperform international peers, downside risks are accumulating and acceleration in growth from here seems unlikely.
Statistics New Zealand have recently changed how they measure net migration, with the new data suggesting the resident population comprises around 50,000 fewer people than previously thought. This week we take a closer look at these data and discuss how they have affected our understanding of New Zealand’s recent economic performance – and what that could imply for the outlook. All up, we don’t think implications for how we view the economy will be large. But one thing’s for sure, the susceptibility of these data to large revisions will make it difficult to gauge the pulse of the migration cycle – an important element of domestic demand in the economy – in anything remotely resembling real time. The week ahead brings the last of the major Q4 GDP partials: wholesale trade, the economic survey of manufacturing, and the value of building work put in place. So far we’re seeing some mild downside risk to our preliminary pick of 0.6% q/q for GDP growth.
The much-awaited Tax Working Group final report was released last week, recommending that the taxation of capital income be extended, alongside reduced income tax for those on lower incomes. Taxing capital gains would have fairness benefits, potentially lead to increased portfolio diversification, and make property investment less attractive. But the report acknowledges it could also hamper investment, push up rents, and negatively impact savings and productivity. Plus, it would not solve our housing affordability problem. While a capital gains tax has now passed the first hurdle, there is no guarantee it will be embraced by politicians, especially in its current form. And even if the current Government decides to run with it, we will not get clarity on the issue until after the 2020 election. The decision of whether to implement or not may ultimately be up to voters.
The Reserve Bank last week sounded a slightly more cautious tone about the future path for the economy and inflation than in their November projections, but only modestly so. The implied first OCR hike was pushed out to mid-2021 from late- 2020. The market was anticipating a more significant change in tone, perhaps influenced by dovish surprises from the US Federal Reserve and the Reserve Bank of Australia. This meant the NZD and interest rates spiked on the day, even though the surprise relative to most economists’ expectations (including ours) was small. Our expectation for OCR cuts kicking off in November is built on a forecast that GDP growth will fail to accelerate over this year as the RBNZ is projecting, leading to the RBNZ in time concluding that more monetary stimulus is required. There is plenty of data between now and then to make or break our case.
The RBNZ Monetary Policy Statement is this week’s headline act. Since November, the labour market has flat-lined and the growth outlook has a duller pitch, though domestic inflation has been a little stronger. Global data has struck a softer note and risks have increased sharply, with central banks turning more dovish in concert. We expect the RBNZ will join the chorus this week, employing a similarly dovish tone that echoes the tenor of other central banks and market pricing, which has moved to price in a good chance of a rate cut, reflecting the changing balance of risks. That said, a dovish stance so soon from the RBNZ is not a necessary ingredient of our November cut call. The data and market pricing may well strike higher and lower notes, but we think the case for more monetary stimulus will become evident in time.
The outlook for inflation is nuanced at present. Core inflation has been inching up, but non-tradable inflation remains shy of where it needs to be. The RBNZ were surprised to the upside on Q3 non-tradable inflation. But potential growth may be higher, meaning GDP needs to remain strong – and we think that will be a challenge. As such, capacity pressure may be past its peak at a time when firms are still grappling with lack of pricing power, weighing on inflation. From the Reserve Bank’s perspective, capacity pressures still look pretty reasonable, inflation is still tracking up towards where it needs to be, and there are risks in both directions – meaning they can bide their time and wait and see how things unfold. We think that the RBNZ will eventually come around to our view that more monetary stimulus will be required, but probably not just yet.
Our latest economic outlook sees annual growth averaging 2.5% over the next couple of years. While this is still a respectable pace of expansion (given it’s off a high base), inflation pressures are not expected to intensify in this environment. Gradually tightening credit conditions, owing to confirmed and probable changes to bank capital requirements, add to an already lengthy list of headwinds the economy is expected to face (and in large part, is grappling with already). We see the case for OCR cuts becoming more evident in time, and have pencilled the first in for November. However, we acknowledge that the path ahead may not be a straight one, with market pricing ebbing and flowing with the data (the solid print for Q4 non-tradables inflation last week comes to mind). It’s a pretty quiet week ahead data-wise, with Overseas Merchandise Trade for December (out today) the main event.
The QSBO experienced trading activity data last week joined the Truckometer in suggesting that momentum in the New Zealand economy is coming off the boil. Slowing population growth, labour shortages and squeezed profitability are all contributing. Growing off a strong base is harder, of course, and the data is still consistent with growth in a 2-3% range, a soft landing by anyone’s standards. But it’s worth taking a sideways look at the darkening clouds gathering around the global outlook. Fair to say the news on global manufacturing and trade has been pretty one-sided of late. But other sectors are looking more robust and New Zealand’s commodity prices are so far proving remarkably resilient. The highlight of the domestic data calendar this week is Q4 CPI inflation – we expect 0.0% q/q and a slight easing in annual CPI inflation to 1.8%.
Just before Christmas we changed our OCR call. We are now expecting the RBNZ’s next move to be a 25bp cut in November, with two follow-up moves taking the OCR to a record low of 1.0%. There are several reasons for our call. First, while we have not revised down our growth forecasts meaningfully, there are signs of waning momentum, in both the Q3 GDP result and forward-looking indicators. Upward revisions to GDP mean that the RBNZ is likely to conclude that a solid growth rate will be required to deliver inflation sustainably back at target. Second, risks are accumulating around the global growth outlook, particularly China, and liquidity risks are pertinent to global financial markets. The impacts of the RBNZ’s proposed capital changes are uncertain, but unambiguously represent a tightening in financial conditions that will need to be offset with a lower OCR. And finally, the outlook for tradable inflation is also weaker, courtesy of lower oil prices. Data this week includes key reads on both inflation and growth momentum.
With the holiday period fast approaching, we take a moment to reflect on the key themes for markets in the year ahead. Global growth is slowing, but providing an offset, the monetary policy backdrop looks set to shift, with the Fed expected to pause its rate hikes. It looks likely to be a year that will challenge risk sentiment, with growth slower, liquidity tighter and geopolitical uncertainty weighing. The environment looks set to provide a test for the NZD, while global funding markets are likely to remain tight, with the risk of wider spreads that could put upward pressure on New Zealand retail interest rates independent of the RBNZ’s OCR decisions. Policy stimulus in China will be an ongoing theme, with the economy under some pressure. In Australia, the extent of house price falls and behaviour of households will be watched closely. And domestically, the trend in GDP and core inflation will set the tone. GDP data for Q3 out this week is expected to show some payback from Q2 with stable underlying momentum (0.5% q/q, 2.7% y/y). There’s also a sprinkling of other data out this week. With that capping off the year, we would like to wish our readers a safe and enjoyable festive season.
The NZD has strengthened above 68 US cents, reflecting a perfect storm of domestic and global factors. Domestically, data has been positive and the RBNZ has moved towards a neutral stance. Globally, the Fed has struck a more cautious tone, seeing the NZD pick up in tandem with emerging market currencies. Meanwhile the AUD has been out of favour on China risk. We see gravity coming calling again for the NZD, based on both fundamentals and a more challenging environment for risk currencies. But the outlook is by no means clear cut and more volatility seems likely. Recent strength in the NZD will weigh on inflation and we have revised down our CPI forecasts, though expected declines in the NZD will provide some support to inflation over the projection. We expect that the RBNZ will remain focused on core inflation and not be overly swayed by volatility in tradable inflation. That said, recent moves in the NZD highlight the importance of global risks and there is a risk that the NZD is persistently higher, weighing on core inflation and net exports. But for now we are comfortable with our forecast for a lower exchange rate.
Last week the RBNZ further eased the LVR restrictions. In our view, the restrictions have ‘worked’, in terms of reducing risky lending and seeing household debt levels flatten off – albeit at high levels. Too much uncertainty remains to declare ‘job done’, however. The Auckland housing market is behaving itself but history warns against ever ruling out a second wind. The headwinds of tax changes, tougher landlord responsibilities and the foreign buyer ban are finely balanced with very low mortgage rates, improving credit availability, and still-strong population growth. All up we see the housing market remaining contained, with the LVR restrictions still ‘tight’ at these levels, but the RBNZ won’t hesitate to adjust them in either direction should it deem warranted. Credit cycles will remain a feature of the economic landscape, and low inflation has enabled people to frontload more debt than before, so the restrictions are a useful addition to the regulatory toolkit.
International tourism has seen impressive growth in recent years, and has surpassed dairy as New Zealand’s top export earner. This week we discuss some of the key drivers of growth and challenges the sector is facing. All up, international tourism is expected to continue outperforming, but it’s a mixed picture. Rising global demand (particularly from Asia) should support growth in visitor spending, but capacity constraints are expected to keep volume growth contained. While the construction pipeline to alleviate some of these constraints is lengthy, the highly seasonal nature of the sector presents a challenge. Over the longer run, climate change and possible associated costs to air travel could be game changers. A focus on a higher-value tourism experience is an important long-term strategy.
Conditions for business investment are challenging, despite very apparent capacity constraints. We expect to see softness in investment (excluding residential buildings) in the short term, given current challenges. These include profit squeeze, low confidence, reduced risk tolerance, and credit constraints. That said, we believe conditions are in place to see a recovery in investment over the medium term, particularly given the rising cost of labour. There are a number of offsetting forces at play, posing risks on both sides of this outlook. Downside risks have been tempered somewhat recently, given evident resilience in the economy. Yet even with this expected recovery, we anticipate that below-average growth will continue, in light of persistent headwinds. This reinforces our view that it may be difficult for the economy to grow above trend.
The November MPS struck a more upbeat tone, with the RBNZ moving firmly back to a neutral stance with the risk profile balanced, rather than skewed to the downside. The RBNZ now sees the medium term for non-tradable inflation as more assured, and accordingly, the market has now priced out the possibility of OCR cuts. We remain a little more circumspect and are comfortable with our call that the OCR will remain on hold for the foreseeable future, compared with the RBNZ’s projection for eventual increases. That said, looking through potential noise, a considerably stronger labour market starting point suggests that the economy has moved into stretched territory. This makes us also a little more upbeat on the apparent resilience of the economy. We have revised up our forecast a little, but a sustained return to the target is not yet a given. Evidence of broad-based inflation pressures remains scant and a number of growth headwinds remain.
The RBNZ’s Monetary Policy Statement will take centre stage this week. Developments have been a mixed bag since the August Statement, but we expect the RBNZ will remain cautious about the medium-term outlook and reassert a dovish tone. Labour market data also out this week is expected to show a stable, tight labour market, providing continued support to household spending. So far, the household sector has been fairly resilient to the headwinds facing the economy, but our latest ANZ-Roy Morgan Consumer Confidence Survey shows that households are feeling a bit warier about the future. Going forward, we expect that consumption will remain firm, supporting growth. But with businesses and even the RBNZ circumspect about the future, wariness may be here to stay – meaning household retrenchment is a key risk. There’s a slew of other data out this week, including a GlobalDairyTrade auction, with a further fall in dairy prices expected.
Much has been said about risks to the domestic activity outlook, but global risks have increased too, as highlighted by recent market wobbles. Our expectation is that the global environment will remain supportive for New Zealand, but global shocks have the potential to change the economic landscape and the outlook for the OCR very rapidly. Arguably the most important global risk for New Zealand at present is the possibility that China slows more sharply than currently expected. Trade tensions are adding pressure. Weakness in Australia’s housing market has not affected lending in New Zealand, but could if the adjustment were to become particularly pronounced. Abrupt tightening in global liquidity could also see financial conditions tighten. New Zealand is isolated from the direct effects of Brexit and Italy’s political saga, but developments could nonetheless contribute to market wobbles, including in currency markets.
CPI inflation was stronger than expected in Q3, boosted by temporary factors. But underlying the strong print, broad-based inflation pressures are lacking. The RBNZ has made it clear that it needs to see core inflation at or above the target midpoint. And for that to be realised, non-tradable inflation needs to see a decent tick-up, which we suspect may be difficult to achieve. The stronger Q3 CPI print presents a communication challenge for the RBNZ, but we expect the Bank will maintain a dovish tone at the November MPS in light of a still-modest underlying pulse and downside activity risks, which may come as a surprise to markets. We continue to see the OCR on hold for the foreseeable future, with risks skewed to the downside. On the other hand, we are mindful of upside inflation risks, as highlighted in the RBNZ’s upside MPS scenario – but in our view that scenario is still a long way from being a reality.
The NZD is currently tracking lower than the RBNZ’s August MPS TWI assumption on account of a range of factors. Does this mean it’s ‘game over’ for possible OCR cuts? The NZD has fallen more than is justified by a weaker domestic outlook, and is thus providing a buffer that may offset weaker activity, though for a mix of reasons it may not prove as stimulatory as history (and forecasting models) would suggest. On the face of it, relative to the August MPS, a weaker domestic outlook and lower TWI appear to be broadly offsetting for the OCR. But of course, the picture could change quite quickly, as recent global market volatility highlights. And for the OCR outlook, much depends on how the RBNZ is weighing up the balance of risks, and domestic and global risks have clearly increased. As such, we expect to see a continued dovish tone at the November MPS. This week looks set to bring a solid Q3 CPI print of 0.8% q/q, but with transitory factors at play, we expect the RBNZ will largely “look through” it.
Rising oil prices, a lower NZD and higher fuel taxes have conspired to see petrol prices at the pump increase to as much as $2.50/litre in some locations. This will contribute to CPI inflation, which we expect will increase above the RBNZ’s 2% target midpoint early next year before moderating. The inflationary impact of petrol price increases tends to be transitory, and the RBNZ will look through it. However, growth impacts matter too. Higher petrol prices will boost costs for already downbeat businesses, and it will also squeeze the discretionary purchasing power of households. Households lack savings buffers to absorb unexpected events – be that something as dramatic as job loss or as everyday as petrol price movements. Given businesses are already downbeat, a spooked consumer to boot could make quite a dent in the economic outlook. Therefore higher petrol prices are unlikely to make the RBNZ any more eager to hike the OCR.
Net immigration has added more than 300,000 people to the population over the past five years, increasing demand (including for housing and infrastructure), but also adding to the pool of labour. The migration cycle is past its peak and trending lower, but is still expected to add almost 100,000 people over the next two years. Nevertheless, softening population growth implies a shrinking impetus to growth over the years ahead and if the migration downturn is sharper than expected, economic growth could slow markedly, given growth per capita is pretty lacklustre. With such a large pool of recent permanent residents who may have a higher propensity to leave should economic conditions change, the risk that net migration exacerbates the next downturn – whenever that may be – is quite real. The week ahead brings NZIER’s Q3 Quarterly Survey of Business Opinion, ANZ’s job ads and commodity price index, and the next GDT auction. We have revised down our farmgate milk price to $6.40kg /MS and bumped up our CPI forecasts for Q3 and Q4 on higher petrol prices.
The Tax Working Group released its interim report last week. One option that was discussed is broadening the taxation of capital income. Taxing capital gains would have benefits: it would increase the tax base, improve fairness and potentially make property investment less attractive relative to other investments, which at the margin could lead to higher rates of home ownership. But taxing capital gains is no silver bullet. It will make our tax system more complicated. It will not fix our housing affordability problem, could lead to lower investment, may lead to higher rents, and could have negative implications for saving, depending on other tax changes. These pros and cons need to be carefully weighed. Our expectation is that the Tax Working Group will recommend extending capital income taxation in some form, but it is not written on the wall, with many issues still to be addressed. This week brings the OCR Review, along with the latest reads from ANZ Business Outlook and ANZ Consumer Confidence.
The RBNZ has indicated it is willing to lower the OCR to boost the economy if required. But would it even work? In our view, monetary policy is still working well – but it has changed. The neutral OCR is now considerably lower, meaning that although the OCR is at a record low, the current degree of monetary stimulus is by no means unprecedented. The availability of credit appears to be a headwind for the economy at present. But a lower OCR would nonetheless be effective at boosting demand. It would improve household and firm financial positions, stimulate net exports via a lower NZD, and encourage spending and investment. We would also note that while financial stability risks are important, they shouldn’t be a barrier to loosening monetary policy; they can be mitigated. This week brings the GDP and Balance of Payments releases for Q2. We are expecting 0.7% q/q for GDP, boosted by temporary factors.
New Zealand businesses are pessimistic, but retailers most of all. Activity expectations have declined. Profitability is squeezed, on the back of cost pressures, particularly rising labour costs. And firms are looking to shrink their workforces and invest in labour-saving technologies. But while retailers are pessimistic, they have actually been a success story in recent times. They have faced important longer-term challenges: the industry has become increasingly global, leading to increased competition, weakening pricing power and more concentration. And yet firms have adapted to these trends, with innovation, solid productivity gains and strong output growth evident. The industry will need to continue to adjust and the outlook is looking a bit more challenging. But history suggests they’re up to it. There’s a range of domestic data out this week and we’ll be firming up our views on Q2 GDP.
The recent data flow has been weak and the market has moved to price in around 50% chance of an OCR cut by mid next year. Our view is certainly that a cut is more likely than a hike, but is it time to definitively call cuts? We are leaning that way, but are not over the line yet. Our ANZ Business Outlook Survey has been very downbeat, but it is also possible that the survey could be overstating current weakness. We always look at a range of data to assess the state of the economy and so far the picture is looking softer, but very mixed. We suspect that the RBNZ may well be willing to front-foot a response to a slowing before seeing it manifest in official GDP data, but it would nonetheless need to be convinced that the slowdown is real and relatively broad-based, and that extra monetary policy support is therefore warranted. As such, there is a range of developments we – and the RBNZ – will be watching closely over the next couple of months.
The Australian and New Zealand economies are facing broadly similar economic headwinds and tailwinds at present. Both have very high house prices and household debt. However, with house prices falling in Australia but steady in New Zealand, this risk remains primarily confined to Financial Stability Reports in New Zealand, whereas it is garnering increasing attention in Australia. On the other hand, businesses over the ditch are feeling more confident, reflecting that per capita growth has lifted well above that in New Zealand of late. Fiscal policy is stimulatory in both countries and exporters are similarly exposed to China. Domestically, the main risk presently in Australia surrounds where and when the housing market will bottom, while in New Zealand, it is that business pessimism could become a self-fulfilling prophecy.
We are no longer forecasting that the next move in the OCR will be up. The Reserve Bank is reluctant to hike; they made that abundantly clear in the recent Monetary Policy Statement. And we see growth averaging 2½% over the next couple of years; hardly a stall, but considerably softer than the Reserve Bank’s expectation. That combination is not consistent with forecasting rate hikes. We are now forecasting that the OCR will be flat for the foreseeable future. Of course it is not that we literally believe the OCR will never be moved ever again; rather, we no longer believe on balance that the next move will necessarily be upwards. Indeed, given how long it is until a hike could plausibly be on the cards, the balance of risks is, if anything, tilted towards the next move being a cut. But the economy is muddling through for now. We still expect core inflation to rise further in the near term, reflecting previous strength in the economy. But beyond that, the resilience of underlying inflation does not look assured.
The macroeconomic data flow has turned patchier around the edges of late; particularly some of the more forward-looking data, such as the activity indicators out of the ANZ Business Outlook survey. The RBNZ made it clear last week that it is concerned about downside risks to the growth outlook, and entirely unconcerned about the looming cost-push lift in inflation. The Government, meanwhile, argues that while the economy might be going through a bit of a bumpier patch, the fundamentals are strong and we’ll soon bounce out. This week, we step back and take a look at the big picture: is it all over bar the shouting, or is the economy indeed just experiencing a few bumps as it transitions to a newer, more sustainable growth model that will see the good times roll for years yet?
The construction industry is dealing with significant challenges. Firms are experiencing financial strains and there are reports of unsustainably thin margins. At the same time, the industry is struggling to keep up with demand in the face of capacity pressures. Labour shortages are a much-cited problem, but problems run deeper; as well as issues with contracts and boom/bust dynamics, the productivity performance of the industry is poor and needs to be addressed. In light of these challenges, we believe it will be difficult to achieve further increases in construction activity from here, despite strong demand. Our central expectation is that the industry continues to muddle through at still-high activity levels, but recent events highlight that it is not an easy road ahead. This week brings the RBNZ’s August Monetary Policy Statement. We expect the OCR track to be similar to last time, with continued neutral messaging given offsetting developments.
The growth outlook has softened recently, but inflation looks set to lift, boosted by a range of cost-push factors. This makes the outlook for monetary policy a bit more complicated at present, and focusing primarily on CPI inflation in this environment runs the risk of missing important nuances about the policy response. We expect that the RBNZ will be concerned with the underlying trend in inflation and its persistence over the medium term. This means that the RBNZ will be willing to “look through” higher CPI inflation to the extent that it is not expected to be permanent. Our expectation is that core inflation will increase towards the 2% target midpoint only gradually and that we will see limited impacts on medium-term inflation expectations as inflation pressures broaden. If inflation evolves as we expect, the OCR will eventually need to rise – but not any time soon. We continue to pencil in late-2019 for a hike, but a lot could happen between now and then.
June quarter inflation was stronger than we expected at both the headline level and in spirit, with measures of core inflation clearly ticking a little higher. With that in mind, now is a useful time to revisit where we see inflation heading from here and the key judgements underpinning this view. We expect headline inflation to gradually pick up to 2% by Q2 2019. In light of the Q2 surprise, this is one quarter earlier than our previous forecasts. Underpinning this is an ongoing gradual acceleration in non-tradables inflation, and some near-term strength in tradables inflation. On balance, the risks to this outlook are skewed a little to the upside in the near term, but to the downside in the medium term, reflecting a deceleration in economic activity. This week is quiet on the data front, with just trade data and ANZ Consumer Confidence out.
This week we explore what business surveys can tell us about the economy, looking deeper than the confidence measures that grab the headlines. Headline business confidence measures are by nature subjective and can be affected by the political cycle in addition to purely “economic” factors. But whatever the drivers of the responses, they are accurate barometers of how businesses are feeling, and the recent fall in business confidence appears to be flowing through into decisions around investing and hiring. Business surveys provide a broad and rich set of data, which gives useful colour on developments and helps gauge the pulse of the economy. The data has its limitations (as all data does) and should be interpreted within the wider context of the economic information available. But to ignore business surveys is to overlook important information about what businesses are experiencing, how that is affecting their decisions, and the implications for the wider economy.
For some time now the New Zealand Treasury has emphasised the importance of intergenerational wellbeing as part of its stewardship responsibilities. This week we take a look at the Treasury’s next phase in its approach to measuring wellbeing (through the Living Standards Dashboard) and discuss how a broader consideration of wellbeing might, in practice, impact on policy advice provided by the Treasury and other government agencies. While some may see it as a way for the Government to divert focus away from what is happening with the business cycle, or as a way for the Government to get around fiscal responsibility requirements, we’d disagree. The macroeconomic performance of the economy and fiscal prudence is always going to matter for wellbeing, but these provide limited insight in terms of what’s happening under the hood. On the data front this week, the June Food Price Index and ANZ Monthly Inflation Gauge will provide a steer on Q2 CPI. June Electronic Cards Transactions will be closely watched after running into a soft patch recently.
Our latest set of economic forecasts depicts a New Zealand economy at an interesting juncture. The global outlook remains positive, but downside risks have increased. Domestically, the economy is going through a softer patch and we expect it will struggle to grow above trend from here. That said, cost pressures are increasing and we expect that margin pressure will provide the catalyst needed for firms to pass through price increases, though likely in a gradual fashion. Based on the balance of risks and all else equal, we expect inflation will increase gradually and that the OCR will eventually rise. That said, downside risks have increased that could delay monetary policy.
This week the key domestic event will be the RBNZ OCR decision. Although we expect no change in message from the RBNZ, we have updated our view on the outlook for the OCR. We now expect the OCR will lift in November 2019, rather than August, consistent with a softer outlook for GDP growth and a more gradual increase in inflation. The RBNZ will wait for inflation to rise in a consistent way, and this will take some time in this environment. There are risks on both sides of the ledger. But on balance, we think cost pressures – especially wage costs – will push inflation higher and that the OCR will eventually rise. That said, with forecast hikes sitting very late in the economic cycle, there are decent odds they may not happen at all. One of the key risks to up the ante of late is possible fall-out from trade war escalations. The implications for New Zealand are not yet clear. In the short term, New Zealand could benefit. But as a small open economy, we have benefited from the freeing up of global trade in recent years. We could be impacted significantly if this process were to go systematically into reverse or should the Chinese economy slow.
A bill is currently under consultation that will restrict foreign buyers from purchasing residential property in New Zealand. Outcomes are uncertain; we expect the policy may dampen house price inflation, but only temporarily and by a small amount, as foreign buyers currently comprise only a small part of the market. However, a lack of historical data means we cannot draw any firm conclusions about the impact the policy may have had if introduced earlier, or the impact it may have on the next housing cycle. It is clear though that banning foreign buyers is not a quick fix on housing affordability. Housing demand is underpinned by still-low mortgage rates and still-strong net migration, and on the supply side, there are important issues around high construction costs, restricted supply of land, and provision of infrastructure. It is important that the restrictions are not permitted to signal that New Zealand is closed for business. The benefits of openness are large and accrue to all New Zealanders.
Education exports are a big earner for New Zealand and the Government’s proposed tweaks to post-study work rights have got the media and industry talking. This week we discuss how we see these changes playing out in terms of their impact on the New Zealand economy. Overall we think the macroeconomic impacts will be modest; New Zealand remains an attractive place to study and we do not expect student arrivals will be significantly affected. Nonetheless, it’s hard to know how much the industry may be impacted from heightened policy uncertainty or how the proposed changes might impact business sentiment, given the current relatively pessimistic landscape. The week ahead brings a plethora of data, some of which will shine light on the degree of inflation pressure and the resilience of business activity.
The current economic cycle has been a bit unusual, not least for its lack of general inflation, but also arguably because the broad consensus is that it still has legs yet (which is also our view admittedly). This is despite the cycle starting to get a little ‘long in the tooth’, and capacity constraints and late-cycle headwinds making themselves felt. That is not to say there aren’t risks that could change this picture. Left well enough alone we believe the economy can continue to record reasonable GDP growth around trend. But with the data flow turning more mixed of late, and some key growth drivers of recent years running out of puff, it is timely to take a look at the upside and downside ‘home-grown’ risks for why growth could be either stronger or weaker than expected.
New Zealand’s economic expansion is getting a little long in the tooth; fiscal policy and the terms of trade are the two main factors that look set to keep growth ticking along. This week, we take a look at the make-up and the robustness of the current record high in the terms of trade. In short: it’s encouragingly diversified by good, but less so by market. Looked at individually, the global supply-demand balance for our main commodities looks price supportive, even though it appears global growth is past its peak. But if a more marked slowdown were to emerge, history suggests our commodity prices are likely to go down together. The week ahead brings reads on both business and consumer confidence, as well as consents, the terms of trade, and the RBNZ’s latest take on financial stability risks.
In last week’s pragmatic Budget, principled prudence took precedence over promises, as we expected. In the context of the economic cycle, prudence is a good thing. Increased government spending is counterproductive if it crowds out private sector activity and drives interest rates higher, or creates the need for austerity down the track. But at the current juncture, we think macroeconomic conditions could accommodate a bit more capital spending to address New Zealand’s sizeable infrastructure deficit. On a longer-term basis, beyond the realm of the economic cycle, New Zealand has a looming fiscal time-bomb in the shape of a rapidly ageing population and a non means-tested superannuation system that kicks in at an unaffordably early age. While fiscal prudence today is a good start, it’s not going to solve the long-term problem.
As the RBNZ was at pains to point out in last week’s Monetary Policy Statement, wage inflation is weak, and weaker than one might have expected given the conditions in the labour market, even given the subdued inflation environment. We expect that wage inflation will increase from here. But with underemployment elevated, participation on an upward trend, and overseas workers readily available, we are open to the possibility that there may be more spare capacity in the labour market than the unemployment rate would suggest – and that this could weigh on wage inflation going forward. The Budget is the key event this week: we expect strict adherence to the fiscal targets, but with upside revenue surprises and spending reprioritisation perhaps allowing a few cheap lollipops.
Migration inflows have been very strong in recent years and this has been a key driver of the economic cycle. In a broad sense, the impacts of strong population growth have been predictable: it has boosted demand and put pressure on housing and infrastructure. But the effects have been subtly different to previous cycles, in that we have seen less resulting inflation pressure. As well as the general backdrop of subdued inflation, we put this down to two specific factors. First, the demographic mix of net migration has led to a solid boost to labour supply, and the pool of potential workers has effectively been larger. And second, headwinds for the housing market have of late outweighed the migration impact. Going forward, the outlook is uncertain. The migration policy outlook is unclear, and even if one could predict migration, the different dynamics this cycle mean the impact is subject to uncertainty.
As a small, open economy, New Zealand is significantly affected by the global economic cycle. Currently, economic indicators point to ongoing, above-trend growth in the global economy. But global markets are sending some mixed signals: equities are volatile, but other markets less so. The global economy is navigating some challenges, which could have flow-on impacts to New Zealand. In some ways, New Zealand is more robust than it once was to adverse global events. But in other ways, vulnerability has increased. We remain optimistic about the global outlook and by extension the environment for New Zealand’s commodity prices, goods and services exports and funding markets. But we will be watchful for any change in conditions. One thing seems clear: it’s going to be a bumpier ride than it has been.
Since taking office, the Government has reiterated its commitment to its fiscal responsibility targets. It has also promised to invest in correcting the so-called “infrastructure deficit”. Weighing these objectives is a difficult balance. We think an argument can be made for increasing near-term debt targets for the purpose of growth-enhancing infrastructure spending. The Government books are in a good position and years of strong population growth but constrained Crown capital spending have put significant pressure on infrastructure. In our view, simple, transparent debt financing would be optimal. A long, relatively smooth forward-looking pipeline of appropriately prioritised infrastructure spending, with the option to ramp up if economic activity were to soften, should be the goal. The sector is resource-constrained, but given the long lead time of infrastructure projects, it does not seem an inopportune time to get planning underway.
Firms’ expectations of their profitability have deteriorated since mid-2017. This week we ask: should we be concerned? Weaker profit expectations can reflect either weaker expected sales, or increasing costs. We think it’s the latter, and in that context, it is neither surprising nor alarming. While squeezed margins are not a comfortable situation for firms, it is a typical feature of the business cycle. They encourage firms to increase their prices in order to claw back profits, consistent with our expectation of rising inflation. All that said, a lack of pricing power has been a feature of this business cycle and we don’t think that is about to change. Inflation will increase only gradually as a result. Q1 CPI should be consistent with this theme.
Consumption has been growing at a robust pace, driven in part by strong population growth. But household spending could conceivably have been stronger; it has not tracked capital gains as strongly as it did last cycle. This begs the question: are households choosing to show restraint, or is their spending constrained? We suspect it’s probably a bit of both, but that constraints from both high house prices and high levels of debt are the dominant influence. Either way, the impact is the same – softer demand than would otherwise have been the case, and we think this will continue to be a theme going forward. We expect households will strengthen their savings buffers and that consumption growth will moderate from here. Income growth is expected to remain solid, with conditions in place for a pick-up in real wage growth.
The economy is currently growing about trend pace, after cooling from the strong rates of growth seen over 2015 and 2016. There are some challenges to navigate but we don’t see the economy rolling over, even though that has been the historical tendency at this point in the cycle. Overall, the story is a positive one. Our forecasts depict an economy growing broadly around trend for the next couple of years, with the unemployment rate set to remain low. We see wage growth gradually lifting off lows, with a modest broadening in domestic inflation pressures in time. That lift should eventually see the RBNZ join other central banks in removing monetary policy stimulus. However, we feel strongly that it will be late to that party, with the first hike not until the second half of 2019. The main risks lie offshore.
The new Policy Target’s Agreement (PTA) was signed this morning, with the RBNZ now expected to contribute to supporting “maximum sustainable employment” in the context of its medium-term inflation target. This policy mandate is broadly in line with those in the US and Australia. Although policy rates (and now mandates) in these economies are currently very similar, the policy outlooks are quite different. The RBNZ does not expect to increase interest rates until 2019, whereas the FOMC increased rates last week and expects two more hikes this year. Market pricing for policy in New Zealand is similar to that in Australia, with about a 30% chance of a hike priced for both by year end. Given the similar policy outlooks for the RBA and RBNZ, we expect the NZD/AUD to keep muddling along. However, the NZD/USD will be put on the defensive in 2018. Policy rate differentials and diminishing global liquidity suggest depreciation may be only a matter of time.
The pace of economic activity struck a more moderate (but still respectable) tone in 2017, with the economy navigating some late cycle headwinds. But we believe that recent credit developments are an important – and under-appreciated – part of the story too. The slowing in bank deposit growth over 2016 that forced banks to put the brakes on new lending meant that credit conditions exerted a moderate, negative impulse on the economy over the past year or so: the housing market has softened and businesses have found it more difficult to access credit. However, we enter 2018 with that adjustment having broadly played out. Lending and deposit growth are not far apart now, suggesting credit developments will have a broadly neutral impact on activity going forward. This leaves the economy able to continue to record an around-trend pace of growth.
The New Zealand dollar has surprised many with its resilience over recent months. Its strength has been in the face of the disappearance of interest rate differentials versus the US, higher volatility on global markets, and the recent threats of global trade wars. Elevated commodity prices, a still decent domestic growth signal, and relatively robust structural metrics (by New Zealand’s standards at least and with the exception of household debt) perhaps explain this resilience. However, the USD is also out of favour currently due to concerns over its ‘twin deficits’ – large and increasing deficits on both the fiscal and trade fronts – and it has been this theme that has arguably been the biggest driver. But we are not convinced this will persist, particularly as global liquidity continues to tighten, which should eventually put the NZD back on the defensive.
Business confidence fell sharply late last year following the election, raising the question of whether employment and investment decisions might be deferred or cancelled as a result. Putting this together with a weaker housing market and signs of a ‘peak’ in some previous growth drivers, we built a short-term wobble into our economic forecasts – but not as much as the headline confidence numbers would suggest. We take a look at the data-flow since then and conclude that while firms remain cautious, perhaps the wobble is not going to be a large one, with the tone of the recent data remaining positive overall. Nevertheless, our bigger picture views on the economy have not changed; the economy is still struggling with late-cycle issues and achieving above-trend growth over the next few years will be a challenge. In data this week, the final key partial indicators we look at for Q4 GDP are out, which should allow us to finalise our forecast. In addition, we suspect the next GlobalDairyTrade auction will show prices again easing modestly.
The latest data shows New Zealand’s recent labour productivity performance now fits into the ‘not too bad’ category, rather than being in the woeful state previous figures implied. Like recent GDP revisions, it helps to square the circle on a number of issues: strong corporate profit margins, modest inflation pressures and the relative strength in the real exchange rate. However, it doesn’t alter our view that at a time of slowing population growth and a more constrained labour market, more onus will fall on productivity growth to sustain reasonable rates of GDP growth going forward. That is possible, and we are hopeful, but it is likely to require greater levels of capital investment than has been the case recently. Shifts in the relative price of labour and capital look set to help, but other tweaks (like some of the measures the new Government are suggesting) may assist as well. This week, a number of our proprietary indicators will be watched to gauge early-2018 momentum. The terms of trade should post a new all-time high, and a small monthly trade balance looks set to be reported.
Although the housing market has shown more signs of life of late, we have not changed our overall views of where it goes from here. A number of opposing forces are likely to see prices effectively stay ‘on ice’ for the foreseeable future. All else being equal, we expect this to be a headwind for consumption growth going forward, although perhaps to a lesser extent than history would suggest, given that the softer housing market has not been driven by a turn in the interest rate cycle, but rather by a more restrictive credit landscape, including macro-prudential policy. Nevertheless, with the household saving rate having deteriorated over recent years (to an unsustainable level in our view), weaker house price performance is expected to see households look to rebuild precautionary saving, and this will be a headwind for overall activity growth. In data this week, the retail trade survey for Q4 is likely to show decent spending growth (perhaps the last hurrah?), while we expect global dairy prices to take a breather.
Global financial market volatility has staged a dramatic come-back, raising questions regarding possible contagion, broader asset price corrections and a negative hit to growth. We are watchful and will be keeping a close eye on broader financial conditions (which have tightened only modestly so far). While we think decent global growth can persist for a while and inflation looks unlikely to surge higher, higher volatility is something that looks here to stay as markets transition to a world where central bank liquidity is less abundant. While more ‘normal’, it does present a less favourable backdrop for risk assets, all else equal. For New Zealand, we see few reasons to change any of our core views yet. A stronger external balance sheet means the economy is more resilient to shocks, although our asset prices have also benefited from low global interest rates, so we can’t completely turn a blind eye. But for now, we see it primarily as another factor that leaves us comfortable with our cautious views on the RBNZ, and our belief that at these levels, the NZD will remain on the defensive.
The global economy is in a strong and synchronised upswing. It is a positive backdrop that we by and large expect to continue, although it is probably ‘as good as it gets’. But this strong global picture is one of the main reasons we retain a constructive view on New Zealand’s medium-term growth outlook. The impact of the strong global picture can already be seen in the likes of the record terms of trade and December’s all-time high in export earnings. The NZD has also clearly benefited. But we would question how much further the latter theme can run, especially with interest rate differentials to the US narrowing sharply. The shine came off the NZD Friday night and we would not be surprised to see this continue. The RBNZ should remain cautious and watchful in this week’s Monetary Policy Statement, and we expect Q4 labour market figures to show a reversal from Q3’s phenomenal strength.
While it was not the only factor that contributed, the soft Q4 CPI figures were the catalyst to see us push out the timing of when we see the first RBNZ OCR hike to August next year. Indeed, the first hike is now such an intangible notion we toyed with the idea of flat-lining our profile altogether. It is clear that the relationship between economic slack and the inflation process has weakened in recent years, which emphasises the need for the economy to run hotter to get inflation up sustainably. At a time when we have a somewhat circumspect view on the near-term growth picture, and see growth returning only to trend (or thereabouts) after that, there are questions over how inflation is going to lift in a sustainable fashion. While we do still believe that wage growth will pick up off cycle lows, it is not clear that this is going to be enough to offset ongoing global deflationary forces. In data this week, our jobs ads and consumer confidence series will give the first steer on early 2018 activity, while net migration figures are likely to be consistent with a peak in net inflows.
There are three potential inferences for the inflation outlook and hence monetary policy from the recent upward GDP revisions: 1) the economy was running hotter, and higher inflation is coming (if not stronger growth); 2) domestic inflation hasn’t eventuated so it must be that the potential growth rate of the economy was higher too; or 3) it doesn’t matter much in any case as the relationship between the output gap and inflation has weakened. We suspect there are elements of truth in all three, but it all leaves the outlook for inflation rather murky. Our own forecasts do incorporate a modest lift in domestic inflation pressures in time. Ultimately, this highly uncertain inflation outlook is likely to keep the RBNZ watchful. For now, we expect this week’s Q4 CPI figures to show annual inflation holding steady, with signs of a lift in price pressures beyond housing still only tentative at best.
When we take a look at what has been driving GDP growth over recent years, we are left with the clear impression that the economy will require a reasonable lift in productivity performance if recent GDP growth rates are to be maintained. It is entirely possible that will occur, but it is hard to have strong conviction, given weak productivity trends both here and abroad. It doesn’t mean we are bearish on the domestic growth outlook, but we do see a more modest pace of growth occurring going forward, lower than official projections. In data this week, the QSBO is likely to show a hit to sentiment, but perhaps not as much as our own Business Outlook. Housing market figures may show further stabilisation, while three of our proprietary indicators (Monthly Inflation Gauge, Truckometer and Commodity Prices) will help form views on how growth, inflation and local farm-gate returns finished 2017.
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