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Clearing skies?

-Donal Curtin

Friday 10th October 2008

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It's doom and gloom at the moment: the financial sector is panicky, business confidence surveys keep getting worse, and it's raining all the time. But is the outlook quite that bad?

The factor that played the single most important part in bringing the New Zealand economy near, or actually into, recession, has eased back significantly. That was the fatal combination of high interest rates and a high currency. Many companies could handle one or the other; together, though, they were deadly.

That's seen most easily in the "monetary conditions" index that the Reserve Bank still calculates (but doesn't explicitly steer by any more). The index takes account of both the exchange rate and interest rates, in a single summary formula showing how tough conditions are for business. By late last year that index was in all-time tough territory - tougher than it was in the first days of getting inflation down in New Zealand in 1989 and 1990 (and they were seriously tough times in their own right), and tougher than the squeeze that brought the 1992-1996 boom to an end.

Pressure on both the currency and interest rate fronts has eased significantly. In the past quarter the Kiwi dollar has dropped by nearly 6% in overall trade-weighted value, and there's been particular relief for those companies whose main or only export market is Australia. In the past six months the Kiwi has slumped from 88 Aussie cents to today's 78 Aussie cents. That's enough to transform profit margins on many export contracts.

On the interest rates side, the picture is a bit more nuanced, but also heading in the right direction. The Reserve Bank has cut short term rates once already, and is odds on to keep doing so. The financial markets are picking, probably rightly, that short term rates will be a whole 1% lower in six months' time. Longer term rates have also been dropping: the benchmark these days is a thing called the "swap" rate, and the three year swap rate, which started the year at 8.5%, is now down to 7.1%.

The "nuanced" bit comes from the fact that borrowers (you and me, but also New Zealand's banks, which rely on offshore borrowing to fund the loans they make)
don't pay that benchmark swap. They pay the swap plus a margin on top, reflecting their credit risk. In today's deeply unsettled markets that margin has blown out,
as would-be lenders have become deeply anxious about risk. Until the end game of the credit crisis arrives, those wider credit spreads are holding up the full benefit of lower interest rates being passed through to you and me. But, that said, big falls in the swap rates at least prevented things getting worse, and in time will see interest costs

We also need to remember the other major policy lever that's been pulled recently: fiscal policy is strongly supportive of the economy. We all know that's the case at some intellectual level, from picking apart the Budget and the like, but the actual money impact hasn't (for the most part) happened yet. When 1 October rolls round and people actually notice the extra on National Superannuation or on the pay slip, it'll make a difference. The Bush administration's recent move of sending tax refund cheques "out in the mail" seems to have done the trick in helping out the American economy in the June quarter, and there'll be something similar here. There's also the real prospect (going by their just-announced tax policy) that if National do make it onto the government benches, the fiscal boost will be stronger again.

There are several other developments worth mentioning. One is oil: it's still no fun watching the meter at the petrol pump, and the weaker Kiwi dollar has undone some of the effect, but the fact is that the world oil price has dropped US$20 per barrel in the space of a month. That's useful relief to the household budget.

Another is the outlook for farm incomes: oil might have dropped a lot, but our commodity prices are still doing pretty well. On the ANZ Bank's economists' reckonings, our export prices in June, in Kiwi dollar terms, were up 12.5% on a year ago. That's a big boost, taking prices back up to pretty much all-time highs.

Plus the drought's broken. Our GDP didn't drop in the March quarter because of the drought alone, but the drought was certainly playing an important part in the earlier weakness, and now that's turned round, too.

All of these factors aren't instant solutions. They'll take time to have their effect. But I'm beginning to wonder whether the trough of our downturn isn't here or hereabouts, and whether 2009 might be starting to look rather better than we had any right to expect three months ago.

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