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The maturing of a ‘rock star’ economy

Key highlights

New Zealand is maintaining strong momentum through 2014.
There are early signs that growth will moderate towards a more sustainable pace over the next year.
Continued strength in the NZ dollar despite softer commodity prices a continued worry for the RBNZ.

Report prepared by:

Nick Tuffley, ASB Chief Economist
Phone: +64 9 301 5659
Email: nick.tuffley@asb.co.nz

The purported ‘rock-star’ economy is halfway through what we expect will be the strongest year of the current expansion.  Looking ahead, the current above-trend growth pace will inevitably moderate into something more sustainable but less headline-grabbing, from 3.7% growth this year to just below 3% over calendar year 2015.

This year the economy is still carrying the momentum we had expected it to at the start of the year.  The coming together of on-going momentum in the Canterbury rebuild, the emergent lift in long-overdue Auckland house-building, strong net migration flows, and a good run of commodity returns is delivering strong growth for 2014. 

Looking ahead to 2015, the current drivers will still be exerting influence on the economy, but the collective impact won’t be quite as strong.  The current growth pace is above what the economy can sustain for a long period of time.  The RBNZ’s lifting of interest rates is intended to transition the economy back to a sustainable growth pace in a smoother fashion than a hands-off boom/bust cycle would deliver. Interest rates have further to rise over time, crimping the mortgage belt further, and increasing the cost of debt capital to businesses – though also giving better returns to long-suffering savers. 

A further headwind to growth we are wary of is the NZ dollar.  In our feature piece we look at the linkages of NZ’s solo journey to higher interest rates, the dynamics with the NZ dollar, and the negative flow-on effects of the high NZ dollar beyond pastoral commodities.  Given the strength of domestic demand within NZ’s recovery and consequent emerging inflation pressures, the RBNZ does want to get interest rates up from low levels to avoid overheating occurring.  But the reality is that, with NZ ahead of much of the developed world in lifting interest rates, a floor is being put under the NZ dollar.  In the current global environment of low volatility, high asset prices, and subsequent focus on yield, NZ stands out.

There are other currency drivers, and commodity prices are an important one over the long term.  But there are periods when the NZ dollar can decouple from commodity price trends, as it has since dairy prices began falling in February.  And while lower dairy prices without a weaker NZ dollar acting as a buffer will eventually affect economic growth (and inflation), the impact is not immediate.  Overall, the wider economy has been relatively resilient so far to the sustained strength in the NZ dollar.  However, some parts of manufacturing, notably electrical and mechanical manufacturing, have been weak.

The NZ dollar is likely to remain fairly strong until NZ’s interest rates are no longer seen as advantageous – either through rates in the major economies finally catching up or the risk environment flicking the switch to worrying about the safety of capital.  Next year we do see the NZ dollar starting to soften on a sustained basis.  The RBNZ is about halfway through its tightening cycle and we expect it will finish in the second half of next year.  By that point other countries will be either lifting interest rates themselves or be very close to it, reducing the yield advantage of NZ dollar denominated assets.  So even though growth will be slowing to a more sustainable pace, over time some moderation in the NZD will help create a bit more balance within the economy.  Meanwhile, continued NZD strength is one factor likely to keep the RBNZ on hold until late in the year.

Read the full PDF Report

Important Disclaimer - The views expressed herein are those of the authors and are based on information believed but not warranted to be correct. Any views or information, whilst given in good faith, are not necessarily the views of ASB Bank Limited and are given with an express disclaimer of responsibility and no right of action shall arise against any of the authors, ASB Bank Limited or its employees either directly or indirectly out of any views, advice or information.
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