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Economic Risks

Uncertain global outlook...

Global developments can impact New Zealand through migration, trade, confidence and financial channels. Risks posed to the outlook for key trading partners, and global financial settings in general, are all factors that can lead to rapid changes in the economic outlook for New Zealand.

…as risks to New Zealand's key trading partners remain...

Risks to the growth outlook for China remain, even with June quarter growth strengthening after a weaker March quarter. The property investment and construction boom that stimulated Chinese growth following the global financial crisis was fuelled by rapid credit growth. Concerns around the high level of local government debt, the quality of lending in the shadow banking sector and exposure of financial institutions to housing market vulnerabilities persist. China's growth could slow more quickly than in the central forecasts if financial market disruption resulted in significantly tighter credit conditions; however, their impact is likely to be limited by room for further policy adjustment, sustained urbanisation and solid income growth.

Commodity prices have fallen recently, led by declines in export dairy and forestry prices. While the weaker outturn in the GlobalDiaryTrade auction held in early August poses a downside risk if sustained, commodity prices tend to be volatile and the latest prices may overstate the weakness in demand. There have also been some positive offsets: sheep meat prices have strengthened as demand from China has increased, while meat supply remains constrained in the US. The extent to which these trends continue is uncertain. A continuation of recent dairy auction price falls would pose a downside risk to the main forecast, which the first scenario explores in combination with further weakness in household consumption in New Zealand.

...and the US economy starts to gain momentum...

Recent strong growth in investment, consumption and construction, combined with the lowest market volatility since 2007, give the US economy significant potential to outperform current forecasts. Recent speeches by Federal Reserve Chair Janet Yellen indicate that if future data releases are stronger than expected, normalisation of monetary policy would happen earlier. However, a stronger US economy could further exacerbate the risks to emerging economies if expectations of a faster withdrawal of monetary stimulus were to develop. The impact of an earlier tightening in US monetary policy on the New Zealand economy is explored in more detail as part of the second scenario.

...while geopolitical developments could contribute to price volatility...

Recent geopolitical developments in Ukraine and the Middle East have been watched closely by markets for any possible impacts on energy supplies, with much of the focus on oil. While long-term implications of the recent geopolitical developments remain uncertain, further deterioration that impacts energy supplies may further increase prices. Similarly, improvements that enhance the stability of energy supplies could reduce energy prices. The impact on New Zealand of Russia's recent ban on food imports from selected countries (not including New Zealand) is uncertain at this stage.

Domestic outlook is also uncertain...

Key areas of uncertainty remain, including the speed of the Canterbury rebuild and its wider economic implications, the reaction of households to higher debt servicing costs, and the scale of the current migration cycle and its impact on domestic demand.

...with the timing and extent of the Canterbury rebuild an area of uncertainty…

There is still uncertainty around the overall timing and magnitude of the Canterbury rebuild. Key determinants continue to be the pace of the settlement of remaining insurance claims and the evolution of resource pressures in the construction sector. While the resolution of insurance claims has continued to progress, there are risks that the greater complexity of remaining claims could slow the rate of settlement. The availability and mobility of skilled labour will also impact on the pace of reconstruction if specific skill shortages act as bottlenecks in the construction industry. If the rebuild were to progress more slowly, residential and non-residential investment and employment growth could all be weaker than reflected in the central forecast.

The Canterbury region will account for a greater share of GDP than in previous construction booms and regional resource pressures will act to crowd out activity in other parts of the economy. The extent to which prices and wages rise to facilitate the transfer of resources remains heavily influenced by competing demand pressures elsewhere, especially in Auckland.

...as is the sensitivity of households to increasing interest rates…

Household debt levels have increased recently after falling since the global financial crisis. Households are relatively exposed to interest rate increases as the majority of mortgage rate debt will quickly reflect increases in the OCR. Households are, however, increasingly shifting to fixed rate mortgages which have not increased as much as floating rates so far. If households exercise more restraint, debt levels would be lower than otherwise but consumption growth would be weaker, which scenario one explores in more detail. On the other hand, if households are less sensitive to interest rate increases, consumption growth would be higher than otherwise, and in the absence of stronger income growth this would lead to higher debt than otherwise.

...while the housing market weakens in spite of strong net migration

House price growth and house sales have slowed as loan-to-value restrictions have impacted mortgage lending. Mortgage rates have also begun to rise, with the expectation of future increases as the tightening cycle continues. This weakness in the housing market has been in contrast to the near-record net migration gains, which historically have increased the demand for housing, contributing to both house price inflation and construction activity. While higher net migration flows would pose an upside risk, there could also be a delayed response to the recent increases in net migration, leading to stronger demand for housing and possibly higher private consumption growth. The second scenario incorporates a larger effect from the central forecast's net migration gain.

Other risks around key judgements

Economic relationships are complex and judgements need to be made about key economic variables such as the exchange rate. If, for any reason, key factors such as those outlined above play out differently than assumed in the central forecast and impact on the inflation outlook, then the Reserve Bank's setting of monetary policy would be responsive to those different conditions. Interest rates could rise by more or less and the pace of tightening could be faster or slower depending on the direction of change.

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