Brian Fallow: NZ could feel spillover of global slowdown

In China credit growth has been exceptionally fast. Photo / Bloomberg

COMMENT:

Global concerns loomed large in the easing bias the Reserve Bank signalled on Wednesday.

The monetary policy committee's conclusion that an even lower official cash rate "may be needed over time" echoes the dovish noises coming from major central banks.

Even though each rate cut leaves fewer bullets in its sorely depleted bandolier and drags us closer to the dreaded zero lower bound, the Reserve Bank cannot ignore the risk that a widening gap between New Zealand and offshore interest rates would push the kiwi dollar higher.

As it is, even with a historically favourable mix of export and import prices, the country ran a trade deficit of $5.5 billion in the year to May.

And it is tradables prices, which collectively fell 0.3 per cent in the year ended March, that have kept the consumers price index stuck in the lower half of the Reserve Bank's target band.

In addition to the financial channel, the committee noted the global slowdown's intensifying impact on the economy through trade and confidence channels: "The members noted in particular the dampening effect of uncertainty on business investment."

The MPC is rather less downbeat about the domestic picture. It notes evidence of a slowdown but expects that low interest rates and increased government spending — this was the first OCR review since the Budget — will support a lift in economic growth and employment.

That was also the view of the Organisation for Economic Co-operation and Development and the International Monetary Fund, both of which have just given the economy the once-over.

The IMF's preliminary view is the downside risks to an improving near-term outlook have increased, mainly due to the international picture.

The cooling of the housing market could morph into a downturn either because of external shocks or diminished expectations, it says.

"Risks to global trade and growth from rising protectionism have increased, and this could have negative spillovers to the New Zealand economy, including through the impact on China and Australia, two key trading partners. High household debt remains a risk to economic growth and financial stability, and it could amplify the effects of large, adverse shocks."

Reserve Bank Governor Adrian Orr. Photo / File

The global backdrop to this week's OCR decision is the sombre fact that 10 years after the Great Recession the world economy remains heavily medicated in terms of monetary policy.

For 10 years now across the developed world central banks' policy interest rates have been negative in real terms, occasionally rising, here and there, to zero (as New Zealand's is now). And where that has been insufficient trillions of dollars' worth of quantitative easing has been undertaken.

Bond markets are pricing the expectation that this will continue for years yet. Low for long, we are told, is the new normal, though that is a phrase reminiscent of what have been called the four most expensive words in the language: This time it's different.
The side effects of this dependency on monetary opioids are high levels of debt and inflated asset prices.

New Zealand's debt level — household, corporate and government combined — measured against the size of the economy at 208 per cent of gross domestic product is back where it was on the eve of the global financial crisis.

For advanced economies as a whole it has risen from 235 to 271 per cent of GDP.

In China, which took 26 per cent of New Zealand's exports in the year ended May, credit growth has been exceptionally fast, rising from 146 per cent of GDP in 2007 to 254 per cent of GDP by the end of 2018. In other words debt has been growing at roughly twice the (impressive) pace of economic output, which in a normal market economy would be considered perilous.

The IMF, however, seems to regard this more as a chronic than an acute problem.
"The IMF has flagged the rapid rise in credit and leverage more broadly as a risk for quite some time," Thomas Helbling, who headed the IMF team, said on Wednesday.

"In the current conditions it is seen primarily as a more medium-term risk. You always worry if there are also short-term triggers that could amplify the debt or credit problems, but these issues have been around for a while. The bigger change in the risk has come from the trade front."

From the United States, meanwhile, we have seen not only the weaponisation of trade policy, but also badly timed fiscal stimulus (now fading) and a cavalier view from the White House of the independence of the Federal Reserve.

Europe is hardly an edifying spectacle either, so thank goodness for that haven of tranquillity, the Middle East.

But the IMF officials take a surprisingly sanguine view of the signals from saggy bond yield curves and stubbornly low interest rates.

"Low interest rates are not just an indication of easy monetary policy," Helbling said.

"There has been a trend decline in interest rates and the fund has commented that a number of forces are at play there, including demographics and lower productivity growth."

The basic idea there is that baby-boomers save harder as they approach retirement, while weak productivity growth reduces confidence in a rising tide lifting all boats.

"And while the fund has noted that accommodative monetary policy is still needed in many countries, at the same time there is also a need to take measures to manage the potential side effects, in the sense of increased asset valuations and risks coming from there. In the specific New Zealand context low interest rates are one of the factors that have contributed to higher house prices, and is a reason we have put a lot of emphasis on macro-prudential polices [like loan to valuation ratio curbs]," Helbling said.

The IMF warns that with the Reserve Bank's easing of LVR restrictions improvements to some risk factors such as credit growth have recently stalled or started to reverse.

Given how high household debt levels are, you might want to go easy on any more of that, is the fund's message there.