21 Oct 2019
New Zealand should record modest growth of around 2 per cent in 2020 as the economy navigates a number of headwinds and tailwinds, according to ANZ Research.
There is increasing evidence the slowdown which has afflicted NZ is finding a floor with a consistent turn upward across a number of indicators, including business and consumer confidence.
"NZ businesses appear to be returning to a mindset of seeking out openings and possibilities - and that’s great to see.”
ANZ Research now thinks the Reserve Bank of New Zealand (RBNZ) has done enough to get inflation on target in the medium term and team has updated its official cash rate (OCR) forecast to remove a cut pencilled in for May.
But making predictions for a year ahead is always a risky business. In 2020, the fate of the NZ economy isn’t entirely in its own hands.
The weather, natural disasters, commodity prices, geopolitics, credit markets and the NZ dollar could all have a say in how the economy performs. ANZ Research will also be watching credit availability, business sentiment, infrastructure spending, the housing market and inflation pressures.
Global risks resulting from a decade of easy monetary conditions have not gone away and markets and sentiment can turn quickly. But while building resilience into a business is very important, planning for the worst-case scenario at all times will ensure a legacy of missed opportunities.
NZ businesses appear to be returning to a mindset of seeking out openings and possibilities - and that’s great to see.
Still, it’s always worth asking what could go wrong. It’s fair to say there’s a lot of luck involved in making an economic forecast over a whole year. Let’s start with the things that can’t be controlled.
So far, so good
When it comes to the weather in 2020, it’s a case of ‘so far, so good’ for most parts of NZ although some northern areas are drying out fast, according to the NIWA drought monitor.
The share of agriculture in NZ’s gross domestic product (GDP) isn’t large but volatility can really throw the numbers around. Additionally, just through pure bad luck, NZ’s droughts often seem to arrive at the same time as some other nasty shocks – the Asian crisis in 1998 and global financial crisis of 2008, for example.
NZ does have some influence on global dairy prices, being a pretty big player in this market, but it’s largely through milk volumes which over the short run are weather-dependent. Broadly NZ commodity prices are holding up well, when one considers both global markets and a range of indicators regarding the state of the Chinese economy.
Constrained global supply is the factor that squares the circle. But commodity supply does eventually respond to price signals and how long NZ’s charmed run can continue is hard to know.
NZX dairy futures suggest a solid outlook. A sharp lift in European dairy production would spoil the party - but this is not ANZ’s forecast as prices are not at enticingly high levels.
On the demand side, the tailwind of the westernisation of Asian diets continues. But China’s manufacturing sector is still struggling with the implications of the trade war and if this feeds into employment and consumer spending, NZ will feel it.
Getting on with it
NZ’s leading indicators suite is showing signs of bottoming out, consistent with ANZ’s GDP forecast. The housing market is starting to respond enthusiastically to the marked fall in mortgage rates. On the other hand, hard data has yet to show signs of a turn so a false dawn can’t be ruled out yet.
There is no reason for NZ growth to drift lower until some inevitable recession. The economy should indeed be bottoming out, looking at the big picture growth drivers: interest rates have dropped markedly, the exchange rate is significantly lower than a couple of years ago and population growth via net migration is still strong, among other things.
There are certainly headwinds. Key issues constraining growth at present include still-low business confidence, credit constraints and the tight labour market.
When weighed up, ANZ Research sees an economy set to accelerate only gradually, with a marked disparity between different sectors.
For now, the risks to the growth forecast look more balanced and firms are showing signs of concluding it’s time to get on with it. If around 2 per cent is the trough of growth over the next few years, NZ can count itself pretty lucky.
Risk appetite in global credit markets is definitely worth keeping an eye on in 2020 but again not something easily predicted. Free-flowing liquidity has seen a pretty lackadaisical attitude to risk of all kinds develop over time.
BBB-rated bonds, the lowest investment tier, now make up nearly 60 per cent of the investment grade universe, low-covenant loans with fewer protections for lenders have become the norm and risk spreads of all kinds have contracted as investors seek yield wherever it can be found.
This has benefited NZ as a relatively risky, indebted economy. But history shows collective attitudes to risk are prone to abrupt swings and there is no reason to think this time will be any different.
What the catalyst and timing will be is impossible to know but at some stage, pundits will reassess the amount of risk out there – and the appropriate reward they should be receiving for taking it.
Typically, this happens when things are turning pear-shaped and the RBNZ is slashing the official cash rate, swamping the upward impact on rates of widening risk spreads. But now, with limited room to cut rates further, it is not inconceivable that NZ rates could rise because times are bad.
That’s something not seen often, if at all. There aren’t any particular signs such a development is coming but the risk hasn’t gone away.
The NZ dollar has been behaving itself, tracking at or below where commodity prices suggest it should be, making for some nice farmgate returns and supporting inflation.
The NZ dollar is of course affected by monetary policy decisions but can reflect a lot of factors. The currency can jump horses without much warning, from commodity prices, to interest rate differentials, economic data and global risk appetite.
It makes exchange rate forecasting a mug’s game but the path of the dollar is a major determinant of many businesses’ decision-making and profitability. It’s an important relief valve for the NZ economy and a key part of monetary conditions, particularly with rates so close to practical limits.
Let’s turn now to things that typically reflect NZ choices and policy settings. The RBNZ’s final bank capital decision implies a less-sharp build-up of equity capital than the original proposal.
This roughly halves ANZ Research’s estimate of the impact of the move. While it will still be a decent headwind, it’s no longer looking like a handbrake.
It still has consequences for credit availability, which is of particular concern as a range of factors coincide, including bank capital changes, the dairy sector and interest rates.
The 2010 rules that made NZ banks less reliant on short-term foreign funding made them more reliant on deposits. If these fall this could limit banks’ ability to grow lending.
In practice, observed credit growth is a combination of demand and supply factors. Credit availability is only observable by proxy, through the RBNZ’s credit conditions survey, and the credit availability question in the ANZ Business Outlook survey. Both are flashing orange at the moment.
ANZ Research will be keeping a close eye on them and also credit growth as the year progresses. Credit availability has implications not least for business investment, the outlook for which is the main point of difference between ANZ Research’s and the RBNZ’s growth forecasts.
In general, the vibe around business sentiment has definitely improved - and that is very welcome. But will it actually lift activity? Or is it merely a correction from an overstatement of risks on the downside? At least the risk NZ is talking itself into a slowdown seems to be diminishing.
All else equal
The NZ government has announced $NZ12 billion in infrastructure spending but so far details are scant on what the projects will be.
In the bigger picture, catching up on NZ’s gaping infrastructure deficit will benefit productivity and wellbeing but in a pure GDP growth sense the impetus is likely still some time away.
Of more immediate interest is the housing market. Record-low mortgage rates are clearly working their magic, with prices starting to lift quickly.
A strong housing market supports sentiment, GDP growth and inflation. If consumers start to spend more freely then perhaps retailers will finally have an opportunity to rebuild their squeezed margins. On the downside, it’s not the sort of growth New Zealand needs. Household debt is already very high, housing affordability is a significant economic problem and price rises further exacerbates wealth inequality.
If things really start to get silly, the RBNZ has the option of tightening lending restrictions once more. It can’t be ruled out.
Still with the RBNZ, the starting point for the inflation outlook is pretty much bang on target, albeit with some one-off factors at play. This means that the RBNZ can afford to be patient, waiting to see how its previous rate cuts flow through into the economy. The impact on the housing market seems clear but for business investment, whether certainty about interest rates will be sufficient to offset other forms of uncertainty remains to be seen.
Those are the main things ANZ Research will be watching in 2020. As always, however, it could be something comes out of left field.
The main theme of the forecast remains the same: the NZ economy is navigating some typical late-cycle challenges that make high speed more difficult to achieve but, as things stand, there is nothing that suggests a derailment.
Sharon Zollner is Chief Economist, NZ at ANZ
This article was originally published on ANZ's Institutional website
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
21 Oct 2019
15 Nov 2019