Growth prospects for the New Zealand economy still look relatively poor in the short term but in a way this is good because the scene is being set for reasonably good growth over 2010 and perhaps – dare one suggest – even from late 2009.
Back in 2006 when businesses were feeling very despondent, although they said employees would be laid off this did not occur because of high awareness of the structural tightness in the New Zealand labour market.
This time around, although that awareness is just as strong layoffs are occurring. We have seen zero growth in job numbers over the first half of this year with the unemployment rate rising from 3.4% to 3.9%.
This time around, the difference is that businesses have far greater cashflow pressures. Energy and raw materials prices have risen strongly and with the ability to increase selling prices constrained by the extreme weakness in household spending, businesses are having to cut their own spending to prevent bleeding cashflows.
This means laying off some people, slashing inventories, plus some delaying of capital expenditure. This is exactly the sort of thing which happens in a normal economic cycle and once things get moving along the scene becomes set for natural downward adjustments in both interest rates and exchange rate. That is what is happening now.
Two months ago, the Reserve Bank signalled it would cut interest rates before the end of the year; then on July 24 it did so by taking the official cash rate from 8.25% down to 8%.
Since then, it has emphasised its plans to cut interest rates further, although it has warned any excessive decline in the currency could stay its hand.
Our expectation is that the official cash rate will get somewhere close to 6% late next year but borrowers should not be optimistic about unusually low interest rates appearing in New Zealand this cycle.
In the past, the cash rate has tended to bottom out around 4.5%. But this time around the Reserve Bank is unlikely to think it needs to slash interest rates in order to deliberately generate more inflation. Our economy remains fundamentally short of employees, electricity, roading capacity, communications capacity, and so on.
This means that for any given rate of growth in the economy inflation will be higher than if these resources were readily available. So businesses should by all means anticipate funding costs will reduce over the coming year but try not to pencil in declines of more than 2%.
Anticipation of the Reserve Bank easing monetary policy further is one of the reasons behind the Kiwi dollar’s recent firm decline. Another is the sheer weakness of economic data and also a rebound in the US dollar.
The greenback has risen firmly in recent weeks in line with commodity prices pulling back, plus expectations that the Federal Reserve will increase interest rates next year while other economies will be cutting interest rates, and a feeling that the US economy will pull out of the effects of the credit crisis sooner than other economies.
Over the remainder of this year into early 2009 we think business conditions in New Zealand will remain very tight for domestic operators while improving for those in the export and import competing sectors.
Housing activity will remain muted but it is going to be interesting to see the impact a second round of tax cuts in April next year could have on household willingness to spend. Keep an eye on that one.
