Quarterly Economic Forecasts

October 2011

Summary

Confronting Global Challenges

New Zealand Economic Outlook

The New Zealand economy is navigating four large events simultaneously, at a time when there is growing downside risk to the global scene. The interaction of these shocks will see more volatility across the business cycle amidst a lower trend growth rate. A better national balance sheet is a precursor to a strong pro-cyclical upswing and we are not there yet. But progress is being made.

Global outlook

A global recession in 2012 is not our core view. However, tail risks from a structural overhang of global debt will take years to overcome, and Western economies face a period of lower trend growth. Robust growth from emerging economies will provide an offset to some extent, but we are cautious over how much they can be insulated from a slowdown in growth in the developed world.

Commodity prices

We expect New Zealand’s export commodity prices to remain elevated, supported by favourable supply-demand dynamics. We are bullish on the long-term trend for commodities, but caution against banking on excessive gains. Sustainable commodity price trends will be more slow-moving.

Labour Market

The unemployment rate is expected to ease lower over the forecast horizon. A by-product of a "getting back to basics"approach across the economy is expected to see better productivity growth, but this will take time.

Fiscal policy

Any new government is in a fiscal straitjacket for a decade, with fiscal policy staying contractionary for five years at least. Such austerity will present an economic headwind, but will keep interest rates lower than otherwise.

Inflation

We have an inflation trajectory averaging 2¾ percent over the forecast horizon. To us, slightly higher inflation outcomes will be a natural by-product (or sacrificial pawn) of navigating multiple shocks and greasing the wheels of the economy through such frictions.

Exchange rate

Global wobbles will throw the NZD around in the near-term. Our key judgement is that the USD faces significant structural headwinds, and if the USD is lower the NZD is higher by default. We see NZD picking up next year on our expectation that the New Zealand economy is set to outgrow a lot of other developed economies, and helped by the RBNZ lifting interest rates.

Interest rates

Our core view is for a mid-2012 start to OCR hikes, but the risk profile is clearly towards a later increase as opposed to sooner. Long-end interest rates are also likely to remain lower for longer, in line with global rates. Indeed, the US Federal Reserve is trying to extend its influence further along the yield curve with "operation twist"and global markets are sceptical of the growth outlook.

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