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Cablegate: New Zealand Reacts Cautiously to U.S. Economic

VZCZCXRO2236
PP RUEHNZ
DE RUEHWL #0020/01 0280227
ZNR UUUUU ZZH
P 280227Z JAN 08
FM AMEMBASSY WELLINGTON
TO RUEHC/SECSTATE WASHDC PRIORITY 5019
INFO RUEHBJ/AMEMBASSY BEIJING PRIORITY 0381
RUEHBY/AMEMBASSY CANBERRA PRIORITY 5077
RUEHUL/AMEMBASSY SEOUL PRIORITY 0282
RUEHKO/AMEMBASSY TOKYO PRIORITY 0682
RUEHNZ/AMCONSUL AUCKLAND PRIORITY 1606
RUEHDN/AMCONSUL SYDNEY PRIORITY 0630
RHHMUNA/CDR USPACOM HONOLULU HI PRIORITY
RUCPDOC/USDOC WASHDC PRIORITY 0210
RUEHRC/DEPT OF AGRICULTURE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY

UNCLAS SECTION 01 OF 02 WELLINGTON 000020

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EAP/ANP, EEB, INR, STATE PASS TO USTR, PACOM FOR
J01E/J2/J233/J5/SJFHQSTATE

E.O. 12958: N/A
TAGS: ECON EFIN ETRD PGOV NZ
SUBJECT: NEW ZEALAND REACTS CAUTIOUSLY TO U.S. ECONOMIC
DOWNTURN


1. Summary: New Zealand politicians along with its Reserve
Bank reacted cautiously last week to the news of a possible
downturn in the U.S economy and its potential impact on the
New Zealand's economy. Attempting to soothe the concerns of
the equity and export markets, the Prime Minister and the
Finance Minister tried to reassure the public that NZ was on
safe economic ground and its fiscal and monetary policies
were capable of adjusting to any nearterm challenge. The
Reserve Bank of New Zealand (RBNZ) continues to see inflation
as the greatest foreseeable threat to the NZ economy and
decided to keep pressure on inflationary forces by continuing
to maintain its tight monetary controls (i.e., highest in
industrial world.) Several New Zealand economists are also
proposing that the Asian economies, which have generated most
of the world's growth in recent years, have enough momentum
of their own to shrug off at least a short drop in NZ exports
to the U.S. End summary.

GNZ Officials Downplay Negative U.S. Economic News
--------------------------------------------- -----

2. Reacting to a two-week downturn in New Zealand's equity
markets and fears of a possible recession in the United
States, Prime Minister Helen Clark last week publicly
extolled the resilience of the New Zealand economy to help
ease investors' jitters. The New Zealand Stock Exchange's
(NZX) index of its top 50 domestic companies, the so-called
"NZX 50" finished last Wednesday in positive territory for
the first time since its fright along with other world
financial markets over recession predictions in the United
States, closing eight points or 0.2 percent higher after
Tuesday's initial dramatic losses. The NZ Cabinet also
discussed the turmoil on world markets at its first meeting
of 2008 on Thursday (1/24). Noting that the New Zealand
market had reacted positively to the U.S. Federal Reserve's
announcement of a rate cut, PM Clark said New Zealand was in
good shape to weather this bout of international volatility.
According to the PM, "the country had had years of good
growth, low unemployment and skills shortages, and the net
debt position was in 'very, very good shape', conditions that
were the opposite of recession." "And we're in a resilient
position compared with where New Zealand has been in past
periods of shock so we are not unaffected, but we are more
resilient than many," she said.

3. Minister of Finance Michael Cullen has also been talking
down any risks to New Zealand's economy, saying talk of
global recession has been "over-hyped" and it is still too
early to see what kind of impact the U.S. crisis might have
for New Zealand. Cullen has promised that the 2008 Budget
will not include anything that might exacerbate domestic
inflationary pressures. If on the other hand the economy
does take a downturn, the Finance Minister has at his access
a budget surplus of NZ$1.5 billion (US$1.2 billion) worth of
possible tax cuts as potential fiscal stimulus.

4. RBNZ Governor Alan Bollard used his annual speech to the
Canterbury Employers Chamber of Commerce on Friday (1/25) to
reflect on some of the economic shocks New Zealand has had to
contend with recently. He attempted to ease market fears by
saying the country is enjoying its longest (but not
strongest) expansion since World War II, accompanied by low
inflation which has averaged 2.2 percent over the past 10
years but he cautioned that the reduced volatility in both
prices and growth should not be taken for granted. He
maintained that the challenges the Reserve Bank faced today
sprang in part from the growing importance of China, India
and other rapidly industrializing countries in the world
economy. Their demand for fuel has seen oil hit US$100 a
barrel this month and these higher oil prices have added 0.5
percentage points a year to inflation since 2004. The
emerging economies' demand for oil is not the only factor in
any new price shocks the Bank has had to think about - there
is also the issue of "carbon pricing." While acknowledging
that much of the damage to the climate came from the
accumulated stock of greenhouse gas emissions mainly from the
advanced economies, it was the emerging economies which would
contribute most to emissions in the future, Bollard said.
The Government's principal policy to combat climate change is

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an emissions trading scheme which will raise petrol and
diesel prices from the start of next year and electricity
prices from 2010. The bank estimates these measures will add
0.25 percentage points to inflation next year and 0.35 in
2010.

5. In last Thursday's Monetary Policy Statement (MSP), the
Reserve Bank of New Zealand (RBNZ) announced that its
Official Cash Rate (OCR) would remain unchanged at the
current level of 8.25 percent (one of the highest official
rates in the developed world). Dr. Bollard, in releasing
January's MSP said, "on balance, the outlook for interest
rates is little changed from the December, but the level of
uncertainty in the economy has increased." He further stated
that, "although the consumer price index (CPI) level of
inflation is expected to remain above 3 percent during 2008,
we believe that the current level of the OCR remains
consistent with future inflation outcomes of 1 to 3 percent
on average over the medium term." (Translation: RBNZ not
likely to change OCR in the medium term in 2008.) He based
his opinion on the expectation that the New Zealand housing
market will continue to cool and the labor market will remain
tight at 2 percent unemployment, while domestic income growth
is expected to remain strong, especially from dairy exports
with core inflationary pressures still persistent. The
Governor took special note of the ongoing turbulence in
international financial markets and deterioration in the
outlook for the United States and European economies. He
said he will be watching these developments closely,
particularly their implications for the Asian and Australian
economies and their effect on world commodity prices.

Strength of Asian Economies May Cushion New Zealand Economy
--------------------------------------------- --------------

6. Brent Layton, chief executive of the New Zealand Institute
of Economic Research said he remains optimistic for the NZ
economy's prospects. He maintains that the U.S. slowdown
would not amount to a full-blown recession. He is a
proponent of the "decoupling theory" that proposes that the
Asian economies, which have generated most of the world's
growth in recent years, have enough momentum of their own to
shrug off at least a short drop in NZ exports to the U.S. He
said, "I don't think Asia will slow a lot, hence the impact
on Australia (NZ biggest trading partner) will not be so
great, thus helping New Zealand." "Share markets volatility
reflected uncertainty," Dr. Layton said. "They were not
always a reliable barometer of true economic outlook." "It
is only a very small proportion of the total value of
equities that gets traded on any day," he said. "You can
have large movements which affect the value of the market but
only a small proportion of players are participating." Tony
Alexander, chief economist of Bank of New Zealand is
predicting the NZ economy will grow at a weak rate of below 2
per cent this year. Per Alexander, "there will definitely be
an impact but there is some insulation," he said, citing the
dairy boom, infrastructure spending, job security and wage
growth, the prospect of tax cuts and level of businesses
investing. Any fall in local fixed-term mortgage rates would
be limited, Mr. Alexander said, when U.S. interest rates
began to rise again later in the year as concerns about
inflation came to the fore again.

7. Comment: The magnitude of the impact of a U.S. economic
slowdown on New Zealand's economy will depend on how long it
lasts and how much validity there turns out to be in the
theory of "decoupling". That is the extent to which the
Asian economies, which have generated most of the world's
growth in recent years, have enough momentum of their own to
shrug off at least a short drop in NZ exports to the U.S. If
NZ is sufficiently "decoupled" from the U.S. market then the
impact on commodity prices (particularly dairy), whose
current strength underpins the growth prospects for New
Zealand, should be modest. End comment.
MCCORMICK

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