NZ economy 'ultimate Houdini' - bank economist

NZ's pulled off a 'Houdini- like escape - getting economic growth without accompanying inflation, says Westpac economist Dominick Stephens. Photo / Thinkstock

The New Zealand economy has managed the ultimate "Houdini" act by achieving strong growth without the usual attendant inflationary pressures, says Westpac.

The bank, in an economic overview, said lower commodities prices were going to make life difficult for some regions but it expected domestic demand to remain robust.

The consumers price index increased by a lower-than-expected 1 per cent in the year to September while gross domestic product (GDP) surged by a sturdy 3.5 per cent in the June year.

"Like some kind of Houdini, New Zealand appears to have escaped from the traditional economic bind," said Westpac chief economist Dominick Stephens.

Westpac expects annual inflation to be at just 1.3 per cent in March 2015 and for the Reserve Bank to keep the official cash rate on hold until September next year.

Rapid economic growth often leads to inflation or higher interest rates, either of which can put the brakes on growth.

"But New Zealand's current bout of rapid growth has surprised us by producing no inflation to speak of."

New Zealand's 'speed limit' - the rate at which the economy can grow without generating inflationary pressures - appeared to be higher than first thought.

"That means the economy has more freedom to grow without the Reserve Bank hiking interest rates so vigorously."

Stephens said it now looked as though the official cash rate hiking cycle would peak at the "stunted" level of just 4.75 per cent, from the current level of 3.5 per cent, and that the outlook was for another year of solid economic growth.

Sharply lower dairy and forestry prices would hit some regions and some sectors, but Westpac economists expected broader domestic demand to remain robust, fuelled by the rebuilding in Canterbury, burgeoning construction activity elsewhere, and booming net immigration.

The bank was concerned that later in the decade New Zealand would experience a significant economic downturn when the Canterbury rebuilding had passed its peak, population growth had eased "and the housing market has finally cracked under the pressure of higher mortgage rates".

Westpac said GDP data highlighted the stark contrast between a weakening export sector and the stronger domestically focused parts of the economy.

Dairy, forestry and mining output fell in the June quarter, and non-food manufacturing was a little better than flat.

But the services sector, which accounts for 70 per cent of the economy and is more geared towards domestic conditions, registered its strongest quarter of growth since 2006.

The bank expects economic growth next year to top 3 per cent, driven by population growth and steady consumer spending.

An expected drop in the Fonterra dairy payout to a forecast $4.80 a kg of milk solids this season would represent a "huge reversal of fortune" for New Zealand's biggest export industry, but it would not automatically translate into lower economic activity.

Many farmers had used last season's windfall to shore up their balance sheets rather than spending more, leaving them well placed to absorb the shock of a low payout.

The lower dairy payout forecasts and fresh doubts about global growth had darkened New Zealand's export outlook.

"But with rampant migration adding fuel to a construction boom, and low inflation keeping interest rates low for longer, we expect domestic demand to stay as strong as ever," the bank said.

A $4.80 payout was likely to lead to some financial stress among higher-cost dairy farms, though this might not become apparent until next year, given that farmers had just received the final payments for last season's record price of $8.40/kg.

See a Statistics NZ chart showing NZ inflation rates over the past decade:

Read the full Westpac report here: