THOUGHT LEADER : Of Interest Rates And Ambulances

Business managers attempting to get some measure of how the general economic environment in New Zealand might affect their individual enterprises over 2010 and 2011 may be excused for being somewhat confused and bemused right now.
The economic forecasters are just as confused as well, as we observe current gross domestic product (GDP) forecasts ranging from +1.5 percent to +4.5 percent for the next 12 months. The only area of consensus is that we will be out of the negative (recession) numbers we experienced in 2008 and 2009. However, there are very wide-ranging and very divergent opinions on the speed and degree of recovery. There still seems to be too many economic/market imponderables and unanswered questions to settle on firm view just yet.
• Will the global economy, as many forecast, actually grow at four percent in 2010?
• Have international commodity and equity markets already priced-in too much expectation on global demand and economic growth in 2010?
• When and how do the Americans and Europeans unwind monetary and fiscal stimulus measures and let the economic casualties fare for themselves?
• Is the US economy on recovery path and how far ahead of Europe is it?
• What are the chances of the debt-fuelled property bubble in China bursting with adverse impacts on the global economy?
• How long will New Zealand’s Reserve Bank leave official interest rates at record low 2.5 percent levels this year?
• Will our export commodity prices hold their current high levels?
• The $NZ has depreciated from $0.76c to $0.69c against the $US over recent months, so will it continue to fall to $0.60c to provide the export sector with real lift?
• Are the super high business and consumer confidence indices to be believed and will that optimism transfer into stronger economic activity?
What we do know is that domestic economic data so far this year has all been weaker than expected. The money markets have therefore pushed back the commencement of official interest rate increases to the second half of the year. When the Reserve Bank starts lifting interest rates it will only be increasing the 2.5 percent official cash rate (OCR) up to the 4.5 percent level by mid-2011, leaving our market interest rates at levels still well below historical averages.
New Zealand’s good economic news is that our agricultural export commodity prices are now all at high and strong levels. If the $NZ continues to decline against the $US to the mid to low $0.60s, the prerequisite conditions for stronger export led recovery in 2010 seem excellent.
The wild and unpredictably large swings in value of our dollar over the past four years have reduced exporter confidence, business expansion, profits and investment. The economy needs some currency stability to restore these fundamental drivers of incomes and livelihood.
Relative interest rate levels between us and the rest of the world are big determinant of the $NZ/$US exchange rate. What global commodity prices, the $A and the $US are doing are just as important, but we can’t control those variables. The Reserve Bank’s monetary policy can, however, reduce the currency volatility by stabilising interest rates at lower levels. There is more than reasonable chance that the RBNZ’s future “neutral” setting for monetary policy will be short-term interest rates at five percent, instead of the 6.5 percent benchmark to date.
This would align our interest rates more closely with the rest of the world cutting the massive capital inflows attracted by our previous high eight percent rates. Experience shows that tight monetary policy with eight percent rates drove the $NZ value up and manufacturing exporters out of the country.
The new RBNZ regulation of bank funding provides another lever to control economic excesses, including inflation. Hopefully, there will be less reliance on using interest rates only to control inflationary pressures. Both the RBNZ and Government understand the importance of investment in and expansion of, the export sector to achieve higher and more sustainable economic growth. downward paradigm shift in our interest rate structure seems likely and will assist in achieving those objectives.
In addition to more weapons in its armoury, the Reserve Bank must think about using its influence and power to create economic policies that deliver more competition in the economy. Competition is the best anti-inflation weapon. The Reserve Banks needs additional powers to push for more economic competition to stifle inflation at source. We need workable competition policies that reduce upward price pressures. An ambulance at the bottom of the cliff is not the answer to countering inflation.
The recession has shown that we need to get smarter with economic policies and to conduct monetary policy to provide the right conditions for businesses and industry to contribute to long-term growth. I have some optimism that these messages are now being heard and understood in Wellington.

Roger J Kerr is the director of Auckland-based, Asia-Pacific Risk Management. [email protected]

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