Soaring growth set to ease with housing market

By BRIAN FALLOW

The economy began the year at a scorching pace but the momentum is expected to flag from here.

The 2.3 per cent rise in gross domestic product recorded in the March quarter, and 3.6 per cent for the year, was well above most analysts' forecasts, which were clustered around 1.5 per cent, or the Reserve Bank's pick of 1.3 per cent.

But there are several reasons not to see the result as heralding similar strength to come:

* Quarterly GDP numbers jump around. Over the past year growth saw-toothed between 0.4 per cent, 1.5 per cent, 0.7 per cent and 2.3 per cent. And although Statistics New Zealand discounted any leap-year effect, Bank of New Zealand economist Stephen Toplis said every other leap year the March quarter had been big and the June quarter had been small.

* One of the biggest contributors in the March quarter was residential investment, up 9.8 per cent for the quarter and 18.8 per cent on a year ago. But net migration has been declining for a year and dwelling consents, while still strong, are starting to ease as well. Deutsche Bank economist Darren Gibbs said: "The economy normally goes where the housing market goes and the forward indicators of the housing market have been slowing for some time."

* Household consumption was the single biggest contributor to growth on the demand side, up 2.8 per cent for the quarter and 6.9 per cent for the year. The latest retail sales and consumer confidence readings recorded a small dip.

* Reserve Bank governor Alan Bollard has raised interest rates three times this year and two weeks ago foreshadowed more to come.

Toplis said that following the GDP result the futures market was now fully pricing in rate increases in July and September and appeared to be looking for an excuse to fully price in another move after that.

"We agree with the first two but there is plenty of water to go under the bridge between now and October 28 when a third increase could occur," he said.

"From corporate New Zealand's perspective the environment is going to get quite difficult. Demand growth must slow - you can argue about how much but it is not going to keep going at 2.5 per cent a quarter - at the same time costs are going to rise.

"Not only are wage costs likely to rise as a result of labour shortages but because the currency has come down input costs for raw material are going to go up. So there is quite a potential there for a profit squeeze."

The strong GDP result means it is a stronger starting point that the Reserve Bank is trying to slow the domestic economy from.

Economists estimate the "output gap" is positive by about 1.5 per cent.

"What that means is you have to have at least one year of growth 1.5 per cent below trend [which is 3 per cent or so] to alleviate the capacity constraints we have currently got," Toplis said.

"It does not mean we have all got it wrong and the economy can keep trundling along at 3.5 per cent. It means we have to have a correction and hopefully it will be a soft landing rather than a hard one."

Business investment in plant, machinery and transport equipment was up 5.7 per cent in the March quarter, and as a share of GDP is at its highest level for at least 17 years.

It reflects the fact that many businesses are operating at full capacity.

Labour is in tight supply, so to the extent capital plant can be substituted for workers there is an incentive to do so.

Interest rates have been relatively low and, in the March quarter at least, the strong kiwi dollar made imported capital goods cheaper.