Brian Fallow: Forecast largely fine, but clouds loom

Graeme Wheeler will be watching closely for signs of inflation. Photo / NZME.

Prospects for NZ economy are for continued growth but outlook for global dairy prices could sour the party

Businesses, consumers and economic forecasters agree: 2015 should be a reasonably good year - weaker than 2014 but still pretty good by the standards of the recent past.

The usual caveat applies; the capacity of the other 99.8 per cent of the world to sideswipe the New Zealand economy with some shock remains.

In that respect the largest cloud on the horizon is the outlook for dairy prices, which have halved since last February, though they showed some signs of stabilising in the last GlobalDairyTrade auction.

"One bad year for dairy prices is manageable," says ANZ economist Sharon Zollner. "Two is not. We are sceptical that global prices will rebound quickly."

The latest crop of sentiment surveys and economic forecasts suggests that while we may be at or just past the peak of economic cycle, the downhill slope from here is a gentle one.

ANZ's Business Outlook, released on December 18, recorded some softening of confidence from November levels but the readings for firms' own outlook and profit expectations and for their hiring and investment intentions remain well above long-term average levels.

"The New Zealand economy has been in a sweet spot for some time now," Zollner said.

"Growth is solid, currently running at 3.2 per cent per annum, but inflation has remained tame [1 per cent], meaning the Reserve Bank party police have been content to let things run. The survey details flag more of the same."

Westpac's quarterly survey of consumer sentiment, released on December 22, also fell but to levels which remain high by the standards of the post-global financial crisis period.

The economic news of the past three months has been very mixed, said Westpac chief economist Dominick Stephens.

"Fonterra slashed its dairy payout forecasts, against the background of generally poor economic news from offshore," he said.

"But consumers' purchasing power has been boosted by plunging oil prices and falling mortgage rates. And with the election taking a capital gains tax off the table, the housing market has started showing fresh signs of life - bad news for those wanting to get on the property ladder, but good news for homeowners."

The consensus among nine economic forecasting organisations surveyed by the New Zealand Institute of Economic Research last month is that growth in the coming year (to March 2016) will be softer than in the current year across a range of measures: private and public consumption, residential and business investment, and employment.

One area where they expect to see a pick-up is exports, at least in volume terms, as output rebounds from last summer's drought.

However, Labour's trade spokesman, David Parker, sees the scale and the concentration of New Zealand's exports as a fundamental structural weakness of the economy.

Exports represent 28 per cent of gross domestic product, which is low for a small, open economy, Parker says, and well short of the Government's erstwhile target of 40 per cent.

Imports, meanwhile, are running at 33 per cent of GDP and are forecast to grow faster than exports over the coming year.

The Reserve Bank has just re-weighted its trade-weighted index for the exchange rate, including the Chinese yuan for the first time with a weighting of 20 per cent, second only to Australia's 22 per cent.

Two basic commodities, milk powder and raw logs, made up nearly 60 per cent of New Zealand's exports to China in the year ended September.

Both the Reserve Bank and the Treasury have lifted their forecasts for economic growth over the next two years compared with their views in September and August respectively.

And since they made those forecasts global oil prices have fallen steeply which, while they last, will increase households' spending power and businesses' profit margins.

Both institutions have raised their estimates of the economy's potential growth rate, which is the rate at which it can grow without inflation, to nearly 3 per cent a year.

A key reason has been the continuing strength of net immigration, underpinned by the comparative weakness of the Australian economy.

Another relevant change has been a shift in household behaviour since the recession towards spending less and saving more of their incomes.

Even so, the Reserve Bank has been surprised, given past relationships, how little inflation has emerged so far given the pace of economic growth. Its December statement still sees more interest rate hikes in our future but fewer and further away (starting late 2015) than previously.

Since then, however, Statistics New Zealand has substantially revised down the historical track of GDP over the past six years, cutting back its previously reported growth rates in 14 of the past 24 quarters.

So it seems that the weaker-than-expected inflation we have experienced might have more to do with weaker-than-reported growth than any enduring structural change in the sustainable growth rate.

All else being equal - and it never is - that suggest the Reserve Bank's next monetary policy statement in March might project a lower trajectory for growth and a higher track for interest rates than its December statement.