Economy flat as consumers repay debt

Shamubeel Eaqub. Photo / Brett Phibbs

The economy is on the mend but the recovery is threatened by a darkening global outlook, the Institute of Economic Research says in its quarterly economic forecast.

"An abrupt slowdown in the Australian economy, renewed recession fears in the United States and a spreading sovereign debt crisis in Europe will soften the global growth outlook," said the institute's principal economist, Shamubeel Eaqub.

He is forecasting gross domestic product to be "pretty flat" this year, growing just 1.4 per cent, before picking up to 2.6 per cent next year and again in 2013.

At that rate it will not be until 2015 that per capita output will be back where it was in 2007 before the global financial crisis. Domestically, the dominant dynamic remains one of household deleveraging - a focus on repaying debt and a reluctance to borrow - which limits spending growth to the pace of income growth.

Other headwinds include the fact that net migration flows have turned negative over the past five months and increasing evidence that the task of rebuilding Christchurch will start later and take longer than at first thought.

"We have been taken aback by the scale of job losses in Canterbury," Eaqub said. Since the first earthquake a year ago 26,000 private sector jobs in the region had been lost.

Retail spending has been grinding higher, Eaqub said, though most of the increase is on necessities such as food and fuel.

"People are starting to buy more durables. They have enough confidence to spend, but not necessarily to borrow and spend. They certainly won't be spending like crazy as they were in 2007."

On the trade front, cracks are appearing in the export story, Eaqub said.

China has accounted for the lion's share of export growth over the past three years but the trade has come off its peak since the start of the year.

And to see import volumes falling at this stage of the cycle is a bit of a worry, he said.

Higher levels of business investment are an encouraging sign, but profit margins remain razor-thin.

Eaqub expects inflation pressures to be contained by slow growth.

Excluding the one-off impact of the increase in the GST rate last October, inflation has been coming either from other Government-influenced factors or from necessities, rather than from sources the Reserve Bank can influence.

"There's just not the bargaining power for workers or the pricing power for businesses."

The central bank should not raise interest rates while the global economy is so vulnerable and the New Zealand dollar is so high, Eaqub said.

When it does raise rates - which should not be before June next year - it will have an almighty impact, as more than 80 per cent of mortgages are on floating rates or fixed rates less than a year from reset.

"Even a 1 percentage point interest rate increase will raise the annual mortgage bill by $1.4 billion."