We continue to forecast a solid ongoing economic expansion. Economic growth is expected to average just under 3% over the next three years. But we remain toward the pessimistic end of the spectrum largely as we see little spare capacity to grow. Another tick lower in the unemployment rate adds to the case. The RBNZ, as per today’s Monetary Policy Statement, remains relatively upbeat on the economy’s growth prospects seeing growth exceeding 3% for much of the three years ahead. This includes stronger growth in domestic demand than we see. This is an area to watch ahead as competing forces such as an anticipated record terms of trade and a cooling housing market do battle. Business and consumer confidence have remained robust as we head into the 23 September General Election. Next week’s Q2 retail sales will be the latest gauge on how domestic demand has been travelling; probably a bit slower than in Q1.
Interest Rate Outlook and Strategy
Today’s RBNZ Monetary Policy Statement held no surprises. The OCR was held at 1.75% and is projected to stay there for some time. We formally push out our forecast for the first RBNZ rate hike May to August 2018 – still well ahead of the RBNZ’s expectation but not substantively different to market. NZ short end rates will likely be anchored by an on hold and neutral RBNZ. We expect NZ 2 year swap to (mostly) trade a tight 2.15% to 2.25% range. Global forces represent the key upside risk to NZ rates. If we are right and the Fed remains on track for further rate increases and other major central banks join in, then pressure will be for NZ curve steepening and lower NZ-global spreads.
We are struggling to see much upward force for the NZD from here and plenty of downward forces. Technicals and positioning both signal headwinds ahead; the positive terms of trade story is well priced; risk appetite must surely fall from its current elevated levels; election risk overhangs the NZD over the next couple of months; NZ monetary policy won’t be a supporting factor; and the USD looks heavily oversold. Certainly our year-end target for the NZD to go sub USD 0.70 looks a stretch at this juncture, but we remain comfortable in our call for a softer NZD towards year-end, against the trend of the past few months. We expect the US Fed and BoC to continue along the path of higher rates, and the ECB to signal and then begin tapering its asset purchase programme soon. BoE tightening is more likely early next year than this, while the RBA is expected to remain neutral. These forces support downward bias to the NZD on many of the crosses.
Could it be that the jinx of being in government in a year ending in 8 is about to end?
In an otherwise robust-looking NZ economy, we continue to wonder about where the housing and construction markets are going to end up, given their extremely stretched starting points. That’s not to say we are forecasting a big dip, although the risks of such are there. In respect to monitoring trends in the housing market, we welcome the Real Estate Institute’s new SPAR house price indices. These look to give the best signal-to-noise ratio of the many house price measures out there. Their June outcomes, published this morning, proved about as soft/flat as we expected regards Auckland, and for the rest of the country perhaps not as robust as we figured on. The more immediate issue for inflation, however, is next Tuesday’s Q2 CPI report. With the recent drop in fuel prices, we now expect this to increase just 0.1%. This would drag its annual inflation down to 1.8%, from 2.2% in Q1. While this might be viewed as a disappointment by some, just don’t forget to check the various core inflation measures too, as these have been firming up more recently.
With the word “uncertainty” being bandied around a lot lately, and a local election fast approaching, New Zealand’s business sector is in fact full of confidence and expectation. Today’s ANZ business survey provided the latest proof. Far from doing a nervous Nelly, its net confidence index strengthened to +25 in June, from +15 in May. Own-activity expectations burgeoned to +43, from +38. These results are consistent with annual real GDP growth in the order of 4%. Not that the economy will be able to achieve such a strong degree of expansion as that, with capacity constraints already biting on most fronts. This is starting to seriously limit the wherewithal to grow, even though the demand side indicators are pushing hard for it. In this we continue to ask questions of those who judge that the economy is not only devoid of resource pressures but is still running some spare capacity. We believe next Tuesday’s NZIER Quarterly Survey of Business Survey will very much support our view.
We are not down in the mouth about today’s reported 0.5% expansion in March quarter GDP (2.5% y/y). Yes, it under-clubbed market expectations of a 0.7% gain and was even further below the Reserve Bank expectation of a 0.9% lift. That being said, we expected Q1 GDP to be this slow, largely on technical/timing issues. More to the point, we still think the economy is fundamentally pressing on, but as its room to expand is diminishing, because of capacity constraints. At the same time, we have today finalised the extent of extra demand impetus through our GDP forecasts (which was still a work in progress at the last Strategist). Much of this stems from the 25 May Budget. This has mainly meant for more sustained growth in private consumption expenditure, with a particular push in calendar 2018. All considered, we now forecast real GDP growth of 3.1% for 2018 and 2.4% for 2019. Pre the Budget (of 25 May) these were 2.5% and 1.8% respectively.
There is a strong income pulse brewing in the New Zealand economy, courtesy of rising export prices and relatively subdued import prices.