Quarterly Economic Forecasts

June 2010

Summary

New Zealand Economic Outlook

The domestic recovery is underway. This partly reflects normal cyclical dynamics, as the economy rebounds from recession following policy support. However, continued deleveraging will contribute to a more gradual recovery over much of 2010 than is typically the norm. There will be volatility in the economic data over the second half of this year due to the increase in GST. We expect growth to strengthen from late this year as these structural forces unwind, and the boost to the terms of trade flows through the economy. Beyond a strong 2011, the five year picture is one of modest growth, which in part reflects a sustained period of structural change across the economy.

Global outlook

Global growth is set to return towards trend although this masks a huge dichotomy between developed and emerging market economies. Risks remain though, with inflation a growing concern in China, while sovereign debt concerns is set to weigh on growth prospects in the Eurozone and potentially spill across into the wider global economy. We put the odds of a double-dip global recession at 1 in 4.

Fiscal policy

Headline inflation will be extremely volatile, pushing past 5 percent for a while due to government policy changes. Excluding “one-offs”, we expect underlying inflation to remain within the target band, though at the upper end of that band. We view the inflation risks as more up than down, due to emerging supply side constraints.

Inflation

Headline inflation will be extremely volatile, pushing past 5 percent for a while due to government policy changes. Excluding “one-offs”, we expect underlying inflation to remain within the target band, though at the upper end of that band. We view the inflation risks as more up than down, due to emerging supply side constraints.

Exchange rate

The outlook for the NZD is dominated by global forces. This includes EUR weakness, a resurgent USD and fickle investor sentiment. We see the NZD/USD being supported by high commodity prices and rising local interest rates over the year ahead, but for NZD/AUD to head lower as Australia continues to outperform New Zealand on the growth front. On a trade weighted basis, the NZ dollar will remain firm over the near-term. However, the risk profile is that a weaker UER/USD biases the NZD/USD the same way over the coming six months.

Interest rates

With the economy on the recovery path and momentum expected to accelerate later this year, the RBNZ is set to remove policy stimulus from June. We envisage a gradual tightening cycle, with a pause along the way to assess the impact. Elevated bank funding costs, more borrowers on floating rates and a steep yield curve mean the terminal cash rate will be lower for this cycle. Prospects for further global jitters may defer the initial removal of policy support, but not the spirit of rising rates towards a lower endgame.

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