Economic - Commercial

​​STATE OF THE NATION - JUNE 2018

Economic Update from Liz Kendall – ANZ Senior Economist

The economic outlook remains positive, underpinned by a number of supportive factors: 

• The terms of trade remain high, with commodity prices elevated. This is supporting national incomes and the NZD (although interest rate differentials have encouraged some recent depreciation). 
• Immigration remains elevated, but is declining gradually. Strong rates of population growth will continue to support consumption and GDP growth.
• While Budget 2018 emphasised prudence over promises, fiscal policy is expected to support economic activity. Pressure on spending is likely to continue; the economy grapples with an infrastructure deficit in the face of recent population growth.
• Monetary policy is expected to remain accommodative for an extended period.

Nonetheless, the economy is grappling with some challenges.

• Firms remain pessimistic, with concerns about the economic environment lingering beyond the election. This is consistent with some softening in near-term GDP growth, which may also weigh on employment and investment.
• Housing affordability concerns and high debt levels are dampening household sentiment, and will weigh on the housing market and consumption.
• The economy is grappling with late-cycle headwinds, with capacity constraints, cost increases, margin pressure and credit constraints all evident. 
• Global conditions have moderated slightly. As a small, open economy, New Zealand is often buffeted by external events. Since the start of 2018, financial market volatility has increased, global liquidity has tightened, and activity indicators have softened. Nonetheless, we expect that global growth will remain above trend.

In light of these challenges, the economy is expected to continue growing at (but not above) its trend pace of 2-3% over the medium term. Some recent drivers of economic activity have reached their limits and are unlikely to contribute significantly to growth from here, including migration, construction and tourism.

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Late-cycle headwinds will continue to temper the outlook, although we are not seeing inflationary pressures that would usually be evident this late in the cycle, necessitating higher interest rates and contributing to a sharper downturn. Credit is not expected to be a significant headwind to growth, but bank prudence is expected to continue. And firms are likely to remain cautious in the face of rising costs and margin pressure. Capacity pressures are expected to tighten further and labour shortages are acute, particularly in industries like construction. 

The housing market – which typically moves in line with broader spending – has moderated, with prices pressures and activity expected to remain broadly stable. That said, the labour market is strong, which bodes well for household income growth and consumption. We expect consumption will continue growing at moderate rates, but that household will rebuild their saving buffers in light of housing affordability and debt constraints.

Capacity pressures are expected to lead to higher inflation in time. Higher labour costs are expected to contribute to this, with the labour market tight and Government policies supporting an increase in wage expectations. At the same time, we expect the NZD to face more downward pressure on narrowing interest rate differentials, which will also give inflation a nudge. But with wage inflation weaker than one might usually expect, the outlook is uncertain. And the forces dampening inflation are expected to dissipate only slowly.

Inflation is expected to lift towards 2%, albeit gradually. The OCR is expected to rise eventually – we are pencilling in a hike in August 2019. But a lot can happen between now and then, and the RBNZ will be cautious, waiting to lift rates until it sees a definite broadening in inflationary pressure. For now, with evidence of a lift in domestic price pressures lacking and the outlook uncertain, the OCR remains firmly on hold.

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