Negatives To Dominate This Year
Headline article from the BNZ Weekly Overview of January 16.
A few people have been asking when the first issue of the Weekly Overview for 2003 will appear so to satisfy those eager
beavers here it is. As a trial we will be releasing the WO on Thursday nights. The reason is that releasing on a Monday
means working over the weekend to incorporate exchange rate etc. movements from Friday trading in New York, but with a
fourth child born two days ago one’s ability – let alone enthusiasm – for giving up weekend time has diminished
somewhat.
So what’s been happening in the past few weeks to get people excited? Basically the rapid rise in the Kiwi dollar. At
the time of writing the NZD was near a three and a half year high against the greenback of just over US 54 cents. This
is up from just over US 50 cents five weeks ago and 28% higher than the US 42.3 cent exchange rate of a year ago.
Against the Aussie dollar we have also soared to just over 92 cents from 89 cents five weeks ago and lie 13% above the
81.6 cent level of January 16 2002. Against the AUD we are at our highest level since July 1995, for the USD it is May
1999, the British pound and Euro June of last year, and the Yen July of 1999.
First the obvious question, why the recent rapid rise in the NZD? Part of the answer lies in the weakening greenback. In
the past five weeks it has fallen to 118 yen from 124, and it now costs US 1.055 to buy a Euro from 1.01 five weeks ago.
The dollar has weakened partly in response to continuing worries about the state of the US economy, as evidenced by the
over 100,000 fall in job numbers in December reported last week. But the dollar has also been pushed lower by the fears
of war in Iraq, and more recently the deteriorating situation in North Korea. Some selling also may have been generated
by the USD674bn fiscal stimulus package proposed by President Bush and the resulting increased reliance upon foreign
funding to finance a growing budget deficit.
But there have also been factors relating to things in New Zealand. First and foremost our currency has long been viewed
as undervalued so one should consider the recent rise as a continuation of the recovery from around US 41 cents which
started in March. Second, our recent economic growth record has been good. Our economy grew 1% in the September quarter
after growing 1.7% in the June quarter and in the year to September spurted up by 4%. As an aside, some people are
saying they think New Zealand has entered a new higher growth plateau. Rot. We have simply been hit by a combination of
factors going in the right direction whereas they went the other way during the Asian Crisis and pushed us into
recession back then. Specifically…
The weather the past few seasons has been good, boosting farm incomes. In contrast we had a drought in 1997-98.
Migration inflows are booming whereas they collapsed from mid-1996. The housing cycle has turned massively upward
whereas in 1997 it embarked on the “correction” we had been forecasting since 1995. Finally, whereas in 1998 the Reserve
Bank mucked things up by keeping interest rates too high for too long, this time around they have kept rates at below
average levels.
So one should not think there is something permanent about the recent strong performance of the New Zealand economy.
We’ve simply been lucky. Now throw in the constraints of insufficient skilled and unskilled labour, increasing business
regulation, and insufficient business investment in plant & equipment, and you get one reason why we expect growth to slow to 2.2% this year.
This slight tangent aside, the truth is our recent strong performance at a time when our trading partners have only
managed around 2.5% on average stands us in good steed in the FX markets.
The NZD has also been supported by our relatively high interest rates with our cash rate at 5.75% versus Australia’s at
4.75% and the US rate at 1.25%. Perhaps the good fiscal numbers have also helped at a time of deteriorating fiscal
stances in other countries.
Finally, FX trading can get a bit thin during the Christmas-New Year period so it only takes a few buyers to get a
currency chugging along quite quickly.
So where to from here? We see the NZD continuing to rise to a range of US 55 – 60 cents and staying high against the AUD
for longer than we previously thought. The AUD has failed to keep up with the rising NZD partly because of the drought
there.
How will the stronger NZD affect our economy? The manufacturing sector may be the worst hit as most of their exports go
to Australia and the rising cross rate comes at a time of slowing growth across the Tasman. Farmers will have their
returns suppressed, but note that there will be some insulation from improving international dairy prices, and droughts
overseas underpinning meat prices.
The tourism sector will eventually be negatively affected. But there are many factors at play in this sector including
positives like our distance from conflicts overseas and exposure from movies. We see tourist numbers rising 8% this
calendar year, but the risk is we are too optimistic.
Retailers will be negatively affected as we Kiwis shift some spending toward international travel and away from a new
DVD player for instance. Borrowers will benefit from the downward pressure on interest rates generated by the rising
currency, and there is a chance the Reserve Bank will even cut the official cash rate before the middle of the year.
This interest rates outlook will tend to keep the housing sector going strongly.
On the face of it lower than otherwise interest rates would be expected to boost badly needed business investment. But
decades of research have shown it is not the level of interest rates which mainly drives business investment, it’s the
probabilities assigned to generating increased profits. And this is where things come a bit unstuck. Business confidence
dipped quite sharply early in December – before the bulk of the recent currency rise had occurred – and one could not
rule out a big negative hit from events in Iraq or even on the Korean Peninsula. Uncertainty is high and in such an
environment it makes sense to be cautious. This will mean capacity pressures remain strong and there will be some offset
to the downward pressure on inflation from falling import prices and suppressed export incomes generated by the stronger
exchange rate. Wages growth will likely accelerate as business try and meet capacity shortfalls by hiring labour
instead.
Overall, mainly because of restrained exports, slower jobs growth, cautious business investment, and low consumer
confidence, we see New Zealand’s growth rate slowing down, but a recession being easily avoided. But one must remember
that we make this forecast assuming things go ok for the West in the Middle East and oil prices don’t spike up for very
long when and if the invasion of Iraq occurs. Given that we have zero special insight into developments over there
people should be prepared for surprises.