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June Newsletter - Economic Commentary

The Budget in May saw a continuation of the Government’s fiscal restraint with new initiatives being funded out of the new allocation allowance along with some re-prioritisation of other spending.  Revenue forecasts were also lowered again as a result of lower nominal GDP growth.  The Government signalled that reaching an operating surplus would be delayed to 2015/16. However, the trending improvement in the operating balance remains in place which is important for markets and rating agencies when looking at New Zealand. 

The key policy initiatives have all been overshadowed by the unexpected interest rate cuts in June. The rate cuts came after persistently low inflation outcomes, and the Reserve Bank of New Zealand (RBNZ) shifting to an easing bias in April plus a generally weaker than expected March quarter labour market report. This and changes to loan-to-value ratio (LVR) restrictions and the tax treatment of housing also made interest rate cuts more likely. The cut of 25 basis points however still came much earlier than predicted by most economists and is the first lowering of interest rates in over four years.

The recent low inflation outcomes have been the result of low global inflation, the lower price of oil and the high exchange rate which have kept tradeable inflation low.  At the same time the economy has demonstrated capacity to grow without generating inflation. The March quarter retail sales highlighted the RBNZ’s conundrum, with retail sales volumes growth at 7.4% year on year (yoy), while the implicit deflator is running at -2.3%. New Zealand was not suffering from deficient demand. Wage inflation is at 1.8% (Labour Cost Index (LCI), private sector) which is close to being consistent with 2% inflation. The TWI has moved lower recently although this was off the back of increased expectations of lower interest rates.  Few people therefore expected the RBNZ to cut interest rates in June, and many believed that conditions were not in place for interest rate cuts this year.

In explaining his decision the Reserve Bank Governor Graeme Wheeler cited falling dairy prices and recent rises in petrol prices as the factors that will slow income and demand growth.  This increased the risk that the return of inflation to the mid-point would be delayed.  In light of this situation and the expected weakening in demand, Wheeler said a lower New Zealand dollar was needed to put New Zealand’s net external position on a more sustainable path.

In the post-statement conference, Wheeler commented that the RBNZ expects that further easing of the OCR may be appropriate, depending on the data, and has factored another cut into its equations.

Global equities continued to climb higher during May with the MSCI World Index returning 1.3% in local currency terms. The US stock market pushed ahead despite comments by US Federal Reserve Chair Yellen suggesting that US equity valuations are “quite high”. Concerns around Greece being able to meet its debt repayments saw European markets end May relatively flat. The New Zealand share market gained 0.9% during May, slightly underperforming the global market. Domestic property stocks ended the month down 0.3% and generally domestic listed property continues to trend sideways, having declined a modest 0.1% over the past four months. This follows gains of around 25% in the 2014 calendar year. The high yielding sector has come under pressure lately as interest rates start to edge higher and this could be one of the sectors to benefit most from a low interest rate environment.

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