We are currently enjoying a period of increasing momentum across the New Zealand economy, underpinned by strong performance in the housing sector, which in particular is boosting growth in Auckland and Christchurch.
According to forecasts from the Reserve Bank (RBNZ), this will help GDP growth in the second half of this year accelerate to a 3% annualised rate, up from less than 2% in the first half. This momentum is expected to carry forward into 2014 where GDP growth should remain close to 3%.
The domestic consumption picture in 2014 is likely to be even stronger, with 3.5% private consumption growth forecast for 2014, as well as a very strong 10.6% increase in total investment.
Of course, this strong growth outlook, on top of the existing price and financial stability issues in the housing market, may push the RBNZ to increase the official cash rate (OCR).
But what about inflation? CPI (consumer price index) data for the June quarter released yesterday tell us that price pressures in the economy remain generally low. Total prices rose by just 0.2% in the quarter, to be up 0.7% versus a year ago, the lowest annual rate since 1999.
The high level of the NZ dollar has been a key driver of this – prices for tradable goods and services (which represent 44% of the total CPI basket, and reflect items that can be imported/exported and are priced on international markets) fell by 0.5% in the June quarter, and are down 1.1% in the past year. However this factor will turn over the next year reflecting the recent weakness in our currency.
In non-tradables (goods and services which are not traded internationally, thus where prices are not directly influenced the currency), there are signs of increasing price pressures. Non-tradable prices were up by 0.6% in the June quarter, to be up 2.5% on the year. Prices in the housing and household utilities group rose 1.1% in the quarter, and new housing costs are up 4.1% in the past year. Pressure here will continue in the September quarter, which alongside a jump in petrol prices should mean a much higher (over 1%) quarterly CPI.
For interest rates, the other factor we will be closely watching is the impact of the RBNZ’s upcoming LVR (loan-to-value ratio) lending restrictions. Most recent data on housing finance suggests banks may already be pulling back somewhat from more aggressive mortgage lending. We still believe that these LVR restrictions are unlikely to meaningfully reduce pressures in the housing market. Once momentum in the housing market builds, it can be difficult to stop.
Pulling this together, we see a picture where low inflation gives the RBNZ room to keep rates on hold for a little while yet. However, it is increasingly clear that the economy no longer needs a record low cash rate. Financial markets are currently forecasting a first increase in the cash rate in March 2014. We consider this may be too late –in the absence of an unexpected further move down in our currency, we see a high chance that the first OCR hike comes at the RBNZ’s January meeting, and quite possibly as early as December.