NZ Economy

New Zealand is something of an economic star in the global economy at present. Of the four dollar-bloc countries it has the fastest growing economy, the lowest unemployment rate, inflation largely in check and large budget surpluses.

Indeed, New Zealand’s image as a low growth performer relative to the rest of the world will soon need to be revised. After its recent GDP out-performance, the New Zealand economy has now expanded at a similar pace to the United States on average over the past 10 years, something both Germany and Japan have struggled to achieve.

The economy posted annualised growth of more than 5% in the first half of 2002. This eased back to 4% in the third quarter of 2002, but the performance overall was still very impressive given the weak global economy.

There are three main reasons why New Zealand’s economy has outperformed the global economy. First, New Zealand missed out on the global information technology boom, so companies never out-geared nor created excess capacity.

Second, the lagged impact of strong terms of trade, low interest rates and strong net migration meant that a housing boom boosted the economy.

Finally, a low (but rising) dollar helped insulate New Zealand from the global volatility.

However, two of these influences have shown marked turnarounds. The terms of trade has fallen sharply and are now close to their 10-year average, while the NZ dollar has appreciated strongly against all our major trading partners, particularly the United States (+22.5%) and Australia (+12.0%) in 2002. This suggests the macro environment is unlikely to be as supportive of growth as it was in 2002.

The loss of momentum has been most evident in business confidence surveys.

A key factor behind the slump is likely to be the sharply rising NZ dollar, which has leapt to US$0.55 in the New Year. Several factors suggest the local currency could go higher still. These include:

• a relatively strong growth differential in favour of New Zealand. While the outlook is for the growth gap to close, New Zealand should still out-perform the United States, at least in the first half of 2003;
• with US monetary policy on hold, the solid premium offered by New Zealand interest rates is likely to continue for some time yet; and
• general US dollar weakness. Falling net equity flows into the United States and a rising current account deficit suggest the US dollar will continue to struggle this year.

The combination of these factors has encouraged us to lift our NZ dollar forecasts higher to around US$0.56-58 by mid-year.

New Zealand’s best chance of continued solid growth in 2003 is for the international economy to recover.

However, despite some better data in the United States at the end of last year, there remains a great deal of uncertainty over the global economic outlook. Indeed, we believe no sustained recovery in the US economy is likely while uncertainty over war with Iraq remains.

Even if the US war effort goes smoothly, the economy may have more to go in adjusting to the bursting of the stock market bubble. Much still depends on the continued vitality of the US consumer.

Global uncertainty and a rising currency have seen the Reserve Bank leave the official cash rate (OCR) “on hold” for most of the second half of 2002, despite continued strong growth and inflation tracking at the top end of its target range.

Contrary to most commentators, we think that the next move in the OCR will be down rather than up based on the following considerations:

• NZ growth is likely to weaken to around 2-2.5% in 2003, dragged down by reduced rural sector incomes and slowing net migration inflows. Although the most recent migrant data for November revealed the third strongest net inflow for 2002, equivalent to an annual inflow of over 1% of the current population, recent changes to English language entry requirements are expected to impact negatively on these strong inflows in 2003.
• Inflation is expected to quickly move back to the mid-point of the RBNZ’s target band thanks to a sharply rising NZ dollar and a softening housing market.

While an interest rate easing, at this stage, would not be warranted while the housing sector and employment conditions remain firm, a modest easing around mid-2003 is looking more likely, particularly if the currency continues to appreciate and the global economy disappoints.

Geaff Mason is the manager of investment strategy at BNZIM

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