The one cloud on New Zealand’s economic horizon

New Zealand’s economy is set to grow strongly over the coming year, but there is one potential challenge that could cause problems for the Reserve Bank.

The Reserve Bank of New Zealand expects real GDP to grow at a steady pace of about 3 per cent until the end of 2016, according to a Monetary Policy Statement released earlier today. Long-term sustainable growth has been supported by steady increases in business investment, strong growth in the labour force and improved productivity growth.

New Zealand GDP and potential output growth (annual)

After 2016, growth is expected to moderate somewhat as the effects of loose monetary policy diminish. New Zealand’s construction boom -- driven by the rebuilding of Christchurch and Canterbury -- will also begin to ease at around the same time.

Construction, excluding the rebuild, remains somewhat below its pre-crisis level. The RBNZ expects residential investment in Auckland to boost construction over the next few years.

New Zealand SNA total construction expenditure (Share of potential output)

The housing sector more broadly continues to be supported by low interest rates, strong migration and supply shortages in Auckland and Canterbury. The RBNZ believes that annual house price growth will ease over the next few years, with prices continuing to rise but at a modest pace.

The RBNZ took steps last year to ease lending activity and slow the clip of house price gains. At this point it -- along with 100 basis points of monetary tightening -- appears to have done the job. However, there may be more to it, with the RBNZ noting that “conditions in the housing market are weaker than would normally be suggested by still-low interest rates, high net migration and supply shortages, even after taking account of the estimated effect of LVR restrictions.”

The RBNZ notes that “the Australian labour market is expected to remain weak relative to New Zealand’s for some time.” They expect this to result in net migration from New Zealand to Australia remaining at near historic lows over the coming year.

Growth among New Zealand’s major trading partners will continue at around its historical average over the next few years. Exporters have made the shift towards fast-growing Asian economies, which should support growth but there are obviously some risks associated with the global outlook. The risks in Australia and China, for example, probably lie to the downside and may weigh on New Zealand’s export growth.

An important narrative for New Zealand recently has been the surge in its terms-of-trade, which has supported income growth and was a key reason behind the need to raise interest rates. The terms-of-trade is expected to ease further over the next 12 months. New Zealand’s commodity mix differs considerably to Australia’s and prices are expected to recover somewhat after 2015.

The RBNZ expects the New Zealand dollar to ease over the next few years as growth begins to slow and other central banks begin to normalise monetary policy. That’s true for the United States but Europe and Japan and even Australia appear unlikely to contribute to policy normalisation for at least a couple of years, which may create some upside risk for the dollar in the medium-term.

New Zealand dollar trade-weighted index

Low inflation has given the RBNZ the opportunity to assess its decision to hike rates earlier this year. But inflation growth is widely expected to increase over the next few years, reflecting ongoing capacity pressures due to the Canterbury rebuild and a softer New Zealand dollar.

The RBNZ believes that inflation will push towards the 2 per cent midpoint of its annual target, although it’s important to recognise that its forecasts include the assumption that the bank will raise rates further. In the absence of those hikes, the outlook for inflation would be somewhat higher.

The New Zealand economy is well placed for a strong Christmas period and a solid 2015. Growth has become increasing broad-based more recently, although in the medium-term, the economy will still be dominated by the Canterbury rebuild.

Global growth creates some downside risk, particularly the weakness in Australia, and I suspect that the New Zealand dollar may surprise the RBNZ on the upside. That’s potentially the sole major challenge for an economy that appears to be firing on all cylinders. 

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