Economic slowdown a long time coming

A predicted economic slowdown never arrived in 2004 and 2005 proved little different - except there were clear signs the slowdown would arrive in 2006.

Latest figures showed the economy expanded a creditable 2.7 per cent in the September year, well down from 4.3 per cent a year earlier.

The Reserve Bank went merrily on raising interest rates, even this month, as inflation rampaged up to 3.4 per cent.

But consumer and business confidence surveys at year-end made ugly reading.

The ANZ National Bank survey showed confidence was at its lowest point since the 1987 sharemarket crash and a survey of companies' expectations had turned negative.

"These indicators, if they are to be believed, predict a hard landing, in other words a recession," said bank chief economist John McDermott.

More evidence of gloom ahead came in one of the year's last surveys, showing consumer confidence plummeting to its lowest level in five years.

"The combined effect of higher interest and exchange rates, increased petrol prices, parlous business confidence and a rapidly slowing economy have severely dented consumer confidence," Westpac chief economist Brendan O'Donovan said.

He said households had money for Christmas, but faced a bleak 2006.

And one of the last economic indicators for the year - the balance of payments - showed the extent of the hangover we face. The deficit has blown out to $12.9 billion in the September year, or 8.5 per cent of GDP, its highest level in almost 20 years.

Goldman Sachs JBWere economist Shamubeel Eaqub described it as an "absolute shocker".

The balance of payments reflected what was happening at the household level. Westpac estimated the average household spent 14 per cent more than it earned in 2005.

So why have these situations been allowed to get so out of hand?

In a word, houses. House prices have defied the logic of their relationship to incomes, rising 15 per cent this year to top last year's 13.5 per cent rise.

People felt wealthier as equity in their houses rose and they felt comfortable spending more.

Banks were happy to lend and, in the case of Westpac, paid its employees bonuses based on how big a loan could be pushed on to the customer.

The spending not only saw the current account swell as computers and cars were snapped up, but helped prop up the domestic economy.

Borrowing demand was fed by Japanese investors who were attracted by New Zealand's interest rates - the highest in the world.

Over $20 billion of uridashi notes - bonds issued in Japan but denominated in local dollars - were issued here.

That was largely the reason why the New Zealand dollar, on a trade-weighted index basis, rose to its highest since flotation in 1985 despite the dire balance of payments position.

As retail spending rose, unemployment fell - to 3.4 per cent - its lowest in 20 years.

A side-effect was that Government coffers gained from more people in work, fewer on benefits and more tax collected from business.

The budget surplus swelled to nearly $9 billion in 2004/5, although promised big spending will trim that to $5.9 billion this year.

A tight labour market from the low unemployment encouraged workers to at least recoup the inflation rate in wage demands.

That, the big spending, and oil prices, pushed inflation well above the Reserve Bank's 1-3 per cent target to 3.4 per cent.

Reserve Bank Governor Alan Bollard knew exporters were in dire pain from the high dollar and high interest rates but he was forced to raise interest rates three times during the year after doing so six times last year.

He had little choice because inflation was above his mandated ceiling and was threatening to continue rising.

He railed in speech after speech about the foolhardiness of borrowing and investing in an over-inflated housing market.

Those in the real estate industry mocked him about being wrong on house prices last year and they confidently predicted he would be wrong again.

Bollard realised the bank's only tool to control the demand - interest rates - was not working. That is because more than 80 per cent of mortgagees have fixed their loans.

Bollard freely admitted he was running on a knife edge and may have got it wrong.

"If we misread the lags, there is a risk that policy tightening undertaken now will start to bite just at the point when domestic demand is already cooling," he said.

Let's hope not.

- NZPA