Former Economics Editor of the NZ Herald

The two sides of the coin

Finance Minister Bill English painted a picture of recovery in the Budget. But stresses remain and the economy is being pulled in different directions by strong opposing forces, writes Brian Fallow

Photo / Simon Baker
Photo / Simon Baker

Positive forces

The Christchurch rebuild

A key factor that will drive growth over the next three or four years, and underpin activity for years after that, is the need to rebuild our second-largest city after the earthquakes of 2010/11.

The Treasury now estimates it will cost $40 billion "rounded to the nearest $5 billion", of which the Government's share will be $15 billion.

Because, fortunately, we have no experience of anything on this scale, forecasters struggle to estimate the multiplier effects on the wider economy. It will be a boost to the manufacturing sector, much of whose output supplies the construction sector, and to a broad range of service industries. But how much?

Rebuilding Christchurch will compete for resources with Auckland, which has its own construction deficit, and push the country's external accounts from bad to worse.

Resource constraints in the local and national economy mean only half the rebuilding activity will have occurred by mid-2017, the Treasury reckons.

Easy money

Mortgage rates are at multi-decade lows, reflecting a benign inflation environment.

Consumer prices rose just 0.9 per cent over the year to March and inflation expectations are subdued.

The economy has spare capacity. Unemployment remains well above the levels where it is any threat to the inflation outlook.

So the Reserve Bank is not expected to start raising its official cash rate, from the all-time low it has been at for two years now, until next year. The financial markets see only a 50:50 chance it will have started to tighten by this time next year.

Some economists, like BNZ head of research Stephen Toplis and Westpac chief economist Dominick Stephens, warn the markets are underestimating how far rates will eventually have to rise.

Maybe borrowers are too.

The Budget forecasts have the short-term rates, off which floating mortgages are priced, 2 percentage points higher in four years. "We have a more aggressive track," Toplis says.

The biggest threat is that a resurgent housing market will reignite the borrow-and-spend mentality of the mid-2000s boom, which drove interest rates and the dollar to painful highs.

Feeling good

Consumer confidence is at a three-year high, as measured by the ANZ Roy Morgan survey, and actual consumer spending, in real per capita terms, is at a five-year high.

The Budget's economic forecasts assume households are now broadly comfortable with their financial position, having paid down debt and lifted savings over recent years. So the Treasury expects household spending from now on will grow in line with their incomes, which would be a pick-up from the last couple of years.

The missing ingredient is a sustained improvement in the jobs market.

The official unemployment rate has dropped from 6.8 per cent in December to 6.2 per cent in March, but there are technical reasons - to do with participation rates and seasonal adjustment - to partially discount that improvement.

Job advertisements have been on the rise for the past three months but are still lower than a year ago.

Negative forces

The dollar

The Budget forecasts economic growth to average 2.5 per cent a year over the next four years, but it is all about the domestic economy. Net exports are forecast to be a drag on growth.

Though it has retreated a bit over the past couple of weeks, the New Zealand dollar is by common consent overvalued on fundamentals and a persistent problem for exporters and firms competing with imports.

The Government and the Reserve Bank are fatalistic about this, pointing to the massive amount of liquidity being pumped into the global financial system as major economies run extraordinarily easy monetary policy and central banks and sovereign wealth funds look to diversify their foreign exchange reserves.

The Reserve Bank has been selling New Zealand dollars - on what scale we don't know yet. But that is an exercise in putting our money where its mouth is and placing a bet that the exchange rate will eventually correct, rather than an attempt to haul the currency down through brute force.

The housing market

The Northern Hemisphere in recent years has provided gruesome examples of what happens to an economy when a property bubble bursts all over it.

The median house price in Auckland is $555,000, 11 times the average wage, before tax. Nationwide house price inflation has accelerated to just under 10 per cent driven by annual increases of 14 per cent in Auckland and 13 per cent in Christchurch.

The emerging boom is starting from a position where, relative to incomes, house prices and household debt levels are already very high by international and historical standards.

The International Monetary Fund estimates New Zealand housing is overvalued by 20 per cent.

Measures such as the Auckland housing accord may have an effect on house prices, Westpac's Dominick Stephens says, but it will probably be small and slow. "Until either the tax system or interest rates change we expect house prices will just keep on rising."

The Reserve Bank has been empowered to ration low-deposit lending, which may buy it some time before it has to start raising interest rates to burn off demand, given the threat to price stability and financial stability.

The drought

The summer drought means the economy's output this year will be about 0.7 per cent lower than it would otherwise have been, the Treasury estimates.

The impact has been mitigated by it occurring relatively late into what had been, for the dairy sector in particular, a very good season.

The effect on dairy farmers' incomes is softened by a steep rise in export dairy prices, although declines in Fonterra's last two fortnightly auctions suggests that may have run its course.

The effect on sheep and beef farmers has been the opposite, with more stock sent to works and a depressing effect on prices. That is expected to broadly offset the effect of higher dairy prices.

The Treasury concludes that the effect on nominal gross domestic product, which combines real output and price changes and is a proxy of the tax base, will also be a reduction of 0.7 per cent or about $1.5 billion.

- NZ Herald

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