The New Zealand economy would this year face a tug of war against two massive and counteracting forces, Westpac chief economist Brendan O'Donovan said yesterday.
‘‘On one side, high interest rates, high petrol prices and the housing correction. On the other, very strong wage growth, a wall of dairy cash and the carrot of tax cuts. Which side comes up trumps is a key debate among economists at present.'' Westpac believed the income story would win, he said.
The significance of the stimulus coming from higher dairy prices could not be overstated. An extra $4 billion in cashflow in the year to August 2008 was material and the resultant expansion of government coffers was guaranteed to lead to ‘‘considerable fiscal stimulus'' with the 2008 general election looming.
However, these were uncertain times. Domestically, the correction in the housing market posed significant risks to consumer spending, Mr O'Donovan said.
Slowing had already occurred in the New Zealand housing market but a long period of adjustment still lay ahead.
‘‘With the median house price now at $345,000, prices have drifted away from fundamentals and are now grossly overvalued by our estimates. This points to a long period of stagnant house prices, with prices in five years time likely to be no higher than today.''
Offshore, the recent rout in global equity markets was indicative of the vulnerable state of the global economic environment, he said. How the rest of the world coped with a weak US economy was crucial to New Zealand's outlook.
If the global economy - Asia and Australia, in particular - was contaminated by the weak US economy, effects would include lower commodity prices, crimped economic growth, greater fiscal stimulus, a sharp drop in the exchange rate and, eventually, lower interest rates, Mr O'Donovan said.
However, despite the recent carnage on global equity markets, Westpac's central scenario was still that the world economy, outside of the US, would maintain a solid pace of growth through 2008.
The Asian and Australian ‘‘real economies'' were expected to be less affected by the US slow down. Australia was booming and low-to-negative real interest rates in Asia were resulting in very high credit growth.
As the Reserve Bank of New Zealand acknowledged last week, it was those two regions that mattered most for New Zealand and they would be important in determining the direction of monetary policy in the coming year.
If the central bank's theory proved correct, the New Zealand economy faced a serious inflation problem. ‘‘We think annual CPI [consumer price index] inflation is headed above 3.5% in 2008 and will stay high for the next few years.
‘‘In our minds, the Reserve Bank has more work to do and as such we have factored in another two rate hikes before the end of the year.''
In terms of timing, the first hike was likely in the second quarter of the year as the Reserve Bank would probably want more time to be convinced of the Asian and Australian resilience, Mr O'Donovan said.
In an environment of continued robust growth, high commodity prices and higher interest rates, the New Zealand dollar would be well supported and was likely to push through US80c mid-year and remain in the high US70c range until the end of the year.
The powerful forces operating on the New Zealand economy set the scene for a wide variation of performance across both sectors and regions. Even within sectors there were likely to be star performers while others would endure tougher times, he said.
‘‘Don't expect the coming year to be all smooth sailing. The enormous income boost is already driving increased activity in the rural regions with farm sales, farm and cow prices, farm building consents and rural retail sales all growing strongly We think rural areas will continue to outperform urban through 2008,'' Mr O'Donovan said.
ANZ-National Bank chief economist Cameron Bagrie said the domestic economy continued to take a back seat to global developments. That was apparent last week when a 300 point rally in the Dow Jones dragged New Zealand interest rates and the dollar higher.
Markets continued to show volatile swings with equities now in a bearish mode. Equity markets remained the key directional bellwether. All markets, including bonds commodities and currencies were taking their cues from movements in stock markets particularly those in the US.
‘‘Don't underestimate the power of policy makers to respond. The Federal Reserve delivered its biggest interest cut in 23 years last week and another 0.5% is expected this week.
‘‘The Bush administration has come out with an assistance package of tax incentives to help both US households and businesses. Insurance regulators are attempting to pull together a rescue package for ailing bond insurers.''
Such forces would eventually underwrite a rebound in the US he said. In New Zealand, Finance Minister Michael Cullen said the Government accounts were in a ‘‘sound position'' to withstand a global and local downturn and the Government would be in a position to provide support if needed.
