New Zealand growth softer, more easing to come
Recent weak data on dairy prices, business investment and business confidence has resulted in a significant change in the New Zealand growth and monetary policy outlook.
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 so it’s hard to dismiss as just volatility.
While part of the March quarter weakness will reverse out in the June quarter, we have cut our growth forecasts for both this year and next. This mostly relates to the recent acceleration of the decline in dairy prices. We have assumed that dairy farmers would manage one year of returns below breakeven but a second year would have a greater detrimental impact on growth. While we believe the weakness in dairy prices is largely cyclical and price will recover in time, it appears prudent at this point to assume that dairy prices will be lower for longer.
Weaker business confidence is likely to be in part related to the lower dairy price, but already appears to be having an impact on investment activity given the GDP data and a noticeable drop-off in imports of investment goods in the recent merchandise trade data. Weaker business investment also has implications for future growth.
It’s not all bad news for growth. While dairy price weakness is an obvious concern, the prices of other key commodities including beef and wool are doing well. Also, let’s not lose sight of the fact the exchange rate is now 13% lower than its April peak. This will take the rough edges off the dairy price decline and will provide a fillip to the external sector more generally, especially as global growth improves next year. Finally, while the Canterbury residential rebuild is levelling off, Auckland activity should provide some upward momentum.
We now see annual average growth of 2.3% this year followed by 2.2% and 1.9% in 2016 and 2017 respectively.
New Zealand GDP
Source: Statistics NZ and AMP Capital
So what does this mean for monetary policy? The challenge for monetary policy over the last two years is that growth has been rising while inflation has been falling. We now head into an environment in which growth will be slowing and inflation rising. Indeed, we expect inflation will move into the top half of the RBNZ’s 1-3% target range next year.
In terms of the implications for interest rates, it’s important to note that much of the move higher in inflation over the next twelve months will be the result of the lower exchange rate. The RBNZ may well look through that impact. Assuming they do and remain focused on core inflationary pressures, the lower growth outlook gives scope for further cuts in the Official Cash Rate (OCR).
While we had acknowledged the chance of lower interest rates this year, we didn’t expect the RBNZ 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. We expect two further cuts in September and October, in other words a full reversal of the recent tightening.
NZ Official Cash Rate
Source: RBNZ and AMP Capital
One note of caution is that part of the lower growth outlook relates to lower business investment and lower migration. That will also see potential growth declining at the same time, meaning we still need to keep an eye on measures of capacity utilisation. Key factors to watch in the period ahead continue to be dairy prices, the exchange rate and wages.
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