Headline article from the BNZ Weekly Overview of February
Slowdown But Not A Recession
Growth in the NZ economy is going to slow down this year and its really a question of the extent of the slowdown. If the current dry weather continues and things turn completely to custard in Iraq then we could be looking at a nasty slump with growth still there but very low around 1% come late this year. But barring this bad case scenario our view is that growth will slow from an estimated 4.2% last year to around 2.5% this year, or about what it was over 2001.
The factors which will pull down our growth rate include the following.
A higher exchange rate.
The trade weighted index is currently around 19% above where it was a year ago and this year all up will probably average about 15% above 2002 levels and 24% above 2001 levels. Already we can see the effects of the higher exchange rate on the value of merchandise exports. These were down 5% in calendar 2002 after rising 12% in 2001 and 24% in 2000. In the December quarter export receipts were down 8.2% from a year ago. The now two month’s old NBNZ Business Outlook survey showed only a net 34% of manufacturers expecting higher export sales and with the exchange rate rising even more since then that proportion has probably dropped even more.
It is not just a simple export revenue effect reducing the spending of exporters which will come from the higher exchange rate. Capital expenditure will likely be negatively affected. Businesses are wary of the exchange rate rising further and in this environment will have doubts about the ability of their cash inflows to meet current projections and assist in early repayment of any debt taken on board to finance expansion.
Clearly this is something having a big negative effect around the world. The possibility of war has made businesses cautious about investing here and overseas and has kept a generally negative interpretation on economic data coming out of the United States in particular – even though some of these data releases have been quite good recently. We have noticed here in NZ that although business people are aware of the need for them to invest they are unwilling to do so in case the world goes into a war induced recession.
Related mainly to the Iraq issue but also reflecting the cold weather in the United States, strikes in Venezuela and low oil stocks oil prices have increased strongly in recent times. Petrol prices have increased in New Zealand and in a clear case of wealth transfer to the oil exporters will reduce the availability of income for other spending purposes in NZ. Additionally, fears of even higher oil prices are likely to be contributing to the weak business capital expenditure.
On top of the effects of the exchange rate rising strongly farmers are also being hit by dry weather conditions. Maybe more than that, for many the pullback in returns to more normal levels after two extraordinary seasons will come as a bit of a shock and could produce high caution regarding spending levels. At a minimum we will see the ending of the period of major catch-up spending on farm equipment, housing and home furnishings and appliances which so boosted regional economies over 2001-02.
On average over the past ten years our top 14 trading partners have grown by 3.2% per annum. Last year they managed just 2.8% and this year again just 2.8% is expected. This suggests less than average scope for growth in export volumes.
In the December quarter, according to the NZIER’s Quarterly Survey of Business Opinion, capacity utilisation was at a 29 year high. The relative dearth of capital expenditure on plant and machinery over 2002 suggests this situation could get worse before it gets better, placing upward pressure on costs and directly restraining the ability of firms to meet orders. Similarly, a gross 16% of businesses in the survey cited labour as the main constraint on their ability to grow. This is also the highest level in 28 years and from newspaper reports we know is constraining the ability of firms to grow all around the country.
Three nil down and it will be hard for the NZL82 crew to win from here. The defence of the Americas Cup has probably brought $1b or so of extra spending into NZ over the past few years. The absence of this spending will not be a major factor in the country’s overall gross domestic product but is a negative nonetheless.
Last year there was a net gain to the NZ population from permanent and long term migration flows of 38,200 people. One of the key drivers of migration flows appears to be our growth relative to growth in our trading partners. That gap will close this year and in fact reverse if our GDP forecast is correct and our trading partners grow at the consensus pick of 2.8%. Given geopolitical concerns overseas we still expect to see a firm population gain from net migration flows this year, but the magnitude of the gain will probably be nearer 30,000.
Confidence measures can change quickly, but we enter 2003 with consumers feeling worried about the future. Only a net 4% of respondents to the monthly Colmar Brunton survey said they feel the economy will be in a better state in 12 months than it is now. This is down from 21% at the same time a year ago, 11% in December, an average of 16% over 2002 and a long term average of 15%. The result suggests slowing growth in retail spending and housing.
But with all these negatives around and the potential for soaring oil prices from an Iraqi conflict pushing the world into recession, why do we still expect near 2.5% growth in NZ this year?
Although household debt increased by 9.3% over 2002 average house prices rose 10.4% so household balance sheets got stronger last year. Not only that but this year we expect further price gains averaging between 5% and 10% as investors seek a safe haven, migration flows remain positive, interest rates hold below average, and supply takes a while to catch up with demand. Rising house prices will tend to underpin the willingness of consumers to spend from their rising wealth.
In the December quarter the number of consents issued for new dwellings to be built was up 50% from a year earlier and 24% seasonally adjusted from the September quarter. This pace of growth certainly will not continue, but even as it eases off we expect strong house and apartment construction all this year. The main weakness will come late in the year as supply rises strongly while factors mentioned above act on underlying demand.
We believe the average person is aware that the labour market is in their favour as an employee and the expectation of continued employment will tend to underpin willingness to spend.
Although migrant inflows will slow we still see a gain equal to about 0.75% of NZ’s population. This will underpin housing and retail spending.
There is no sign yet that this sector is slowing to any major degree and in fact some light evidence exists of increased enquiries in light of war concerns and worries about safety in even the United States.
Average Interest Rates
We don’t expect the Reserve Bank to start tightening monetary policy until 2004 and there is even a chance that they will cut the official cash rate 0.5% by mid-year. If they do the floating mortgage rate will fall to near 7.35% from 7.85% currently. Fixed interest rates risk jumping up sharply once concerns about war and world growth end. But until that happens home buyers will be encouraged by low debt servicing costs.
While the rising exchange rate is clearly a drag, believe it or not there is some insulation for farmers coming from some improvement in commodity prices overseas. The ANZ export commodity price index in world price terms has risen in each of the past six months with the dairy products index up 36%. Wheat and barley prices have climbed strongly because of drought in Australia, and that same factor plus weather conditions in the United States is underpinning beef prices. This is not really an outright positive, just a small amelioration of the overall decline in farm incomes underway for this season.
Rising Real Wages
Over the past two years average real wage rates have fallen by about 0.3%. This year with inflation around 2.0% expected and wages growth over 2.5% we will see some boost to average hourly earnings. This has been a long time in coming and will be interesting to watch. Recently one large union put in a claim for an extra week’s annual leave and a 5% wage increase.
Overall the negatives outweigh the positives and growth will slow. But the positives are strong enough to leave us forecasting over 2% growth this year. The slowdown in growth from around 4.2% last year is likely to be felt most keenly in dairying regions because of the big fall in the payout.