STATE OF THE NATION – DECEMBER 2018
Economic Update from Liz Kendall – ANZ Senior Economist
Economic momentum has softened since 2016 and the economy is grappling with headwinds. Businesses are wary about the future, rising costs are squeezing profits, and credit is a constraint for some. At the same time, engines of economic growth are not revving as they once were: population growth is slowing, construction activity is constrained, the housing market has softened, and the shine has started to come off our commodity prices of late. After a decade of expansion, the cycle is getting long in the tooth and growth is becoming more difficult to achieve.
And yet despite these challenges, the New Zealand economy has shown considerable resilience. GDP grew 2.8% over the year to June – only a little below where we see trend. And in the September quarter the unemployment rate fell to 3.9% - the lowest level in more than a decade. Following strong growth in the economy over the past few years, resources are currently stretched. The labour market is “tight” and it is difficult for firms to find labour. Given this strong position, the labour market looks in good stead to weather a softening in activity.
Softer economic growth is expected through the second half of 2018, with businesses expected to be cautious about investment in the short term. However, an improvement in business conditions is expected to see growth in business investment improve through 2019, particularly in light of capacity constraints.
A number of factors continue to support the economic cycle. Financial conditions remain supportive, particularly for households given recent declines in mortgage rates. And the strong labour market is expected to continue to support consumption, with households judging that it is a good time to spend. Fiscal spending is also expected to support growth, although only modestly, with the Government prioritising prudence over promises. Moreover, the global environment remains supportive for New Zealand, with the terms of trade still elevated, despite some softening in commodity prices. On the whole, we expect to see growth of around 2.5‑3% y/y over the coming few years – a robust pace, albeit a little below where we see trend.
With resources in the economy stretched, conditions are in place for wage and price inflation to increase. But in our view, it may be difficult for the economy to grow above trend and to sustain inflation at target over the medium term. Resource pressures are expected to linger around current levels, rather than intensify, and domestic inflation is expected to improve only gradually.
Inflation is currently running at 1.9% y/y, boosted by a range of factors, including oil price increases, recent exchange rate depreciation, and increases in the minimum wage. However, the impact of these factors is expected to be only temporary. Indeed, we have seen oil prices in global markets fall considerably over the past month while the exchange rate has appreciated, both of which are expected to flow through into lower petrol prices.
Looking through temporary factors, core inflation remains low and a little below the RBNZ’s target midpoint. The RBNZ will continue to look through transitory influences affecting inflation and remain focused on the medium-term trend in inflation. In particular, the RBNZ will want to see a sustained increase in core inflation and expects to keep the OCR on hold for a considerable period to see this happen. On current projections, the RBNZ expected the OCR will be on hold until the second half of 2020.
The resilience of the labour market and strong starting point for the economy has given the RBNZ more assurance regarding the outlook for inflation and risks to the outlook are now considered balanced, rather than skewed to the downside. On the one hand, there is a risk that inflation is stronger than expected if recent factors weighing on inflation dissipate or if margin squeeze encourages business to pass through more of their costs to higher prices. But offsetting this, risks to the activity outlook remain. Firms’ intentions regarding investment and hiring are very weak, which could weigh on the outlook more than expected. At the same time, the global outlook is expected to remain positive, but risks have increased that could have important implications for New Zeeland as a small, open economy.
We currently see the OCR on hold for the foreseeable future, in contrast to the RBNZ’s own expectations for eventual hikes. In our view, it will be difficult to sustain inflation near target over the medium term, given the headwinds facing the economy. It is not that we literally think that the OCR will be on hold forever, but risks appear to be broadly balanced and we are not convinced that the next move is necessarily a hike. We are mindful of risks on both sides of the ledger. If inflation picks up more quickly than expected, then a cut may be required. But if the economy underperforms, then more monetary stimulus may be needed.
This material is provided as a complimentary service of ANZ. Whilst care has been taken preparing this document, ANZ cannot warrant its accuracy, completeness or suitability for your intended use. Its content is for information only and is not personalized financial advisor service under the Financial Advisors Act 2008. The material is subject to change and is not a substitute for commercial judgement or professional advice. To the extent permitted by law ANZ disclaims liability or responsibility to any person for any direct or indirect loss or damage that may result from any act or omissions by any person in connection with this material.