Capital markets set to grow in a positive environment

The New Zealand economy has had a poor start to 2011 following the Christchurch earthquake but should gradually strengthen as the year goes on. Photo / Simon Baker

The global economy exited 2010 with some considerable momentum and Deutsche Bank expects 2011 to be another year of above-trend growth, although the composition of global growth will shift toward the developed economies as the Chinese authorities seek to engineer a soft landing.

Despite the apparent robust US economic expansion, we expect the Federal Reserve to "lag" the European Central Bank while inflationary pressure will turn as the lagged impact of demand and higher commodity prices starts to flow through.

Nonetheless, recoveries are never "straight line" with risks in Japan, peripheral Europe and the Middle East a feature of the global landscape over 2011.

The stronger global economy is supportive for both Australia and New Zealand and is boosting commodity prices which in turn are pushing export income to multi-decade highs.

However, flow-through to the local economy in New Zealand from the rise in the terms of trade has been modest to date. This is because the strong growth in rural incomes is yet to translate into spending, with many farmers instead concentrating on debt repayment.

In Australia, in contrast, higher commodity prices have translated into a massive forward path for investment in the mining sector that is now being translated into activity. This is putting pressure on a labour market that is already close to fully employed.

The forward path for investment spending in Australia and the resulting pressure on the labour market has seen the Reserve Bank of Australia effectively normalise interest rates.

This normalisation has put pressure on consumer spending and those parts of the economy that do not get the direct benefit of higher commodity prices, such as the tourism sector, which is leading to significant discussion about the 'two-speed' economy.

Looking forward we think this debate will intensify as the divergence in performance between the mining sector and the risk intensifies.

The New Zealand economy, which disappointed in 2010 due to fundamental and one-off factors restraining growth, has had a poor start to 2011 following the Christchurch earthquake but should gradually strengthen as the year goes on.

The recovery will be helped by the recent easing of monetary policy, surging rural incomes, the beginnings of Christchurch reconstruction and activity associated with the Rugby World Cup.

As always the global outlook remains a key risk. We think growth will be above-trend for the next few years, but with fiscal policy at its limit and monetary policy in key countries such as the US already very stimulatory the scope to offset further negative shocks are limited.

In New Zealand, a further increase in household saving rates - still low by international standards - would hinder growth in the short-term and even after some deleveraging we think the RBNZ will not need to drive borrowing rates as high as in the past given high household debt levels, the greater margin between the cash rate and borrowing levels and what is likely to be more cautious approach by households on an ongoing basis.

The New Zealand and Australian markets have underperformed most other equity markets but the worst may be in the past. Both countries have seen earnings downgrades, however earnings growth is expected to be solid in 2011 and 2012 and relatively low PE ratios raise the prospect of a re-rate to drive the market further.

Improved financial firepower and boardroom confidence drove a strong recovery in M&A volumes in late 2010 which is expected to continue into 2011. Corporate paper is in very high demand globally with favourable conditions for borrowers. New Zealand's debt and hybrid capital markets remain well supported.

Within the equity capital markets, Contact Energy has recently announced a $351m renounceable rights issue, the largest equity raising in two years and second largest follow-on capital raising in the energy sector.

This activity is heartening in light of the Government's proposed mixed ownership model. This unprecedented programme of Crown-led public offers may result in IPO activity never seen before in New Zealand and result in the capitalisation of the New Zealand stock exchange rising by approximately 20 per cent - a tremendous lift.

Overall the outlook is positive both on the world and local stages and we expect the New Zealand capital markets to grow over the next two years.

* Brett Shepherd is CEO of Deutsche Bank New Zealand