NZ economy: Three key factors drive market>Three key drivers will determine the outlook for the New Zealand economy this year, and all of them are very encouraging. Firstly, the two year drought has ended and with it the substantial drag on output growth that occurred in 1998 and the first half of 1999. The rural sector still counts for a lot in New Zealand and real GDP growth this year will reflect the expected dramatic rise in primary production.
Secondly, economic growth among our trading partners is robust. Australia and the US are growing at some 5 per cent each in real terms, and our Asian markets are growing at more than that in some cases, for example Korea, Singapore and China. Our export volumes should therefore grow at close to 10 per cent this year. Thirdly, monetary conditions are very easy, mainly due to the low level of the NZ dollar but also to short term interest rates of under 6 per cent.
The vast majority of regular economic indicators confirms our view that the recovery is solidly on track again after the drop in GDP in the second quarter. Retail sales are growing at over 5 per cent, export volumes are doing likewise, unemployment is declining and wages are rising. So, more personal disposable income is being generated. In addition the exchange rate of the NZ dollar against its trading partners has fallen to the lowest, most competitive level in seven years, ensuring a recovery in rural and manufacturing sector profitability during 2000. The economy is already growing at a 4 per cent pace year on year according to third quarter figures, which should continue in the first half of this year.
Meanwhile inflation pressures are minimal, the CPI only rising at a shade over 1 per cent in the third quarter. We expect a rise toward 2 per cent in the next couple of quarters, but the rate should remain comfortably below the 3 per cent top of the target range for the whole year. Surveyed inflation expectations are at the lowest levels in years.
We do not believe that much will happen in the NZ economy under the Labour/Alliance/Green coalition that would not have happened under a centre-right victory. Economic growth will get a long delayed boost from rising rural output thanks to the ending of the drought, and higher commodity prices thanks to the recovering world economy. The exchange rate is undervalued by more than 10 per cent in real terms at present, ie it is highly competitive, and will likely remain so for much of the year even as it appreciates, as we expect. It is likely that the 90 day Bank Bill rate will rise from its current 5.6 per cent to 7.0 per cent by the end of the year, as the Reserve Bank progressively moves monetary conditions from their stimulatory position towards a neutral one.
The key risk is that interest rates need to be raised more aggressively than we expect. If, as happened last year, the Kiwi dollar does not appreciate due to New Zealand’s commodity export prices remaining stagnant and/or fears regarding the current account of the balance of payments resurfacing, then interest rates will need to rise sharply, possibly to 8 per cent. Interest sensitive areas of spending, for example consumer durables and residential building, would be hit quite hard, and the equity market would probably struggle.
Michael Daly is manager investment strategy for Bank of New Zealand Investment Management.
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