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Recovery on track despite headwinds

Recovery on track despite headwinds

The NZ economy continues to strengthen, with growth on course to hit 3.5% over the next year.

Recent falls in dairy prices and the strong NZD are small flies in the ointment.

The RBNZ will continue raising rates, but the cycle will not be overly aggressive.

New Zealand’s economy continues to strengthen, according to the latest ASB Quarterly Economic Forecasts, with lifting construction activity and dairy incomes from an exceptional season providing a further boost.

ASB Chief Economist Nick Tuffley says, “The economy remains comfortably on course for 3.5% growth over the next year. Construction and dairy remain key drivers, but the recovery is broadening beyond just those areas.”

The housing market has started to cool, but there are structural factors that will partially offset tighter monetary policy. “Net migration flows are boosting population growth and increasing demand for housing,” says Mr Tuffley. “That means house price inflation will slow gradually rather than abruptly in the centres that have been running hot.”

But there are two notes of caution to New Zealand’s economic performance. First, dairy prices have fallen quite rapidly in recent months, down 20% in the Global Dairy Trade auctions.

“Some softening was to be expected from 2013’s lofty levels, but the pressure has been greater and sooner than anticipated,” says Mr Tuffley. “It is important to remember though that the commodity story is not solely defined by dairy. Meat and forestry exports are also benefitting from improved demand.”

The second fly in the ointment is the NZ dollar, which remains stubbornly high and is maintaining pressure on exporters.

“Even as dairy prices were already falling, the NZ dollar Trade Weighted Index hit a post-float high at the start of April,” says Mr Tuffley. “The flipside is that a sustained higher currency would make the RBNZ more cautious about lifting the OCR.”

And with the RBNZ having now kicked off its hiking cycle, the question of how many hikes will be necessary is of paramount importance.

“We revised up our OCR forecast to a peak of 4.5% from our long-held view of 4% after the March Monetary Policy Statement. In a recent paper we looked very closely at a number of key influences on how far the OCR is likely to rise during the tightening cycle and remain comfortable with our 4.5% view.”

That is lower than what the RBNZ’s most recent interest rate forecasts imply. “But in our judgement, higher interest rates will be very potent in restraining borrowing growth and containing rising house prices. This will in turn keep inflation sufficiently in check,” Mr Tuffley concludes.

ENDS


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