STATE OF THE NATION – MARCH 2019
Economic Update from Liz Kendall – ANZ Senior Economist
International economic developments have been in the spotlight of late. Global growth is slowing and downside risks have increased. In particular, Australia and China – our two largest trading partners – are experiencing softening growth momentum. The Australian housing market continues to extend recent price declines, with credit headwinds and housing oversupply weighing on the market, particularly in major cities. This housing market weakness has the potential to weigh on household spending, especially given current low income growth and high debt levels.
Chinese demand is softening (and likely more so than official data suggests). As a key trading partner, developments in China tend to have important implications for New Zealand, particularly our commodity prices. So far, our commodity prices have continued to defy gravity, in part reflecting supply dynamics. But while we expect that the outlook for our export prices remains positive, especially in a medium-term sense, further weakening in Chinese growth could weigh on commodity prices going forward, particularly since these effects are sometimes seen with a lag.
Meanwhile, US-China trade tensions are dampening global growth and creating uncertainty, with the potential for more market pressure points. Manufacturing activity is feeling the strain, in particular, with European data particularly weak. As global risks have increased, central banks have turned more cautious: the PBOC has been easing policy, the Fed has indicated that rate rises are on hold for now, and the RBA has struck a more cautious, neutral tone.
Domestically, the RBNZ has become more cautious too, signalling that the next move in the OCR could be up or down. In the February MPS, the RBNZ indicated that it expected to keep the OCR on hold for even longer – until mid-2021 based on their projections – given some softening in the domestic outlook. The RBNZ highlighted downside global risks on one hand, and upside inflation risks on the other, with risks considered fairly balanced. The RBNZ’s more cautious tone was largely as expected, though we think a case could be made for an even more dovish tone, given building risks to both the domestic and global outlook.
In our view, the New Zealand economy has lost momentum and it will be a struggle for GDP to grow above trend. This will make it challenging to see inflation return to target and for the labour market to improve further. The starting point for the labour market is very positive; capacity constraints are being felt and inflation is edging up. But the economy is also grappling with a number of headwinds, and we suspect that the peak in resource pressures may be behind us. Fiscal stimulus is expected to provide a small boost to growth, while household spending continues. But the impetus to growth from migration and construction is waning, the housing market is stable, businesses are cautious (especially about profits and availability of credit), and credit conditions look set to tighten (due to probable increases in bank capital requirements).
We expect that OCR cuts will eventually be required to see inflation return sustainably to target with the labour market remaining near maximum sustainable employment. We have pencilled in the first cut for November this year, with two follow up cuts expected over 2020.
However, we see risks to the outlook on both sides, with these considered to be balanced at present. Ructions in financial markets or a more pronounced softening in global growth could see the OCR cut sooner than we anticipate – especially if commodity prices start to falter. But on the other hand, it is possible that the RBNZ could have more breathing room if inflation increases more than we currently expect. Firms are experiencing margin pressure, and this could see them start to slaw back profits through higher prices, though in our view this is unlikely without a meaningful acceleration in demand, given the overarching theme of caution amongst firms.
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