High dollar threatens return to growth

Alan Bollard feels a further cut in the official cash rate would not have made any difference. Picture / Mark Mitchell

The Reserve Bank believes the economy will start growing again by the December quarter but the recovery will be slow and fragile.

The biggest risk to the sustainability of that recovery is the dollar whose recent strength the bank describes as unhelpful.

The longer it continues the more it will retard the necessary rebalancing of the economy to one focusing on investing, producing and exporting rather than one that is all about borrowing, consuming and importing.

The problem is that the United States needs to go through the same sort of rebalancing and financial markets at this stage seem intent of facilitating that, with a weaker US dollar as part of the adjustment.

The risk, as governor Alan Bollard put it yesterday, is that the rest of us have to wait in line.

A further cut in the official cash rate yesterday would not have made any difference. After all the last one did not. And the Canadian dollar - another commodity currency - has also climbed even though the Canadian policy rate is almost zero.

Direct intervention in the foreign exchange market would not have any effect in the medium term, he said.

As it was, the June monetary policy statement's overarching message that recovery will begin before the year is out and that monetary policy easing has most likely run its course was enough to see the kiwi dollar jump, and wholesale interest rates rise too.

The bank's forecasts make three key assumptions: that households will continue to shed debt, that the dollar's recent strength will prove short-lived and activity in New Zealand's trading partners is set to recover.

The flipside of household deleveraging, however, is a very weak outlook for private consumption, which makes up more than 60 per cent of economic activity.

The bank believes it shrank 0.6 per cent in the year to March 2009, that it will shrink even more (0.9 per cent) over the year ahead, and post only feeble growth (0.8 and 0.3 per cent respectively) over the two following years.

That reflects rising unemployment, to a peak above 7 per cent, and weak wage growth and is despite a rise in net immigration and the fact that the bank now sees less downside in house prices than it did.

It had expected a peak-to-trough fall in house prices of 20 per cent in nominal terms. It now thinks it may be only 13 per cent, or 2 or 3 per cent beyond what has already occurred.

The monetary policy statement suggests some of the economy's weakness may prove to be structural and therefore longer-lasting and that the trend growth rate on the other side of the recession will be lower.

In particular steep falls in business investment over the past year and the year ahead will pull it down, the bank's head of forecasting, Tim Hampton, said.

"That's likely to turn around as confidence returns but we are projecting a potential growth rate of about 2 per cent over the next three years or so."

What the experts think ...

ANZ's Khoon Goh: "We believe this easing cycle is over, but hikes are still some way away."

BNZ's Craig Ebert: "The Reserve Bank has made its intentions clear, signalling an on-hold path for the foreseeable future."

ASB's Jane Turner: "There is little the Reserve Bank can do about tighter monetary conditions except hope they abate."

Deutsche Bank's Darren Gibbs: "The Reserve Bank's easing cycle is now most likely at an end."

Westpac's Michael Gordon: "For now we are still picking further cuts later this year. However if the New Zealand dollar moderates its gains or global demand improves faster than expected, the Reserve Bank will be on hold from here."

UBS' Robin Clements: "The Reserve Bank is saying it thinks it might have done enough. And we have to accept that it might have."

Goldman Sachs' Bernard Doyle: "The Reserve Bank has done the right thing by standing pat. It is too early to judge how sustainable the signs of life in the New Zealand economy are, but it would be greater folly to ignore their existence."