Despite challenges, growth outlook remains healthy

First of Three Parts

ASB Bank, Auckland, May 15, 2018

Our growth outlook for the next couple of years is still a fairly healthy one, with growth expected to gradually accelerate to 3.4% by the end of 2019.

However, some of the potential threats to that outlook have started to loom a little larger. The most concerning development is the rapid escalation of trade tensions, primarily between the US and China.

US-China Trade Stand-off

The US has long had concerns about some of China’s trade practices and its treatment of intellectual property.

(US President) Donald Trump’s proposed tariffs on various Chinese products have shifted the method of attempted resolution away from the World Trade Organisation’s dispute resolution process to taking (characteristic) unilateral direct action.

After a measured initial response, Chinese started to hit back swiftly and in turn the US upped the ante just as quickly. At this stage the overall volume of trade involved is very small. But the risk is that, if future negotiations don’t resolve the tensions, the protectionism escalates and spreads – and starts to impact on global growth.

New Zealand at risk

At that point, New Zealand’s exports will be at risk.

A home-grown development is the still-wary attitude businesses have of the new Government. Business confidence has yet to recover materially from its post-election slump, even allowing for surveys’ historical downward bias during Labour Government terms.

It is understandable that a change of government has created uncertainty while key policies are being fleshed out and the country gets more familiar with the key Ministers.

We would like to see more recovery in sentiment soon, otherwise there is a risk that economic growth gets impacted beyond a short-term speed bump.

From the Government’s perspective, providing as much certainty, assurance and rationale as possible around government policies will help mitigate this risk.

But the above are risks, and not all risks become reality.

Some positive factors

NZ continues to enjoy some good tailwinds.

The Terms of Trade have set a fresh high, emphasising the strong global purchasing power of what we export. Interest rates are set to remain low into next year, which will support the cashflow of businesses and household borrowers (though partly offset still by low returns for savers). Net migration inflows, although slowing, will still deliver above-average population growth for some time. And accelerating wages will support consumer spending growth. Nevertheless, there is one sector – Construction – for which there is a lot of demand, but it will struggle to grow under the weight of capacity constraints, rising costs, and on-going regulatory hoops.

Even KiwiBuild will confront the same issues, which puts the onus on adopting more productive and innovative ways of developing housing.

This evolution will take time. In the meantime, Auckland housebuilding activity will struggle to lift much further from its current high level, though some winding down in other regions could see some capacity redirected north.

International Outlook

Geopolitical tensions have escalated sharply with the global economy recently taking a few steps closer to the trade war precipice.

A flurry of tit-for-tat tariffs between the US and China has put the world on edge.

However, so far it seems that calm heads will prevail and the US Administration’s China visit is a strong signal that diplomatic reasoning will ultimately win out.

And, if you put the trade risks to the side for a moment, the global economy is still firing on many cylinders.

The US Federal Reserve raised interest rates again in March and continues to signal at least another two rate hikes over the remainder of 2018.

The US growth outlook has firmed (we now expect growth of 2.9% over 2018, up from 2.8%), the labour market continues tightening and inflation pressures are lifting back towards 2%.

Western economies

This backdrop has also seen US 10-year bond rates lift above 3% for the first time in four years. The US economy remains vulnerable to an uncertainty-induced slowdown.

Indeed, recent data suggest that the manufacturing sector is feeling the negative impacts of the tariff uncertainty. The Eurozone surged into the end of 2017 with annual GDP growth hitting 2.5%, the fastest growth rate since 2007. We are expecting growth momentum to ease slightly following this period of above-trend growth, but to remain healthy.

In fact, we have revised our 2018 growth forecasts slightly higher to 2.4% (from 2.2%) and expect growth of 1.9% in 2019.

Despite the strong growth however, inflation pressures remain soft. As a result, we are expecting the ECB to leave deposit rates on hold well after the asset purchase programme ends in the fourth quarter of 2018.

China has proven to be surprisingly resilient in recent months, despite the strong focus by the Chinese Government to de-leverage and reduce risks within the Chinese economy.

GDP growth has, so far, held up better than expected, with annual growth at 6.8% year-on-year in the first quarter.

Editor’s Note: The above is a slightly edited version of the Quarterly Economic Forecast of ASB Bank, one of the largest commercial banks of New Zealand. We will publish two more parts of the Forecast shortly.

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