Two contrasting outlooks emerged from forecasters in Wellington early in July. At Westpac on Lambton Quay, chief economist Brendan O’Donovan and his team peered into the crystal balls and saw trouble in the mists. Within spitting distance (on windy Wellington day), Infometrics economists on Featherston Street were much more bullish.
O’Donovan said we could be grateful the housing market hadn’t yet hit the wall, “or else the dreaded R word [recession] would be the topic of the day”.
Relatively weak GDP results were among the data suggesting the economy had “the wobbles”, he said. Net migration was headed lower; the rebound in the housing market (induced by the mortgage war) was proving temporary; trade data suggested the export- and import-competing sectors were still feeling the pinch of the higher Kiwi dollar. Meanwhile, business confidence was palpably weaker and global growth seemed to have passed its peak.
There were some positives. The labour market remained buoyant and consumers remained reasonably optimistic, even though their confidence was slipping. Consumer spending therefore was maintaining healthy pace of growth, and farmers’ incomes were being boosted by commodity prices still close to record highs.
But the bulk of economic data suggested that “this business cycle is well past its ‘best-by’ date”, said O’Donovan. His observations were especially aimed at officials who fix the official cash rate. “The Reserve Bank is in denial and can’t see the weakness in the economic data,” he said. “Their tight monetary policy is also past its use-by-date, and risks giving the economy bad case of salmonella.”
O’Donovan was also taking issue with commentators who were calling for interest rates to be held up for considerable time.
Westpac expects growth to slow from 4.8 percent last calendar year to 2.4 percent this year. Next year, it is forecast to fall below two percent, when weaker housing market adds to the economy’s woes.
Higher interest rates, in those circumstances, would exacerbate the drag on economic activity. But some economists were championing them on the grounds that the slowdown was result of supply constraints (a shortage of skilled workers, for example) rather than weaker demand. Constrained supply (it was contended) would result in higher inflation (higher wages); hence the need for higher interest rates.
Baloney, said O’Donovan. Sure, the economy’s capacity is constrained, but if capacity constraints were causing the slowdown, why had activity dropped in the primary and manufacturing (and increasingly the residential construction) sectors? Demand and competitiveness factors were at work, he said, and this was classic business cycle, with extremely tight monetary conditions and weaker migration stimulus having their expected impact on growth.
Infometrics painted rosier picture. Its view of inflationary pressures and interest rates was commensurately different.
Sure, economic growth may be cooling after strong performance last year, “but it’s not all doom and gloom”, said managing director Andrew Gawith. His firm predicted the economy would expand by more than three percent year over the next five years.
Gawith’s optimism about sustained economic growth was rooted in higher productivity. Investment in plant and equipment had climbed by 36 percent over the past two years, he noted; this was sign that firms were looking for ways to increase their capacity other than simply hiring more staff. Moreover, the tight labour market would push businesses to reduce their dependence on labour to achieve higher output.
Gawith also focused on the 10 percent rise in New Zealand’s terms of trade since 2003. “This hinted at smarter production decisions behind the scenes,” he said. “Farmers have been changing how they use their land and their expertise to produce higher-value products.” These changes, plus high world prices for many products, had helped keep primary producers profitable despite the surging currency.
A key concern over the next few years, true, was the prospect of household confidence and spending being dented by slump in real estate values. But Infometrics reckons the rapid decline in new house building will limit the extent to which the market becomes oversupplied; therefore house prices in most areas are likely to stagnate, rather than fall. And so households will keep most of the wealth gains accumulated since 2001/02.
Inflationary pressures? Whether the slowdown was cyclical or not, Infometrics forecaster Chris Worthington replied, there seemed to be plenty of inflation left in the economy and even with some slowing, the pressures won’t quickly vanish. Lower interest rates accordingly were some way off.
There’s fine line between the contrasting forecasts. The Reserve Bank has been walking it for several months. It doesn’t want to lift rates just as the economy is at turning point – but it sees little room for relaxation.
Bob Edlin is regular contributor to Management.
