Abundance of good economic news gives Bollard a headache

By NZPA

Friday 14th November 2003

We have been swamped with good economic news this week highlighted by the fall in the unemployment rate to 4.4 percent -- a level last seen in 1987.

As well, September quarter retail sales rose 2.0% with shoppers pushing Eftpos buttons faster than economists had forecast.

That might in part be due to the New Zealand dollar climbing to fresh six year highs of US63.10 cents which has helped make prices cheaper.

Treasury numbers for the first quarter showed the massive $3.8 billion projected surplus for the 2003/4 year was being underestimated by $750 million thanks to lower dole payments, and higher income and company tax collection.

Stephen Koukoulas, chief strategist at TD Securities called the jobs numbers "incredible".

"It's in line with the pick up in retail sales and business confidence and the ongoing strength in housing construction as well as house prices."

Tuesday's jobless figures put New Zealand third best in the OECD club of rich nations.

The Government has been focused on getting its living standard back into the top half of the OECD but there is a good argument to say a low unemployment rate is more beneficial in terms of improved health, education and general well-being.

In the last year, as well as the economy adding 61,000 new jobs, there were statistically significant drops in unemployment for young people.

As well, the unemployment rate among Maori, while triple the Pakeha rate, fell below 10 percent for the first time since the late 1990s.

While the economy is clearly booming and economists are scrambling to revise up their forecasts for growth, Reserve Bank Governor Alan Bollard is clearly caught in a bind.

The annual inflation rate is low and possibly set to fall further thanks to the strong currency depressing import prices, but there is a rampant housing and construction boom that has sent house prices rocketing nearly 20% in the last year.

The labour market is tight, with employers struggling to find workers and a risk wage rises will outpace productivity gains.

Dr Bollard undoubtedly wants to deflate the balloon before it bursts, but the weapons available to him are extremely limited and realistically restricted to hiking interest rates.

Such action would almost certainly push the currency higher and increase the pain for the productive sector.

Finance Minister Michael Cullen baffled financial markets and others last week when he mysteriously said he had "options" to deal with the soaring currency.

He refused to elaborate other than saying it didn't involve ordering the bank to sell New Zealand dollars in the market.

No one seems to have a clue what Dr Cullen has up his sleeve and a check with his office a week later provided no illumination.

"If he thinks he has got a magic wand he can wave to fix it, he is deluded," said National Party's John Key, who used to work in foreign exchange markets.

Although exporters invariably see a rising currency as a curse, most of us enjoy the benefits in the form of cheaper imports and affordable overseas jaunts.

Independent financial analyst Roger Armstrong argues a country's currency is the nearest thing to a sovereign share price and strength reflects economic well being.

The 10% rise of the New Zealand dollar (on a trade weighted basis) this year and 38 percent over three years, is akin to financial markets voting New Zealanders an improved standard of living.

However, currencies have a habit of overshooting, and a rise of the kiwi in this cycle close to its all-time peak of US71.7c touched in November 1996 might not be beyond possibilities.

Some economists said this week's robust data gives Dr Bollard little choice but to lift rates as soon as December 4 when the bank is next due to review the Official Cash Rate.

However, others believe the low inflation rate gives Dr Bollard breathing space.

Deutsche Bank chief economist Ulf Schoefisch said financial markets were over confident about a December move.

"December is probably too early. But if the data continues to come in stronger than expected, then a move in Q1 of next year cannot be ruled out at all".

The surprise decision of the Reserve Bank of Australia last week to lift its cash rate to match New Zealand's 5% makes it easier for Dr Bollard to move earlier.

Australia is facing a more extreme property boom and has seen its currency rise even more steeply that the kiwi dollar this year.

Two of New Zealand's important listed manufacturing exporters, the Fisher & Paykel sisters, reported healthy half year profits this week.

Neither complained too much about the currency.

F&P Healthcare, which mainly sells in the US market has foreign exchange cover in place for two years at less than US45 cents.

"Our hedge portfolio has helped insulate us from much of this volatility and we remain well-hedged for the next two years or so, said chief executive Michael Daniell.

Whiteware firm F&P Appliances also said it was not too concerned about the currency, with the New Zealand dollar having come down on the Australian dollar cross rate and the company having a natural hedge in the United States from where it imports a lot of raw materials.

However, the country's largest exporter, Fonterra this week warned its currency-hedging policy may not be sufficient to protect farmers from the 19% gain against the US dollar this year.

"The whole purpose of our policy is to give our farmers some certainty around payout each season," chief financial officer Graham Stuart said.

"But farmers need to be aware that it does not completely cancel out currency impacts."

Mr Stuart reiterated Fonterra's forecast payment for this season, ending May 2004, will be $3.95 per kilogram of milk solids.

He declined to speculate on how much Fonterra will pay farmers for milk next season.

From this season, Fonterra started buying enough forward contracts to cover 15 months of foreign exchange purchases -- abandoning previous efforts to actively speculate against movements in the New Zealand dollar.

"Fonterra's cover for next season is progressively being put in place," Mr Stuart said.

"Earnings next season will be converted at a rate averaged over the whole year. This is likely to be less than 60 US cents."

BNZ treasury economist Craig Ebert reckons the jobs and sales data showed the economy had "lost the opportunity to lose steam when it need to get rid of excess demand".

He fears damage from "excessive wage growth" arising from shortages of skilled labour.

But he concurs with the view that the currency's rise might buy Dr Bollard more time to make his decision.

"However, when all is said and done, the currency's rise won't be enough to prevent the Reserve Bank from changing monetary policy from its current stimulatory levels," he says.

"It's only the timing we are haggling over."

Interestingly, political scientist Nigel Roberts notes that high employment has had little correlation to governments getting returned to power.

On the other hand, economists have done studies that show a much higher correlation between All Black success and incumbent governments returning to office.

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