By Bernard Hickey
Wellington-based independent economic consultancy BERL has forecast a slowing of economic growth and has suggested the Reserve Bank should allow the Official Cash Rate (OCR) to fall towards 1.5%, given the lack of inflationary and demand pressure in the economy.
BERL Chief Economist Ganesh Nana told a briefing in Wellington that BERL’s formal forecast was for an OCR falling to 2% by the middle of next year, but that the Reserve Bank should be cutting it towards 1.5% if it was purely looking at the inflationary signals in the economy.
“There just isn’t the inflation out there and the tradable sector and core retail have been in deflation for the last three years,” Nana said.
“The inflation target is meant to be on average over the medium term. They’ve got enough headroom to allow inflation to pick up,” he said.
Asked if the sharp fall in the New Zealand dollar in the last year would drive inflation up, he said: “The state of the demand side shouldn’t allow inflation pressures to flow through as much as they have in previous cycles.”
Nana said he agreed with the Reserve Bank’s view expressed last week that a more substantial exchange rate depreciation was required.
He said another 10% fall in the currency was needed towards the high US50c to low US60c mark, and towards the low to mid 80 Australian cent mark. BERL forecast the TWI would fall to 62 from just over 70 currently.
Nana described the current slowing of economic growth as a cyclical downturn rather than something more substantial, largely because of the fall in the New Zealand dollar and lower interest rates was helping to cushion the blow from falling dairy prices, and boosting growth from other export sectors such as meat, wine and tourism.
He said one risk to the outlook for only a moderate downturn was if the Reserve Bank “gets cold feet and sees the ghost of inflation.”
The New Zealand economy had experienced relatively strong growth in recent years because of a coincidence of supportive factors, including the Christchurch rebuild, the surge in dairy prices in 2013/14 and solid consumer spending, along with high net migration, he said.
“Those factors have come off the boil,” he said, adding there was a risk that inexperienced observers over-reacted to the fall in the exchange rate.
“We need that adjustment in the exchange rate to continue a bit further,” he said.
“The significant risk is that we talk ourselves into a downturn and we don’t realise this is an ordinary slowing.”
Worryingly strong M3 growth
Nana also showed a chart (see below) showing a divergence this year between growth of money supply in M3 terms and GDP growth, suggesting strong lending growth was being pumped into asset values, rather than real investment.
This divergence was happening for the first time since the period before 2008 when double digit lending growth helped power double digit house price inflation, Nana said.
“This shouldn’t be happening,” he said, adding it was relatively recent and too soon to make a definitive judgement.
“We won’t call it a bubble yet in terms of asset prices, but there’s a departure between how fast the money supply is growing and how fast the economy is growing,” he said.
“When that departs in those two directions we get a little bit concerned it may be stoking up problems in terms of further unwarranted asset prices, or it may, horror of horrors, flow through into inflation.”
Auckland housing bubble?
Later Nana said Auckland’s housing market was in bubble territory, but there were no obvious factors currently present that would say it was about to burst.
“Yes it’s a bubble. What might burst it? I’m conscious that the New Zealand housing bubble didn’t burst in 2008,” he said, adding confidence levels and the approach of banks would be key factors to watch.
“There’s no inherent factor that would say it’s got to burst,” he said, adding that various supply and demand factors such as increased house-building and slowing migration “would take the froth off it rather than pop it,” over the medium term.
Jobs growth in tradeable sector?
Elsewhere, Nana questioned where the jobs growth would come from as the economy adjusted to the lower exchange rate and exports increased, given employment in the tradable sectors had been largely flat over the last decade despite increasing export revenues.
“We have a dichotomy in front of us. We are reliant on our tradeable sector to earn us dollars and foreign currency, but our tradeable sector does not give us jobs,” he said.
Jobs growth had instead come over the last decade from the non-tradeable sectors such as construction and domestic services such as health, education and financial services.