- Domestic conditions are showing resilience...
- ...despite a worsening global outlook as the euro debt crisis intensifies.
- Headline inflation is currently subdued, but underlying inflation is stronger and is expected to pick up in coming quarters.
- Global weather conditions could see a reversal of recent falls in commodity prices.
The domestic economy is looking in relatively good shape, especially compared to most other advanced economies. Inflation is currently subdued, although we expect it to pick up from late-2012, and activity indicators suggest that moderate growth will be achieved in coming quarters. This outlook comes despite a further deterioration in international conditions.
Headline domestic inflation is currently subdued and looks likely to be slightly below our Budget Update forecasts in the short term. The CPI rose 1.0% in the year to June, the lowest rate since December 1999. The result was constrained by a 1.1% annual fall in tradables prices as the high exchange rate and falling commodity prices reduced the price of imported goods. We expect inflation to pick up in coming quarters as tradables prices stop falling and non tradables inflation accelerates as spare capacity in the economy is absorbed. We believe there is currently some spare capacity and that underlying inflation is around 1.5%.
The global outlook worsened further in July, with downside risks increasing. While there was no development which suggested the euro debt crisis will be tipped over the edge, there were few signs of the crisis abating. There are also other global risks, with the “fiscal cliff” (forced fiscal consolidation on 31 December) looming in the US, and the prospect of a more significant slowdown in emerging Asia. Financial markets have been volatile in reaction to developments and “safe haven” demand continues to be strong with US, German and UK government bond yields at or near record lows.
So far there has been little domestic impact from the recent negative global situation, with relatively small falls in confidence and export commodity prices. New Zealand government bond yields have been pushed down to near-record lows. The falls in confidence were relatively contained and dry weather conditions globally will likely put upward pressure on agricultural commodity prices, benefiting New Zealand. Activity indicators and the main growth drivers have held up well in the face of an uncertain global outlook, pointing to the moderate growth we incorporated into the Budget Update eventuating in coming quarters. Moreover, tax revenue in the 11 months to May has come in slightly above forecast.
This month’s special topic looks at housing market developments. The housing market has undergone a recent recovery with nationwide house prices and sales recording significant gains in the past few months. The special topic looks at the drivers and dynamics behind the current upturn and its implications for our economic outlook.