Through mid-2015, some of the wind came out of the economy’s sails, with annual GDP growth slowing to a tepid 2.3 percent. Combined with low inflation, this prompted the Reserve Bank of New Zealand (RBNZ) to cut the Official Cash Rate to 2.75 percent. We expect the RBNZ will need to continue cutting the OCR, which will help to support spending and economic activity more generally. However, there is a question about when future OCR cuts will occur.
Recently, we’ve seen improvements in a number of key economic indicators, including those related to the household sector. In the year to September 2015, retail spending on electronic cards was up a strong 6.1 percent, with particular strength in spending on durables and hospitality. The past few months have also seen net immigration rising to a record high, and continued strength in both house sales and prices.
It’s not just the household sector that has firmed, as activity in the manufacturing and service sectors has also picked up.
On top of the above developments, it now appears that export earnings in the dairying sector won’t be as large a drag on the economy as feared. Dairy prices have rebounded, rising by more than 50 percent in recent months, albeit from very low levels. This has been sparked in large part by Fonterra’s predictions that its milk collection will be down 5 percent on last season. In response, Fonterra has upgraded its forecast milk price for the current season from $3.85 to $4.60 per kilo of milk solids. Based on current prices, we expect that the payout for the current season will be even higher – we’re forecasting a payout of $5.30 per kilo.
Given the improvement in recent economic indicators, the RBNZ has a bit of time up its sleeve before it needs to cut rates again. Nevertheless, it’s likely that the RBNZ will need to continue cutting the OCR over the coming months. A slowdown in GDP growth is on the cards, with the economy facing significant headwinds from sluggish global trade, the levelling off of the Canterbury rebuild, and sharp declines in consumer and business confidence.
In addition, it’s looking increasingly likely that the economy will face a drought over the summer as a result of deepening El Nino conditions. Although drought conditions would boost prices for dairy, the related reduction in production could put a serious dent in GDP in early 2016. Of course, it’s not just the dairying sector that would be affected. Drought would also imply tough conditions in other parts of the agricultural sector, particularly for sheep and beef farmers.
These conditions will flow through to softer economic activity over the coming year, including retail spending. This will make it tough for the RBNZ to achieve its longer-term inflation goals. Softening domestic activity, along with reductions in Government charges, will keep the domestic components of inflation at low levels for some time.
At the same time, the RBNZ is counting on the fall in the New Zealand dollar (NZD) to generate a large and sustained pick-up in inflation through until late 2018. But we have our doubts about the durability of the coming lift in imported inflation. While earlier falls in the NZD will result in imported inflation rising sharply over the next few months, this will really only result in a temporary pick-up in inflation.
Longer term, it’s likely that the economy will need a significant shot in the arm in the form of lower interest rates if the RBNZ wants to generate a sustained lift in inflation. However, with inflation set to temporarily rise back close to 2 percent, there is uncertainty around when the RBNZ will change its view.
The eventual reductions in interest rates, combined with the continued strength in the housing market and strong population growth, will provide the household sector with a potent cocktail. These conditions will help to buffer households from the headwinds mentioned earlier. As a result, we expect that retail spending growth will be moderate, but nonetheless remain firm over the coming year.
This content originally appeared in the December 2015/January 2016 issue of NZRetail magazine.