Is New Zealand drinking the last of the summer wine?

By NZPA

Friday 9th August 2002

It's been a golden couple of years for the New Zealand economy and despite all the tumult overseas, the signs are that the local economy is still enjoying the fruits of its harvest.

But all good things must come to an end, and New Zealand's inflation watchdog the Reserve Bank has had a barrage of economic data to weigh up this week as it takes the economy's temperature again.

On Wednesday the bank will decide whether it should call a halt to the current round of interest rate rises, its main tool for curbing inflation.

Interest rates have already edged up four times this year, essentially reversing a 100 basis point cut which the Reserve Bank made post-September 11 last year as insulation against a world slump.

On one side, there are plenty of negatives which should keep rates steady. Exports are slowing, commodity prices -- particularly for dairy products -- have already tumbled and sentiment about world growth is distinctly nervous.

On the other hand, the domestic economy continues to chug along nicely. Wages have fallen slightly in recent times, and prices are on the increase, but employment is strong and consumer spending is holding up.

New Zealand's central bank is not the only one pondering monetary policy.

This week Australia decided to hold off rate increases after looking at its ailing export outlook, the stock market slide and a raging drought. Australia last hiked interest rates in June, the second of two 25 basis point rises after dropping its cash rate to 30-year lows.

And while Australia sits tight, there's talk of another rate cut in the world's benchmark economy, the United States. Its rates are already at 40-year lows but disappointing economic data, accounting jitters and sliding stocks has sparked fears of a "double dip recession".

"The fact that most of the other central banks around the world are remaining on hold will be a factor that (the Reserve Bank) will be looking at," Westpac economist Donna Purdue said.

Having said that, she thinks another US rate cut is unlikely given the hopeful speech by Federal Reserve chairman Alan Greenspan just two weeks about his country's recovery.

Bank of New Zealand economist Stephen Toplis agrees, saying that despite the nightmare on Wall St, other sectors of the economy are on track.

"It would be easy to conclude the world had just fallen into an inescapable black hole. But a closer look at the actual data might reveal a slightly different interpretation."

However, the time the US recovery is taking does not bode well for New Zealand's export markets, and Ms Purdue believes the international climate is sufficiently sick to put New Zealand interest rates on hold -- temporarily at least.

"I think the fact the US is showing signs of instability, that really puts into question now whether in 2003 we will be able to achieve (New Zealand's target) 3 percent growth rate."

Most economists agree that if the international scene wasn't looking so bleak, the Reserve Bank would have been looking at another rate rise.

Retail sales -- a major driver of the country's growth -- were up 1.2 percent for the June quarter, and sales volumes were up. The pace is slowing, but still enough to show the Kiwi love affair with retail therapy has not ended.

Unemployment edged down 0.2 percent in the June quarter to a 14-year low of 5.1 percent, and employment growth was a creditable 0.6 percent.

"The unemployment rate at its lowest for 14 years means the labour market is still tight," UBS Warburg chief economist Robin Clements said. Migrants have been "soaked up by employers as quickly as they're coming in".

Balancing that this week was a slight dip in wages over the quarter. The Quarterly Employment Survey showed total hourly earnings for the private sector dropped by an average 0.1 percent during the May quarter, in contrast with the 0.8 percent rise expected by economists.

The Labour Cost Index showed a slight increase of 0.5 percent in overall wages.

"If it wasn't for the wage data we had earlier in the week, this would probably have been causing some concerns about the state of monetary policy," said Mr Clements.

"But that QES wage and labour cost index data has probably calmed nerves considerably, so this data probably leaves the market still pretty content to envisage that the Reserve Bank will be on hold."

Salomon Smith Barney economist Annette Beacher is one of the few economists who believe the Reserve Bank will err on the side of caution and raise rates another 25 basis points to its optimum 6 percent.

"The migration inflow is clearly lifting the pace of domestic demand and is expected to do so throughout 2002.

"We believe that small movements are preferable to more harsh tightening action likely required once global financial markets stabilise."

Mr Toplis is hedging his bets, with a slight bias towards a rise in August. He believes the kiwi dollar is weaker than the RBNZ would like, on top of constraints on manufacturing capacity, the strong migration-fuelled consumer, tight labour market and a surprising resilience in export volumes.

"The head will be saying raise interest rates and raise them now. The heart will be saying it is a very scary world out there and that a pause in tightening cycles is warranted."

How long can New Zealand's domestic economy party on? By the time the international outlook brightens, the lagged effects of its medal-winning run should be fading out. Farmers are already beginning to anticipate the pinch, with world dairy prices having fallen to their lowest levels in at least 16 years.

But the wild card is the weakening currency, which means the prospect of lower farmer returns is not so glum.

"First, and worth emphasising, the exchange rate has completely bled its May-June rush of blood," BNZ treasury economist Craig Ebert said.

"More than just an unwinding, this also allays the recent fears of the New Zealand dollar powering relentlessly higher, through US50c at least, carving rural incomes in its wake."

In addition, the drought-bringing El Nino weather pattern looked like it was going to be less severe than expected, and thirdly, employment growth was still looking pretty strong.

Ms Purdue is reserving judgment. "There's little doubt that things will slow in the second half of the year. The question at the moment is, how much our export sector is going to be able to pick up the slack."

The RBNZ will clearly be mindful of the fact that domestic spending remains robust and that domestic inflation pressures persist, she said.

"Thus, we continue to believe that the next interest rate move will be up -- just not in August."

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