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NZ Growth To Slow Down - BNZ Weekly Overview

Headline article from the latest BNZ Weekly Overview.

NZ Growth To Slow Down

This week’s WO has been sent one day early due to tramping requirements.

The view we have held for a long time now has been that the strong growth in the NZ economy achieved over 2002 would not be sustained over 2003. Our expectation has been for growth slowing from the officially reported 4.4% over 2002 to about 2.5% this year for the following reasons.

1. The stronger exchange rate cutting into export incomes.
2. Dryish weather conditions.
3. Lower commodity prices.
4. An easing off of net migration gains.
5. Ending of a period of catch-up durables expenditure by farmers then eventually urban dwellers.
6. Feed-through into the cities of the rural income decline.
7. Still weak growth overseas for the first half of 2003.
8. Risks attached to terrorism/war.

But in spite of these negatives we have been expecting good support from the likes of the following.

1. Continued below average interest rates this year.
2. Strong population growth.
3. Residential construction.
4. Booming foreigner education.
5. Accelerating world growth from mid-year.
6. A tight labour market underpinning the willingness of consumers to spend.
7. Higher house prices boosting spendable wealth.

Over the past month we have seen a whole range of factors appear suggesting a slowdown in growth will most definitely occur, and if one is willing to believe there is more than just war worries at work then the slowdown could be more than we are forecasting.

Overseas we have seen bad labour market data in the United States plus consumer confidence falling to a ten year low, weak business capital expenditure plans, and growing worries about a ballooning budget deficit and the implications for long term interest rates and exchange rates. In Europe the labour market is weak, businesses appear to be undergoing a round of restructuring and there are worries not just about the war but about the impact on export growth of the Euro’s rise against the greenback. In Japan there remains no sign that consumers are going to boost their spending, the sharemarket recently fell to its worst level in 20 years, the rising Yen will crimp export growth, and hopes of new stimulatory policies from the new Bank of Japan Governor look like being dashed.

Thankfully in Australia the view of slowing growth has not really altered to any great extent recently and there are hopes of a big rebound in agricultural production from late this year as the weather returns to normal. In the UK consumer spending remains robust though the housing market is a source of risk.

Locally we have seen both consumer and business confidence measures fall away sharply. The dry conditions in some parts of the country have intensified to the point where the term drought now seems more appropriate and farmers are very worried about production for next season. Yet another electricity crisis has come along with some businesses cutting production and consumers being invited to boost savings.

Then there is the growing risk of war in Iraq stretching on for longer than people have been hoping – or perhaps myopically expecting given the lack of first world experience of large scale wars for a few decades. And we mustn’t forget SARS which has led to all schools being closed in Singapore, closures and fear in Hong Kong, cancellations of international travel, and a world-wide search by scientists to try and determine what the virus is. The impact of SARS is already being felt in the airline industry, forecasts for growth in Asian economies in the coming year are being revised down between 0.5% and 1.5%, and it is inevitable that just as has happened in Australia we will see a case arrive in New Zealand. Already the Health Minister is talking about asking tour groups from infected countries in Asia not to come to New Zealand. We get around 27% of our tourists from Asia (18% non-Japan) and send about 34% of our merchandise exports there (23% non-Japan).

At this stage there is not that much solid evidence of a slowing in NZ economic growth, just horrible sentiment readings suggesting pain lies ahead.

1. Merchandise export receipts have fallen 6.4% in the year to February, but the trade weighted index has actually risen 11% over that period so there is still volume growth going on.
2. Adjusting for exchange rate changes, imports of non-transport capital goods were however quite weak in the three months to February, up only 1% from a year ago.
3. The annual rate of growth in dwelling sales slowed to 10.2% in February from an average 28% in the previous six months. But there has been only one stronger February month on record and a lot of the slowdown can be put down to listings shortages possibly.
4. In the three months to February the number of consents issued for new dwellings to be built was down 6.2% seasonally adjusted from the previous six months. But this is entirely because of a pullback in soaring apartment consent issuance. Focussing just on houses the change was a very strong gain of 21%.
5. The annual rate of growth in household debt accelerated to 9.9% in February from 9.7% in January and at $719m the increase in debt during the month was $227m better than the February 2002 rise.
6. In the farming sector there are definite signs of spending falling. Farm sales in the three months to February were 19% down from a year earlier. The value of farm building consents in the three months to February was down 39% from a year ago.
7. Registrations of commercial vehicles remain strong, up 15% in the three months to February from a year ago.

But as mentioned, sentiment indicators are bad. The NBNZ Business Outlook revealed that in the first half of March a net 33% of businesses had a negative economic outlook for the coming year. The One News Colmar Brunton poll showed a net 18% of consumers with the same pessimistic outlook.

The picture is not one of the NZ economy risking heading into recession, far from it. As noted we have good support for growth from the various factors listed above. The anecdotal feedback we are receiving also shows businesses continue to experience reasonable levels of demand. Business balance sheets are also in good condition so a round of restructuring to cut costs as an environment of weaker demand develops is not likely. But downside risks have intensified, and while we have tended to base those risks in recent weeks around a possibly protracted conflict in Iraq, the greater threat may actually be from SARS.

This means there is a good chance that the Reserve Bank will ease monetary policy this year. But such an easing is still not a foregone conclusion. For the moment the exchange rate has stopped rising, net inward migration has accelerated and looks like coming in well above the 20,000 factored in by the Reserve Bank for this year, and we have no feedback suggesting capacity pressures are easing. We will get a good update in this area in a couple of weeks when the NZIER release their next Quarterly Survey of Business Opinion.

And anyway, if businesses are not having cash flows greatly constrained by interest rates because they are cash rich through low capital expenditure recently then lowering interest rates won’t have much impact. Plus the differential between NZ and US interest rates is going to remain huge all this year no matter what the RBNZ does so the upward pressure on the exchange rate is unlikely to reverse any time soon and ease the pain for exporters. (More accurately it is not pain as such that exporters are experiencing except maybe those sending goods to Australia, its more the absence of an undervalued currency they are having to come to grips with.)

Our advice to businesses is to tread cautiously in this environment given not just the outright negative factors in play but the risks surrounding SARS, war and electricity supply in particular. Continuing to build cash reserves seems a good idea, but keeping an eye out for discounted vitally needed machinery would also be a good idea because once a more solid growth scenario appears capacity will be in potentially very short supply. As stated in the last slowing of growth over 2001 we also think taking advantage of any easing in the tight labour market to get skilled and motivated people on board would be a wise investment in the future. Similarly not letting them go if things do slow down appreciably might also be a good idea.

For exporters we don’t think there should be strong expectations of a retracement in the NZD in the near future. The weaker the world economy looks the greater the downward pressure on the USD mainly and the better some of our indicators like migration will and relative interest rates will appear. Exporters should look for the periodic temporary retracements in the NZD to get cover on board for the next 12 months, perhaps with less need for those exporting to Australia given the NZD is already well overvalued against the AUD.

Borrowers are likely to continue to face an environment of very low long term interest rates as long as the war in Iraq persists. But given the potential for these rates to jump sharply should things suddenly end quickly in Iraq we retain our view that taking the bird in the hand of already low rates versus two in the bush of rates potentially even more generous is a wise idea.

For investors this is a difficult environment in which high volatility in share prices is likely for quite some time. Returns on cash, bonds and term deposits will be low while property investments will not suit everyone. Frankly sometimes you have to admit your returns will be poor and accept the fact rather than taking on more risk. In this situation you face two choices. Either cash up as some people are doing from managed funds, take one’s losses and settle into low interest earning securities including cash. Or remain in for the very long haul in expectation of returns still averaging around 3.5% real after tax in the sharemarket. One thing to look out for may be the rising NZD moving into well over-valued territory at some stage. When it does – say over US 62 cents if it gets there – then shifting funds offshore might be wise in expectation of the NZD trending downward over the long term to reflect NZ’s poor economic fundamentals which are well canvassed most weeks in one newspaper or another.


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