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A financial turn for the worse

  • Opinion
  • October 13, 2015
  • Felix Delbruck
A financial turn for the worse
Image: Kerryn Smith

Signs are growing that the Canterbury rebuild has reached a peak. This is not good news for consumer demand, though international experience suggests the impact will vary significantly among the regions.

The economic and financial environment has changed radically in the last couple of months.

Prospects for the dairy industry have turned from downbeat to depressing, as the global supply of milk has continued to exceed demand. Slower growth in China is one reason, but not the only one. Of equal concern, global milk production ramped up when dairy prices were high and is showing very little sign of tailing off. Milk producers in the Northern Hemisphere have upped their game in recent years, particularly in Europe, where milk production quotas were recently removed. So even when Chinese demand perks up again, New Zealand may face more competition in meeting that demand than it might have done five years ago. That suggests it could be some time before dairy prices return to the levels we’ve become used to.

As we write, dairy auction prices have fallen to their lowest level in six years, and we are braced for further falls to come. It now looks likely that this season’s farm gate milk price will be even lower than last season’s already very weak $4.40. To put this in context, the milk price for the 2008/2009 season, at the low point of the Global Financial Crisis, was $4.70. These are the toughest times the dairy sector has faced in a long while.

We’ve also seen increasing signs that rebuild activity in Canterbury is levelling off. Of course there is still a massive amount of work to be done. But the nature of that work is shifting from residential builds to larger and more complex commercial projects, and the overall level is no longer rising. That means the Canterbury rebuild is no longer boosting economic growth, and it will become an actual drag on growth as it starts winding down – we think from about mid-2016.

Of course, there are also still some positives worth mentioning. Migration is showing no sign of slowing – and it could stay high for some time yet, until the Australian job market becomes a more attractive alternative for migrants. And the Auckland construction industry still has considerable momentum behind it, with the current pace of residential development nowhere near meeting demand.

But all in all, the economic outlook isn’t looking nearly as buoyant as it did a few months ago, and interest rates and the New Zealand dollar has reacted accordingly. Faced with the very unwelcome combination of a slowing economy and inflation near zero, the Reserve Bank is rapidly undoing last year’s interest rate rises – the OCR is back at 3 percent and will probably go lower still. And that has given financial markets the green light to send the NZ dollar plunging. The exchange rate is a barometer of how well we are seen to be doing compared to other economies, and New Zealand’s image as an outperformer has well and truly faded.

What does it mean for consumer demand? We can get some idea from the recent experience of Canada and Australia following the collapse in iron ore and crude oil prices. Consumer spending in those economies slowed on average, but with wide regional variation. For example, consumer spending grew more than 3 percent in New South Wales last year, but just 1 percent in Western Australia. We would expect a similar pattern in New Zealand, with consumer confidence and spending slowing sharply in the dairying regions, but remaining more buoyant in Auckland.

That said, Auckland consumers are unlikely to be completely immune to the dairy downturn. A major reason is the drop in the exchange rate, which has pushed petrol prices back above $2 a litre and will lift the cost of a wider range of imported goods as the year goes on. Essentially, the lower exchange rate will spread the pain of lower dairy revenues to urban consumers.

We also remain braced for some signs of cooling in Auckland’s rampant housing market in coming months. Auckland will bear the brunt of the investor lending restrictions and tax rule changes to be introduced later this year. It’s also become increasingly clear that speculation is playing a role in driving up prices, which have risen far ahead of what Auckland rents would justify. Our preferred interpretation is that investors are betting on denser development in the existing urban area, driving up land prices in the central districts. As the economy cools, investors’ ebullient beliefs about the value of Auckland land will be challenged.

This story was originally published in NZ Retail magazine issue 739, August / September 2015.

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