STATE OF THE NATION – SEPTEMBER 2018
Economic Update from Liz Kendall – ANZ Senior Economist
Economic momentum has slowed and downside risks to growth have increased. GDP growth has slowed to around 2.5% from its recent peak of 4.5%, and there is a risk that economic growth will soften further in the short term. Business sentiment is subdued. Firms are grappling with a number of challenges, including credit constraints, capacity pressures, margins squeeze, and policy uncertainty. There are also some industry-specific challenges being experienced in the retail and construction industries.
Importantly, business pessimism appears to be flowing through into firms’ decisions, contributing to our expectations for GDP growth at (or a bit below) trend, along with moderate employment and investment growth. A key risk is that business pessimism lingers longer and has a greater dampening impact on the economy than we currently expect.
The shine has started to come off our commodity prices of late, against a backdrop of a softer global picture, which is particularly a concern in light of escalating global protectionism. As a small, open economy, New Zealand is often buffeted by external events, and global conditions have moderated slightly. Since the start of 2018, financial market volatility has increased, global liquidity has tightened, and activity indicators have softened a touch. Nonetheless, we expect that global growth will remain above trend.
It is fair to say that the domestic economy is experiencing a softer patch, but we don’t expect that growth is about to roll over just yet. The economy is grappling with late-cycle headwinds and recent drivers of growth are waning, including the impetus from strong house price inflation, construction activity and high rates of immigration. Spending growth has also been more moderate and the housing market has cooled.
We expect GDP growth will grow around trend over the next few years, with fiscal expansion supportive. While the Government is prioritising prudence over promises, the outlook is for fiscal policy to become slightly expansionary over the next couple of years, after being contractionary for some time. We also expect that income growth will be supportive, in part due to our still-elevated export prices. Financial conditions are accommodative, with RBNZ willing to act if the outlook deteriorates. The economy is expected to continue growing at (but not above) its trend pace of 2-3% y/y over the medium term – a respectable picture this late in the cycle.
Inflation is low in the scheme of things but core inflation is on the rise and cost pressures are increasing. The outlook for CPI inflation is being boosted by a range of transitory cost-push factors, including oil price increases, recent exchange rate depreciation, increases in the minimum wage and public sector pay settlements.
With growth slowing yet inflation rising, the monetary policy outlook has become a bit more complicated. Focusing primarily on CPI inflation in this environment runs the risk of missing important nuances about the policy response. We would emphasise that the RBNZ has the flexibility to “look through” rising CPI inflation to the extent that it is not expected to be permanent. The RBNZ is likely to focus on the trend in inflation, which we expect will increase only gradually. 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. Core inflation has increased but downside risks have not gone away, and should these materialise a cut would be firmly on the table. As a result, we expect that the RBNZ will be comfortable with a continued wait-and-see strategy, even as inflation lifts. The RBNZ will want to see core inflation much closer to the midpoint of the target band (or even an overshoot) before an OCR hike will be on the table, particularly given the softer activity outlook. We continue to pencil in late-2019 for an eventual hike, but a lot could – and probably will – happen between now and then.
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