Tuesday, July 7, 2015

Revising the outlook for NZ growth and monetary policy

Recent weak data on dairy prices, business investment and business confidence has seen us shave a bit move off our GDP forecasts for New Zealand. 

March quarter GDP growth disappointed as the summer drought and lower oil exploration took a greater toll on the economy than we expected.  On the expenditure side of the accounts investment spending disappointed most of all.  Investment data can be volatile but the decline appears consistent with the recent decline in business confidence, as signaled by today’s release of the NZIER’s Quarterly Survey of Business Opinion (QSBO), so it’s hard to dismiss as just volatility.  Lower business investment clearly also has implications for future growth.

In light of the continued weakness in dairy prices and lower confidence levels we have shaved a bit more off our GDP forecasts for this year and next.  We had already assumed a moderation in quarterly growth rates from the middle of this year as both the Canterbury rebuild and net migration peak – we have simply accelerated the pace of slowdown. 
Our previous forecasts had annual average growth at around 3.0% in 2015 and 2016, but this now looks like being closer to 2.5% in both years before a further dip down to 2.0% in 2017. 

These forecasts are not as pessimistic as some in the market as we put some weight on some positive offsetting factors.  As residential construction activity slows in Christchurch, we expect it will be picking up in Auckland and while dairy prices continue to slide, prices of some other commodities are doing well.  The exchange rate is also significantly lower with the Trade Weighted Exchange Rate Index (TWI) now 15% below the recent peak in April.

So what does this mean for monetary policy?  While we had acknowledged the chance of lower interest rates this year we didn’t expect the Reserve Bank of New Zealand to cut the OCR in June.  Developments since that time have vindicated the Bank’s move.  When they cut in June they signaled a further cut was likely which we know expect to be delivered at the July OCR review.  A further cut in September is now likely.

From there it gets a bit harder.  While the outlook for growth is deteriorating we expect inflation to be rising over the remainder of this year and into next. That’s a function of rising petrol prices (which the Bank will look through) the decline in the exchange rate (which the Bank may look through), but also whether pricing intentions and prices will remain low in the face of higher capacity utilisation and the lower currency.  Margins can only be squeezed so much.  We think capacity pressures will remain elevated even as growth slows as we believe potential growth will be slowing also.  Finally, we believe global inflation will be rising next year.

So the key message for today is the RBNZ was right to cut in June, more is coming (we think two more 25bp cuts), but caution is warranted about expecting too much.