Interest rates low with a kick to come

By Nathan Penny


Low inflation and a weak world economy are keeping interest rates low, however price pressures from the earthquake rebuild may spill over into general inflation, leading to steeper interest rate rises than many expect.

The New Zealand economy is gradually gathering momentum, with 1.6 per cent growth in the first half of 2012. This adds to the 1 per cent in the second half of 2011, giving 2.6 per cent for the June 2012 year. While annual growth in the economy is getting back to its 3 per cent average, it has yet to reach top speed.

The Gross Domestic Product numbers were boosted by strong agricultural production, up over 6 per cent for the year. It appears every cloud does have a silver lining. While holiday-makers complained about a lack of sun last summer, farmers reaped the benefits of excellent growing conditions.

Earthquake rebuild adding to momentum

The Christchurch earthquake rebuild is adding to the economy's momentum, offsetting businesses' caution with investing and hiring, households who are listening to budgeting advice more than the call of their credit cards and a Government which is nickel and diming. Residential investment, or house building, increased nearly 6 per cent in the June quarter, largely due to Christchurch.

Things are just getting started; we expect residential investment to grow a whopping 34 per cent in 2013.

Low inflation...

With the economy running below top speed and the high New Zealand dollar keeping the price of imports down, inflation is low. In the June 2012, prices rose 1 per cent from June 2011. This was the smallest rise since December 1999. Moreover, the inflation out-turns over the last four quarters were all lower than the Reserve Bank's (RBNZ) expectations.

While the high dollar aids the RBNZ's inflation-fighting cause, helping to keep interest rates low, it hits farmgate returns. The dollar has remained stubbornly high, despite export commodity prices still sitting lower than a year ago. We suspect the main culprits are large purchases of the dollar relating to Christchurch earthquake re-insurance flows, high volumes of dairy sales, and overseas central banks' New Zealand Government bond purchases. risks to the global economy...

The global economy is growing slowly, with the Eurozone and Britain in recession, while China's annual growth slowed in March from 8.1 per cent to 7.6 per cent in June. In some ways, the slowing Chinese growth is the bigger concern. China is the major driver of world growth and, with it, New Zealand's commodity prices. Although the Chinese authorities are planning measures to boost growth back over 8 per cent, it is very much 'watch this space'.

...add up to low interest rates

As a result, the RBNZ is sitting firmly on its hands, keeping the Official Cash Rate at 2.50 in September.

Over the next year or so, the RBNZ will weigh up the fragile global economy pulling down global inflation, against the earthquake rebuild starting to crank up the local economy and domestic inflation pressures.

We think concerns around the global economy will dominate RBNZ thoughts for some time. This will lead it to err on the side of caution and react slowly to, or overlook to an extent, any domestic inflation generated by the earthquake rebuild.

However, we expect when RBNZ eventually hikes interest rates, probably in the second half of 2013, it will move quickly to get inflation back under control.

Also, as the chart below indicates, interest rate rises may need to be steeper than the RBNZ and financial markets anticipate.

- Hamilton News

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