Economic backdrop

Monday 27 July, 2009

After a period of extended weakness, we expect the economy to rebound in late 2009. A cyclical upswing will combine with preparations for hosting the Rugby World Cup from 2010 and over 2011. But the bigger picture points towards an elongated period of relatively subdued growth as the economy rebalances.

Our core economic view

The economy is still in recession, or moving down one side of the bathtub. Forward indicators continue to point to an economy that is contracting, though the pace of contraction is moderating. The unemployment rate is rising rapidly and is set to continue heading higher into next year. Despite tax cuts and lower mortgage rates, consumer spending remains subdued as households increase their precautionary savings. Private consumption has now fallen for an unprecedented five consecutive quarters. Building consents are at levels not seen since the 1960s, and residential investment is down over 30 percent from its 2007 peaks. Business profitability has been under pressure and firms have been responding accordingly. Business investment has been cut back, falling 15 percent from a year ago – the steepest fall since the early 1990s.

A base is still forming. House sales are up 50 percent from their lows, as buyers respond to lower interest rates. We expect this to flow through to a sizeable recovery in building consents in the second half of 2009, and into actual residential construction activity late this year and early next year. Natural population growth is also providing underlying support to demand. Firms’ own activity expectations from the National Bank Business Outlook (NBBO) survey – a key leading indicator – is now back in positive territory. Consumer confidence is similarly back above the key 100 level, indicating that optimists once again outnumber pessimists. Net migration is running strong, with the last three months seeing an annualised gain of 26,400 people, representing a key source of upside support to the domestic economy. All are welcome.

At this stage we are still cautious about the economic outlook. There is a base effect to be wary of as the bungy-cord dynamic takes hold. House sales may be up, but they are 30 percent below levels seen two years ago. The global scene remains fragile and we see an elongated adjustment panning out. Firms are now being forced to react via reduced investment and employment. The NZ economy is still facing a protracted period of structural adjustment as the economy rebalances away from a model built around debt fuelled consumption and towards export and earning sector growth. This is a transition that will take time.

We expect forward momentum to be regained from late 2009. However, even a subdued recovery will mask heavy regional and sectoral disparities. 2008 was really an Auckland or upper North Island centric recession, as weak housing activity, retailing and a squeeze on income from rising costs (i.e. petrol and food prices) bit. There is still some intensity in these pockets, but increased housing activity in Auckland is now outstripping other parts of the country. Conversely, collapsing manufacturing activity, weakening tourism flows and the big show-stopper – a lower forecast payout to the dairy sector – are set to impact heavily on tradable or export aligned regions. Rural land prices in particular are under significant pressure, and the flow-on effects from a tighter farming chequebook should not be underestimated. While the economy will be travelling along the bottom of the bathtub from the second half of 2009, it will remain a bathtub with waves.

Source: National Bank, Property Focus