Belt up for a bumpy economic ride

Below the surface of this year's election campaign, a taniwha lurks, coated in oil. Political commentators have been saying it, economists seem to agree: it's a good election to lose.

The doom and gloom recipe mixes the current oil shock with longer term trends: creeping inflation, higher wage costs, the high New Zealand dollar, high interest rates for borrowers, lower economic growth and deteriorating conditions for exporters.

It's not 1984 - no one is predicting the kind of shock that greeted David Lange's incoming Government, when a currency crisis exposed the economy's rotten core. But after six years of a bubbling economy, whoever is in charge for the next three is in for a bumpy ride.

"They're starting a term with an overvalued currency that is hurting our exporters, with restrictive interest rates that are hurting borrowers and with high oil prices impacting on motorists and the transport sector," says ANZ National Bank chief economist John McDermott.

"Overall growth is going to be relatively weak for the incoming Government and they're going to be faced with higher inflation. It's a very unfortunate mix."

Westpac chief economist Brendan O'Donovan was equally bearish: "Consumer spending growth is not what it was, housing construction looks as if it's on the edge of a cliff and the trade deficit could have a cameo appearance on Star Trek as a black hole," he was quoted by the National Business Review as saying.

If things aren't yet that bad, we're convincing ourselves they soon will be. Any number of headlines have warned of the flow-on effects of soaring fuel costs, with across-the-board price rises seemingly around the corner.

"Because oil gets into pretty much everything, it will hit the economy broadly," says McDermott. "We will see the transport sector hit in the next couple of months but it will spread to the rest of the economy within about nine months."

It's like lying on a tropical beach beneath clear blue skies, waiting for a monsoon. You almost feel sorry for the winner. Early warning signs are undeniably out there. GDP growth, which peaked at nearly 5 per cent, has been slowing since mid last year. Despite the Lions tour mini-boom, the high exchange rate and rising fuel costs are hitting tourism and the hospitality sector. Visitor numbers have flattened and are predicted to fall 5 per cent.

Clothing, liquor and "big ticket" appliance retailers all report harder times, says Bruce Goldsworthy of the Northern Employers and Manufacturers Association.

"Some of it may be pre-election jitters but it indicates people's discretionary spending is being mopped up by higher interest rates and petrol prices."

McDermott says higher petrol costs are estimated to suck $500 million from household spending in the lead-up to Christmas.

WESTPAC economist Andrew Fung says fuel price rises since January have taken about $11 a week out of household budgets. Homeowners coming off fixed-term mortgages have lost another $20 to $30 a week.

The impact on disposable incomes is being felt in supermarkets. "There are indications across the retail industry suggesting retail spending has slowed somewhat," says Progressive Enterprises chief executive Richard Umbers.

But this is where things get murky. It's a long way from the sporadic belt-tightening to the edge of the precipice which some analysts would have us standing on. Buoyed by the Lions' tour, retail spending was up in July, with 20 of 24 industries recording increased sales. Figures for August are predicted to fall, but Retailers Association spokesman Barry Hellberg still anticipates 5 per cent growth this calendar year.

"The day of reckoning hasn't come to retail yet," says Hellberg. "It is a fact the market is slowing but things are still pretty buoyant."

Good annual results this week for Pumpkin Patch and Hallensteins show there is still plenty of money around.

"There's no reason not to have a good Christmas - people could just put it on the plastic card."

The reason credit cards could be in overdrive is the promise - whichever major party wins power - that people will have more money in their pockets next year.

A slowdown can have upsides. Softer growth could ease the way for the exchange rate to fall and lead to an export-led recovery. Easing house price inflation will increase housing affordability and ease rents.

A reduction in inflationary pressure will, finally, allow interest rates to fall.

Bruce Goldsworthy says manufacturers have not been deterred by events.

"Production levels and forward orders are satisfactory at the moment. Investment in plant and equipment has held up.

"Our most recent surveys show something like two-thirds of companies are looking at some form of expansion or growth in the next 12 months. They are still reasonably positive."

Manufacturers expect growth to come from improving conditions in overseas markets rather than domestic, he says. Bilateral trade arrangements with Thailand and Singapore are bringing new opportunities; Malaysia is a sleeping giant.

"The critical issue is the exchange rate and we don't have a lot of control over that."

And oil. "Fuel prices affect everything - local cartage, raw materials and export freight costs," says Goldsworthy.

Some cartage companies increased charges between 8 and 10 per cent last week after Hurricane Katrina sent already high oil prices to more than US$70 a barrel, their highest level since the early-1980s. For farmers, freight costs had already risen 5 per cent in the year to June.

But the old cost-plus mentality - which assumes that producers and services simply must pass on increased costs - no longer applies. In the global market, suppliers who increase prices run the risk of customers looking elsewhere.

"It depends how much business is willing to absorb," says BNZ chief economist Tony Alexander.

Goldsworthy says margins have become extremely tight and price rises will come. The Reserve Bank is assuming half of any increase inproduction costs caused by higher oil prices will be passed on to consumers.

Everything, it seems, hinges on how quickly oil prices ease back - or whether they settle at historically high levels.

Reserve Bank governor Alan Bollard does not expect the oil price spike to last, though he acknowledges the doubt. In the quarterly monetary policy statement this week - in which he left the official cash rate unchanged - Bollard said: "We are assuming that oil prices will fall significantly from 2006 onwards, back towards a level that some analysts believe will be sustainable over the medium to long term.

"From its current level, prices for Dubai oil are assumed to fall to around US$40 [$56] a barrel by the end of 2007. We recognise this as a key source of uncertainty."

The bank predicts petrol prices will remain around $1.53 a litre for 91-unleaded for the rest of the year and fall by about 10 cents a litre by June. If all goes to plan, inflation is expected to peak about 4 per cent by March and "fall back rapidly" to below 3 per cent by early 2007. Not much to worry about, then.

The danger is that oil prices don't fall back next year, transforming a short-term spike in consumer prices into medium-term "inflationary expectation". If wage increases follow, the period of higher inflation will last longer.

For the moment, producers are holding tight. The food price index fell from July to August, although it rose 2 per cent in the year. Monthly increases in confectionery, frozen chickens, sweets and pies were deemed unrelated to fuel costs.

On the farm, Federated Farmers economist Nick Clark says grains and crops are probably the most vulnerable to fuel cost rises because of their higher dependence on machinery. They are also high users of electricity for irrigation and electricity prices have been rising. Farmers were facing increased costs on a number of fronts.

"If fuel stays where it is or goes higher, it will have an impact on farmers' bottom lines. It would be a worry if a one-off shock translated into more generalised inflation."

ALSO worrying farmers is the prospect of a drought in the South Island after a poor growing season last year. But the price we pay for items such as milk, cheese and meat depends heavily on overseas prices.

"Commodity prices have been pretty high due to international demand factors but if they head back down to historical averages that's a concern," says Clark.

"But if the NZ dollar slipped to fair value of around US55 or 60 cents, that would counterbalance falling commodity prices. When you look at our current account deficit you'd have to expect the dollar has to give."

As long as the exchange rate doesn't fall too quickly, it will clear the way for an export-led recovery.

The BNZ's Tony Alexander does not agree it's a good election to lose. He says after six years of economic good fortune "some chickens will start coming home to roost".

The high dollar will bring an export downturn, while high short-term interest rates and net migration losses will cause the housing market to ease, says Alexander.

"It will be rocky for many businesses. After six years of growth, there will be some who think it continues like that forever. There's going to be some rationalisation of the business sector and household balance sheets as people realise they have taken on a lot of debt.

"But there's not going to be a recession - there's a lot of wealth out there looking for a home."

Westpac economist Andrew Fung agrees. "If we're going into a slowdown, we're in the best possible position for it - coming off a really good growth patch."

Even McDermott stops short of doom and gloom. "At this stage it's a slowdown scenario - as a nation, we will probably have to tighten our belts a bit more. We are talking about 1.5 to 1.7 per cent growth so we're not talking recession - but there are a lot of challenges ahead.

"If you want to improve your education system for a global economy and improve your healthcare system it's a tough starting point to be in."

STATE OF THE ECONOMY

The Bad
* Fuel costs - direct impact on motorists' hip pockets
* Fuel costs - rising transport costs may force prices up
* Higher inflation keeping interest rates up
* Homeowners paying more as fixed mortgages renewed
* Consumer spending declines, retailers suffer
* High dollar squeezing export margins
* Export commodity prices tightening
* Current account deficit keeping interest rates up
* Tourism downturn
* House prices predicted to fall
* Job growth flattens as employers consolidate
* Rising electricity prices

The Good

* Reserve Bank expects inflation to decline next year
* Exchange rate to fall as growth softens; exporters benefit
* Oil price expected to drop towards US$40 ($56) a barrel
* House price inflation to ease
* Global markets to improve
* Trade deals bringing new opportunities
* Manufacturers still expecting growth
* Resilient labour market
* Consumers still spending
* Retailing still growing overall
* Fiscal policies to put more in people's pockets

The Unknown

* Oil price - how long will it stay up?
* The weather - drought fears on the farm
* A major shock - we're vulnerable