It is now universally accepted this is a non-traditional New Zealand recovery. Consumption and residential housing were never going to be driving forces of the next wave of growth. Remember our comment at last year’s Roadshow: If New Zealand doesn’t have an export-led recovery this time we probably won’t have a recovery.
That was said largely for dramatic effect. At that time we were still expecting growth of around 0.5% per quarter, or 2% per annum, over the course of 2010 and early 2011. Over the last 6-months even these miserly forecasts have proven to be wildly optimistic and will probably prove to be optimistic for the December 2010 quarter as well. So our dramatic comment has actually turned out to be somewhat prophetic. I’ll now claim that as a win!
The news is not all bad however. If people aren’t spending, they are saving or at least retiring debt. While that’s bad for growth and jobs right now, it strengthens the medium term outlook. It is also important in terms of reducing the financial and economic vulnerabilities the Savings Working Group was talking about in its report also released this week.
According to statistics compiled by the Reserve Bank of New Zealand, household indebtedness is on the way down. After peaking at 159.3% in Q4 of 2008, household claims as a percentage of nominal disposable income is down to 153.5% as at Q3 2010. That’s a modest improvement but at least it’s heading in the right direction: This ratio was only 57.9% in 1991.
Household’s focusing on retiring debt makes it tough out there for the retail and residential building sectors, and it is likely to remain tough for some time. The Rugby World Cup and rebuilding in Canterbury following the earthquake will provide a boost to activity later this year.
It remains to be seen whether those growth-positive factors will provide a kick-start to growth or if it comes back to a lower level afterwards. That will depend on household behaviour at the time, especially with regards to the comfort or otherwise of individual households with their balance sheet positions.
At this point I’m taking a conservative view on post-RWC and Canterbury rebuilding growth by assuming that household deleveraging will still have further to play out. That doesn’t mean we go back to no growth like the last six months, but it seems to me that it will remain tough going once those positive factors begin to wane.
For stronger growth we are reliant on exports – more so than ever before. That’s good for rebalancing of the economy as resources inevitably shift from the non-traded to the traded goods sector. The reality is that transition would always take time and there would be casualties along the way.
It seems to us that an important part of that process is strong growth in business investment. Here’s another reason to be optimistic: As we said at the release of the disappointing Q3 2010 GDP result just before Christmas, the only positive piece of news that day was strong business investment. More recent merchandise trade data shows strong growth in imports of capital goods. I like that.
Export values have been strong recently, but that has been a price (terms of trade) rather than a volume phenomenon. Strong terms of trade helps incomes (i.e. nominal rather than real GDP). Strong incomes mean strong profits. That’s good for investment.
The obvious question is what does this mean for monetary policy? I’ve given up trying to predict when the tightening resumes, but some things we said a year ago still hold. Given the nature of the recovery, both in terms of pace and sectoral mix, a lower interest rate cycle appears likely this time around.
We also said last year that a level of around 4.5% on the Official Cash Rate, its pre-Global Financial Crisis low, was a good place to head for. We still think that’s the case. Critically, whether that turns out to be enough will depend on the extent to which the Reserve Bank is sufficiently pre-emptive in hiking rates. That’s inevitably going to be a tough call.
All we really have to guide us at this point is the assumption that potential GDP is now lower than it was before, meaning inflationary pressures will start to build at a lower level of growth. That’s some help in working it out, but not much. At this point all we can really say is second half of this year seems likely for the next hike in rates. It’s impossible to be more precise than that at this point.
We have believed right from the start of the GFC recovery that given the recession was structural, the recovery would also be structural. That means some of spare capacity out there in the economy may well be redundant capacity. In particular, we think skills shortages will emerge earlier (i.e. at lower level of growth and a higher level of unemployment) than we saw in the previous cycle. But after today’s labour market result, we won’t have to worry about that for a while yet.
The other unknown is the extent to which fiscal policy does some of the stimulus-reduction work when required. The more work fiscal policy does, the less work monetary policy has to do via interest rates. This will, in turn, keep pressure off the exchange rate. The May Budget will provide further guidance in that regard.
In summary – if you think it’s tough out there, you’d be right.