Squaring the circle on GDP revisions
Recent revisions to historical GDP growth were significant. Annual growth for the year to June 2015, for example, was bumped up from 2.4% to 3.8%, a whopping 1.4 percentage points. This tells us that an economy that was already the envy of the developed world was doing even better than first thought. It also tells us that the slowdown since mid-2016 has been more meaningful than the original data would have had us believe. But the big question at the start of 2018 is what do these revisions mean for the outlook for this year and beyond? The short answer is not much. For the longer answer, keep reading.
Revisions to history are just that – revisions to history. The information value of the new data in helping shape the outlook, outside the obvious of shifting the base, is limited. That said, it does help explain some things, such as perpetually higher than expected fiscal out-turns. Higher growth helps explain higher revenues.
Other things, such as perpetually low inflation, need more imagination to square the circle. How come, if growth was even higher than the high growth we thought we already had, we haven’t seen more inflation? Simple. Taking a leap of faith and assuming that inflation and labour market data are correct, then productivity must have been higher. That means the Reserve Bank of New Zealand (RBNZ) will look at the revisions to actual growth and make an equal adjustment to the country’s potential growth.
In terms of the outlook, the same positive and negative factors we thought would shape the outlook before the revisions are the same factors that will still shape the outlook post-revision, notably:
net migration is slowing, reducing population growth
the residential construction sector is slowing, reflecting capacity constraints
house price inflation has slowed, which will have a moderating influence on consumption activity
growth in labour income is expected to remain strong (though the employment growth/wage mix will change)
robust business investment growth, reflecting the combination of a tightening labour market and still low interest rates
a positive fiscal impulse in 2018 and 2019.
Two other factors that are harder to forecast will shape the near-term outlook – the drought which appears to be intensifying (especially in Taranaki and Manawatu), and the significant drop in business confidence since the election. Absent some meaningful rainfall, the drought looks set to have at least some impact on agricultural/horticultural output over the next few months.
We continue to attribute much of the drop in business confidence to post election policy uncertainty. But while confidence bounced back a bit in December, it didn’t bounce as much as we thought it would. The only bright spot in the data is that firms are more confident in the outlook for their own business than they are for the economy as a whole. The possibility that business confidence remains depressed represents a downside risk to our up-beat business investment expectations.
The upshot is our forecasts for the next three calendar years remain essentially unchanged from those published in New Zealand Insights
last year. We are estimating that annual average growth for calendar 2017 will come in at 2.9%, with the following two years averaging 3.0% (2.8% in 2018 and 3.1% in 2019), and a move lower to around 2.0-2.5% in 2020.
These forecasts remain lower than those of both the Treasury and the RBNZ. For the Government that means the risk of lower revenue growth, which then sets up the May Budget as an exercise in managing the tension of an ambitious policy programme with the possibility of a lower revenue outlook. That means either finding new sources of revenue, scaling back spending plans, or accepting debt will be higher and take longer to reach 20% of GDP.
At first blush, our lower growth forecasts seem at odds with our belief that the RBNZ will be tightening monetary policy earlier than they are currently signalling. That’s because one of the negative growth factors in the period ahead, slower population growth, also means lower potential growth. Essentially, we see earlier and stronger wage pressure emerging than the RBNZ.
For the domestic asset classes in 2018 the economic outlook suggests gradually higher bond yields and a steeper yield curve as monetary conditions become less stimulatory globally but on hold in New Zealand. The New Zealand equity market has been a strong performer over recent years and valuations are stretched and reliant on continued earnings growth coming through. That makes the recent drop in business confidence a key risk to the outlook should it be indicative of lower earnings growth ahead.
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