Cullen forecasts blue skies

By BRIAN FALLOW

Interest rates and the dollar are rising. Oil prices have soared to record highs. Yet business confidence is going up, not down.

And there was scant sign in details of the latest quarterly survey of business opinion, out this week, of the economy's long-forecast slowdown.

Finance Minister Michael Cullen still expects some slowing of economic growth next year, as the boost from immigration (falling for more than a year) and the housing market (cooling fast) wanes.

"But it does increasingly look as though it may be a very modest slowdown and the economy remains in remarkably good shape, despite a fair number of stresses and strains," he told the Herald.

"The combination of high interest rates and a high exchange rate is not having as serious an impact on activity and confidence as would normally be the case. I believe the underlying confidence in the New Zealand economy has been lifting over recent years and therefore we are, perhaps, a bit less nervous about the short term than we used to be."

We may have become a bit more like Australia in that respect, he suggests. And if that it is the case, Cullen says some of the credit should go to the consistency and predictability of Government policy.

The National Government of the 1990s, and the Labour Government which preceded it, created a climate of great uncertainty.

"Everything was always up in the air. While there are some people who love things being up in the air and think it is wonderfully good for you, most people like some degree of stability and certainty about where we are going as a country."

Right now the economy is benefiting from high export commodity prices which are providing an offset to the strong dollar. And on the import side, the high exchange rate is taking some of the sting out of the rise in world oil prices.

"Petrol prices are high, but not much higher than they were in 2000 when the dollar was low."

Nonetheless, oil does pose a risk to the prospect of a "soft landing" for the economy as growth slows to around 2.5 per cent by March 2006 from 4.4 per cent now.

"If oil prices stay high and that impacts seriously on the world economy, then sooner or later that must get translated back into the New Zealand economy."

But so far, economic forecasters are not expecting a dramatic slowdown in the world economy. The most recent consensus forecasts see growth among New Zealand's top 14 trading partners slowing from 4.4 per cent this year to 3.5 per cent in 2005.

"I think the markets are still expecting oil prices to come back somewhat over the medium term. But no one knows what the medium term is."

The recent spike in oil prices reflects nervousness about actual or potential disruptions to supplies from Iraq, Nigeria, Russia or the Gulf of Mexico in the context of a tight balance between supply and demand. Such worries should prove temporary.

"But there is also a recognition that over the long term the real trend is likely to be upwards and that prices are not likely to go back on any sustained basis to US$20 [$29] a barrel."

If oil is one danger, an overheated domestic economy is another. The longer a slowdown is delayed the greater the build-up of inflation pressures and the higher the Reserve Bank will push interest rates, making the eventual slowdown worse.

When Cullen was in Washington this month he was quoted by Dow Jones as saying there was "some danger we get some overshoot with monetary policy correction but [in that event] fiscal policy will come into play because we are now in a very fortunate position".

The comment was condemned by the Opposition as a breach of the convention that the Government does not comment on what the Reserve Bank does, and as foreshadowing a pre-election spend-up.

But Cullen insists he was not saying governor Alan Bollard was going too far in his current tightening of the monetary screws. He was saying only that monetary policy is an extremely inexact science. The judgments the bank has to make about the inflation outlook based on its reading of the evidence are inherently difficult.

"All I was saying was that if we end up overshooting - in other words, if the slowdown is stronger than is required to keep inflation in the target range - then the automatic fiscal stabilisers come into force anyway."

That just means that when the economy slows the tax take suffers, and spending on things like unemployment benefits increases, both of which provide some support for private sector spending.

Cullen said he was not talking about taking additional stimulatory measures, except perhaps in state housing. Because of the overheated house market and overstretched construction sector, the Government had spent less on building or buying state houses than it would have wanted to.

"If the slowdown became very marked in that sector undoubtedly we would use the opportunity to engage in some capital expenditure in that area, and that would effectively counteract a slowdown."

The Australian Government reserves the right to comment on what the Reserve Bank of Australia does; New Zealand Governments by custom are more reticent.

Cullen insists his comments, including reference to the prospect of further interest rate rises, did not cross that line.

"I don't think the Minister of Finance is the one person in New Zealand who is not allowed to explain to foreign media what the state of play is in the New Zealand economy," he said.

"The bank has made it clear that it is expecting certainly one further interest rate rise and everyone is saying there may be one or two more after that." Saying so in no way undermined the bank's independence.

"If I am asked a question overseas about what is likely to happen to the New Zealand economy in terms of interest rates I am going to respond in terms of the broad perceptions. That is not indicating at all my view of what should or should not happen."