Economy will slow to 3 per cent, predicts BNZ

By BRIAN FALLOW

The economy will grow more slowly over the next five years than it has over the past five, says Bank of New Zealand chief economist Tony Alexander.

Resource constraints in labour, electricity and roading are likely to keep the average growth rate just below 3 per cent, ignoring the effects of any international and climatic shocks, he says in the bank's Weekly Overview.

That would compare with an average growth rate of 3.7 per cent over the past five years, achieved by increasing use of labour (which has seen the unemployment rate fall from 7.7 to 4.6 per cent), by an exchange rate on average about 15 per cent undervalued, by farmers catching up on long-delayed capital spending and by the effect on household wealth and spending of house prices rising at about twice their long-term sustainable rate.

Looking forward, however, Alexander expects infrastructure constraints to limit growth.

"The situation regarding electricity supply is likely to get worse before it gets better and energy process will continue to drift up," he said.

In addition roading costs would rise and congestion worsen before hopefully easing down the line in Auckland.

"Having successfully used up the large stock of skilled and unskilled motivated unemployed people in the past decade or so, jobs growth will continue but at a slower rate."

He picks employment growth at nearer 2 per cent a year than the 2.5 per cent averaged over the past 10 years. "Labour shortages will cause wage rates to accelerate, after a brief easing in pressure in the coming 12 to 18 months as cyclically slowing growth causes the unemployment rate to rise temporarily back up above 5 per cent," he said.

"The obvious imbalance between labour supply and demand at current levels of remuneration will eventually produce faster wages growth. How much faster is impossible to say but an employer might wisely assume 1 per cent more per annum for the next five years than they have experienced for the past five years."

To cope with scarcer and more expensive labour, businesses will have to boost productivity by investing more in plant and machinery and more efficient buildings.

House prices on average have risen 1.8 per cent a year over and above general inflation since 1961.

But the variation of house price inflation around consumer price inflation can be extreme, Alexander says, citing 2003 when house prices climbed 22 per cent and the CPI only 1.6 per cent.

Having risen on average 7.6 per cent over the past five years, house prices are about 15 per cent overvalued compared with the long-term trend in real house prices. So he expects slower growth in house prices over the next five years - somewhere between 3 and 5 per cent.

"The New Zealand dollar will eventually correct from its current overvalued levels and probably fall to close to 40USc at some stage over the next five years. On average we expect a rate between 55USc and 60USc."

He expects current account deficits to continue to average around 4.5 per cent of gross domestic product.