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Special Topic:  Key Issues for the New Zealand Economy in 2011

As the Treasury prepares its Budget Economic and Fiscal Update for 2011, there are a number of issues we will need to consider.  This special topic explores some of the main issues that will influence the New Zealand economy in 2011.  

Global

Key amongst these issues is the global economic and financial environment, which will remain an important determinant of New Zealand's fortunes.  The main global issues we have identified are as follows:

Global inflation

Inflation concerns have begun to develop worldwide, with commodity prices rising significantly in recent times.  Strong demand for commodities, especially out of emerging Asia, as a result of better global growth in 2010 than expected has flowed through to inflation.  Severe weather conditions disrupting supply, including the Queensland floods, as well as loose monetary conditions with low global interest rates, have added to the pressure on commodity prices. 

Strong growth in emerging Asia, especially China, has also added to inflationary pressures.  Many Asian countries have begun tightening monetary policy to get inflation under control.  Given that Asia has been the main engine of world growth since the global financial crisis and a major source of New Zealand’s export demand and high commodity prices, any major slowdown due to high inflation and monetary tightening would have significant negative consequences for the world economy, and especially New Zealand.  However, New Zealand does stand to benefit from high commodity prices, as a major soft commodity exporter and with growing links to emerging Asia.

European fiscal positions

Even though the Euro area has seen improving economic fortunes recently, sovereign debt and banking sector concerns still weigh heavily.  With Greece and Ireland having received bailout packages, attention has turned to Portugal and Spain, as well as the banking sectors of some at-risk countries.  If there was further escalation of these problems, through banking or sovereign default or restructure of debt, financial markets may seize up similar to what happened during the global financial crisis in 2008/2009.  However, there may be more discrimination this time around, with those countries seen to have the highest risk factors being discriminated against first.  The financial market strain would limit the ability of the New Zealand government and banks to borrow on overseas markets, and the cost of debt for countries with high debt, including New Zealand, may rise. 

Housing and labour markets

Many advanced economies are yet to see strong enough job growth to significantly decrease currently high unemployment rates.  Also, many housing markets are yet to recover from the large falls experienced over the global recession.  The weak housing and labour markets are currently constraining household spending and limiting the ability of the private sector to take over from previous public stimulus-led growth.  The US is the major example of this with high unemployment and still negative house price inflation constraining consumption growth.  If these markets maintain their drag on growth, private consumption will not be able to fully support the global recovery.  

One-off events

The hosting of the Rugby World Cup is a key one-off event that will boost activity in New Zealand during 2011, with the impact spread across the September and December quarters (the Cup runs from 9 September to the final on 23 October).  Higher service exports flowing from the larger number of overseas visitors will be the primary impact on the economy this year. 

The Canterbury earthquake had a negative impact on the economy in the September 2010 quarter, but earthquake recovery work will boost economic activity in New Zealand during 2011.  This impact is expected to be concentrated in residential investment and, to a lesser extent, private consumption (though both will partly be met out of imports). 

Assuming a return to normal weather patterns, a recovery in agricultural production and exports later in 2011 would be expected to boost economic activity.  The risk of dry conditions or other adverse weather will remain, especially if the La Nina pattern prevails, although a mitigating factor for New Zealand could be higher commodity prices caused by tighter supply here and overseas (La Nina is also contributing to adverse weather in other parts of the world, most notably the Queensland floods).

Saving

New data released in late 2010 paint a different picture of household saving over the past decade than we previously thought, and compared to what was incorporated in the Half Year Update (Figure 4).  Instead of a steadily-worsening trend, the rate of household dissaving (ie, consumption in excess of incomes) peaked in 2007 and declined in subsequent years.  The latest household dissaving rate of 2.2% of household disposable income in the March 2010 year is the lowest since the March 2000 year and the second lowest since 1994.  A key judgement in our Budget 2011 forecasts will be whether household saving rates return to those experienced over the mid-2000s – leading to stronger consumption growth – or whether the improvement since 2007 is part of a structural trend that has further to run. 

As long as nominal house prices remain on their current stable trend, we would view any reversion to previous levels of household dissaving, when house prices were surging, as unlikely.  More probably, consumer spending over 2011 could be expected to grow closely in line with incomes, which this year will be supported by an improving labour market, high farm incomes and one-off events.  This would require the optimism seen in consumer confidence surveys to begin to flow through to actual spending.  The behaviour of other sectors of the economy regarding spending, investment and debt – businesses (including farms) and government – will also be important.

Figure 4 - Annual household saving rate
Figure 4  - Annual household saving rate .
Source: Statistics NZ, the Treasury

Exchange rate

The New Zealand dollar remains elevated on a Trade Weighted Index (TWI) basis and is thus not supporting the sort of export-led growth typical of recent recoveries from recession.  High prices for New Zealand’s commodity exports are partly responsible, while a low cross-rate against the Australian dollar will continue to benefit non-commodity exporters.  A sensible assumption – the exchange rate is notoriously difficult to forecast at the best of times – will be for the currency to hold up around current levels for much of 2011 unless commodity prices move sharply lower.  But without a sustained lower exchange rate, 2011 will be another difficult year for exporters of non-commodity goods to countries other than Australia (the Rugby World Cup will give temporary relief to those exporting travel and transport services).  We are thus unlikely to see any fundamental shift in the economy towards the tradable sector, owing to the natural constraints of expanding agricultural production, the limited size of the Australian market and the stiff competition there as other countries also face a low exchange rate against the Australian dollar.

Summary

Uncertainty surrounds key influences such as the global economy and domestic saving behaviour.  The exact impact of known one-offs could also differ from expectations and of course unexpected events may occur, although perhaps not to the extent they did in the second half of 2010.  At this stage, the outlook for real economic growth in calendar year 2011 (around 3%) is looking better than what was experienced in calendar year 2010 (around 1.5%) – or even than what was expected for 2010 this time last year (2.1%) – which in turn was an improvement on 2009 (-1.7%).  Price developments, particularly the terms of trade, will also be important as further gains are possible based on recent commodity prices movements.  As a result, although actual data have been weaker than expected, the overall outlook for 2011 may not be materially different from that presented in the Half Year Update 2010.

 

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