Turning point is yet to come

By BRIAN FALLOW

WELLINGTON - Dr Don Brash dispensed a large further dose of monetary stimulant to the economy yesterday, recognising that the coming recovery is likely to have to rely more on domestic than export growth.

Though the international outlook had brightened over the past month or so, "at this stage we are not inclined to take these glimmers of light for the world economy as the beginning of a bright new day," the Reserve Bank governor said.

He reset the bank's desired level for the monetary conditions index (MCI) at minus 400, 150 points below its market level on Tuesday, and easier than analysts' forecasts, which were in the minus 300 to minus 350 range.

The easing reflects a significantly weaker growth outlook for both the New Zealand and world economies than in the bank's last monetary policy statement in August.

But though the easing cycle is near its end in terms of level, it is still far from the turning point in terms of timing, according to the bank's projections.

At this stage it does not envisage the need for any significant tightening of monetary policy until mid-1999, Dr Brash said.

The bank projects the MCI remaining flat in the minus 400 to minus 450 range until March 2000, and then firming very gently so that it is still at minus 300 a year later.

Such an elongated trough in the cycle had been greeted with some scepticism in the markets, ANZ Bank chief economist Bernard Hodgetts said.

"That may well prevent monetary conditions from easing to the full extent the bank is projecting," he said.

Bankers Trust chief economist David Plank agreed that the markets were likely to look for an earlier turning point - prematurely in his view - which would tend to keep conditions firmer than the bank had signalled and skewed towards a higher dollar and lower interest rates.

"When the market starts seeing growth it will say monetary conditions need to tighten, even though the bank has made it clear it is not scared of 4 per cent growth; in fact it needs 4 per cent growth to get rid of the output gap," Mr Plank said.

The Reserve Bank is forecasting gross domestic product to start picking up in the first half next year, having shrunk 1.5 per cent during 1998. It forecast GDP growth of 3.4 per cent in the year to March 2000 and 4 per cent the following year, down from 4 and 4.7 per cent respectively in its August statement.

"Compared with the last recovery, in 1991-92, the projected recovery will be modest," Dr Brash said.

"The international environment is projected to remain relatively weak for some time, providing less impetus to exports than was the case in 1991. And household sector debt levels are now very much higher, relative to household sector income, than they were in the early 1990s, which suggests growth in consumption expenditure will be less vigorous than it was in the earlier recovery."

Dr Brash feels able to maintain a stimulatory monetary policy for so long because the bank estimates the output gap - the spare capacity in the economy - has widened to about 3 per cent of GDP.

The result is that even with the pick-up in growth it projects, the bank expects inflation to fall below 1.5 per cent by the middle of next year and stay there for the two years beyond that.

Deutsche Bank chief economist Ulf Schoefisch regards those forecasts as over-optimistic.

With the housing market consolidating and the weaker exchange rate starting to flow through to prices in the tradeables sector, inflation was more likely to head to 2 per cent or above than 1 per cent in 1999, he said.


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