STATE OF THE NATION – JUNE 2019
Economic Update from Michael Callaghan – ANZ Economist
The New Zealand economy has been shedding momentum for a while now, and near-term indicators suggest this process has persisted into the first half of 2019. GDP growth has slowed from its recent peak of around 4.0% y/y in mid-2016 to just 2.5% in Q1 2019. But we don’t see the economy falling off a cliff anytime soon. Several tailwinds are supportive of moderate growth going forward, including solid commodity prices, some near-term fiscal support, and recent easing in interest rates and the NZD. That said, we don’t see any signs that activity is going to lift sharply soon either. Subdued business activity, a soft housing market, and global growth uncertainty are posing headwinds. Absent any adverse global shocks, we expect growth of around 2-2.5% y/y over the next year.
Domestically, households remain in good stead, supported by low unemployment, gradually rising wages, low interest rates, and for some, higher government transfer payments though the Families Package. This is despite activity in the housing market remaining subdued, with soft house sales and house price growth. Residential investment activity remains elevated, but we see downside risks looming in the sector given very weak residential construction intentions, deteriorating profit margins, labour shortages, and land constraints.
One bright spot for the New Zealand economy is that prices for our exports have held up remarkably well, despite slowing global growth. But for dairy in particular, part of the explanation lies with softening global supply. Recent NZD depreciation is expected to support export earnings, but with the global outlook fragile we suspect the pass-through to the rest of the economy will be a little more muted than otherwise. Deleveraging seems more likely than a spend-up.
One aspect providing a bit of a boost to the economy is fiscal policy, with the Government’s recent Wellbeing Budget adding a bit more spending than we had expected. That said, while government spending is expected to support growth in the near term, the impulse isn’t expected to be large or overly persistent. The Government appears adamant on sticking to its fiscal strategy and reducing net core Crown debt to 20% of GDP within five years of taking office. So long as this is the case, the ability for the Government to boost growth will remain contained. Beyond 2022, there is more scope for flexibility.
The Reserve Bank of New Zealand has also been in the spotlight recently, delivering a proactive rate cut in the face of the softening domestic and global outlook. Slowing growth and waning capacity pressures, and the soft signal for future inflation that this represents, were enough for the RBNZ to cut the OCR 25bps to 1.50% in May. While we’ve long held the view that the RBNZ will need to cut the OCR, they ended up doing so a little earlier than we expected.
The RBNZ’s rate cut has kept downward pressure on the NZD and has contributed to sizable falls in fixed mortgage rates, but we think more cuts will be needed to see inflation lift sustainably towards 2%. From here, the RBNZ’s expectation of a vigorous bounce-back in growth in the second half of the year looks set to disappoint. Hence, we expect another OCR cut in August and a follow-up cut in November, to take the OCR to 1%. This additional monetary stimulus should give the economy the boost it needs to support a gradual acceleration in growth over the next few years.
Globally, the growth outlook remains fragile and recent data show renewed softening following tentative signs of stabilisation. Global manufacturing and trade weakened markedly towards the end of 2018, but a few signs emerged that things had stabilised in the first quarter as US, euro area, and China GDP all beat expectations. More recently however, the data flow has softened once again. Industrial production and retail sales in both the US and China has recently disappointed expectations and euro area demand has remained soft. Renewed escalation in US-China trade tensions are unsettling markets and pose further downside risks to global trade and investment activity.
Softening growth globally has seen global central banks turn more cautious and signal easier policy stances. This has supported prices of risky assets, and easier global financial conditions should support activity and reduce the risk of a sharper deterioration in growth. But should the lengthy list of global growth risks materialise and manifest in sharply lower commodity prices, we expect the Reserve Bank of New Zealand will cut the OCR promptly.
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