UPDATE: HSBC economist Paul Bloxham sees OCR at 4.5% by end of 2016

Tuesday 20th January 2015

HBSC chief economist Paul Bloxham is picking the Reserve Bank will lift the official cash rate by 25 basis points to 3.75 percent in the last quarter of the year due to inflationary pressures and by 100 basis points to 4.5 percent by the end of 2016.

Bloxham coined the phrase 'rock star economy' for New Zealand’s strong economic growth last year and is forecasting the encore this year is that the nation will remain one of the strongest performing developed economies in 2015. In an economic report out today, he and colleague Daniel Smith predict gross domestic product growth will slow to 3 percent this year from 3.3 percent in 2014 which would see New Zealand continue to outperform most other developed nations.

Despite the strong economic growth inflation has remained surprisingly low, spurred by a high New Zealand dollar lowering the cost of imported goods, high net migration addressing skills shortages in some sectors and business increasing investment in new capacity.

Due to the fall in oil prices by 20 percent since September, consumers price index inflation is likely to drop temporarily below the Reserve Bank’s 1-to-3 percent target band but as the oil impact fades, Smith said inflation was likely to lift from the second half of this year to towards the 2 percent midpoint of the target band.

“We expect inflation to pick up very quickly in 2016 which will mean the Reserve Bank may have to resume rate hikes before the end of the year,” he said.

The Reserve Bank will review monetary policy next week and is expected to keep the cash rate at 3.5 percent with robust economic activity yet to spill over into inflationary pressures.

The HSBC pair are also forecasting housing price values to continue to appreciate this year.

New Zealand's tight labour market is expected to continue to support consumer spending with employment gains having boosted overall household income despite slow wage growth. As the market tightens this year, with HBSC forecasting a drop in the unemployment rate from 5.4 percent to 5 percent by the end of 2015, there should be a modest lift in wage growth.

They’re also picking the migration boom that has driven population growth and provided spare capacity in the labour market, is expected to peak this year, mainly because of an improvement in Australia’s employment market conditions which could see fewer Kiwis choosing to stay home.

“For now, the New Zealand labour market is noticeably outperforming that of Australia, which is the main source of migrants, although the gap may narrow over time as several indicators point to a gradual improvement in hiring conditions in Australia,” Bloxham said.

New Zealand’s economic growth is expected to be supported by a continued upswing in construction, with commercial construction likely to replace residential repairs in Christchurch and residential construction strong in Auckland.

Low dairy prices will prove a headwind though. Bloxham said their view differed from other economists on how bad the dairy price story was and he’s picking there won’t be a large effect on real GDP.

Alongside construction, the dairy sector was another key driver of growth in 2014 but the outlook for this year remains more challenging. The GlobalDairyTrade index fell by 50 percent between February and December last year leading to Fonterra lowering its forecast for the 2015 farmgate milk price to $4.70 kg/MS which could reduce dairy export earnings by around $ 7 billion in nominal terms and drag down rural incomes.

But Bloxham said New Zealand dairy farmers are a lot less leveraged than they historically have been.

“Leverage and a fall in dairy prices sees the sector struggle but this time around the story is not so acute,” he said.

Plus the main factor behind low dairy prices has been reduced demand from China, with New Zealand accounting for around 60 percent of China’s dairy imports. But Chinese imports now appear to have dropped to seemingly unsustainably low levels and they expect Chinese imports to ramp up again this year as inventories diminish further, which should lead to a partial rebound in prices.

In the medium term outlook Bloxham is picking New Zealand’s economy will remain strong due to its strong Asian ties where rising will drive demand for the country’s high quality food, including beef, lamb and milk and tourism services.

BusinessDesk.co.nz

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