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New Zealand Economic and Financial Overview 2015

Economic Overview (continued)

Recent Economic Performance and Outlook

The New Zealand economy has steadily recovered from the global financial crisis (GFC) despite further disruptions such as the Canterbury earthquakes and occasional periods of drought.

Response to GFC

The New Zealand economy experienced a recession in 2008 and 2009 owing primarily to the intensification of the GFC in 2008. Similar to the experience in many advanced economies, business and consumer confidence plummeted as the cost of credit increased and house prices fell modestly. Local banks' access to funding in overseas markets was temporarily curtailed as uncertainty dominated the global financial and economic environment. Real GDP contracted 2.8% overall between March 2008 and June 2009.

The Reserve Bank of New Zealand (RBNZ) responded to the crisis by lowering the Official Cash Rate (OCR) from 8.25% in June 2008 to a low of 2.5% at the end of April 2009 and introducing facilities to ensure adequate liquidity for the banking sector.

The Government introduced retail and wholesale bank guarantees aimed at restoring confidence in the banking sector and providing banks with improved access to wholesale funding. (Both schemes have since been discontinued.)

The Labour-led government proceeded with income tax cuts in October 2008 and the National-led government, which came to power in November 2008, introduced further tax reductions effective from 1 April 2009.

Other short-term measures taken by the Government in late 2008 included infrastructure projects and a temporary relief package to assist small and medium-sized businesses.

Canterbury Earthquakes

On 22 February 2011, the Canterbury region on the eastern side of the South Island experienced a devastating 6.3-magnitude earthquake. A total of 185 people were killed; the second deadliest natural disaster in New Zealand history. This followed a 7.1-magnitude earthquake on 4 September 2010, in which there had been no direct casualties. The earthquakes (including subsequent aftershocks) caused wide-spread damage to buildings and infrastructure, in particular to the Central Business District (CBD) and eastern parts of Christchurch, New Zealand's second most populous city.

The New Zealand Treasury estimated the total cost of the rebuild at around $40 billion (about 20% of annual nominal GDP), much of which is covered by private insurance (reinsured through overseas insurance companies) and the government-owned Earthquake Commission (EQC).

Economic Recovery and Outlook

The New Zealand economy has made a solid recovery since the 2008/09 recession, which was shallow compared to other advanced economies. Annual growth has averaged a solid 2.2% since the March quarter of 2010 despite a period of softer growth in 2012, and was strong by historical standards in 2014. Growth in the March, June and September quarters of 2014 was 0.9%, 0.7% and 1.0% respectively, bringing annual average growth to 2.9% in the year ended September, the fastest rate of expansion in six years. Growth over the past year has been driven by the construction, services and agricultural sectors, with agricultural output rebounding in the September quarter from a drought affecting some regions earlier in the year.

Despite the significant disruption caused by the earthquakes, the impact on economic activity was less than expected. Many businesses were able to relocate out of the badly-damaged CBD and continue trading, and primary and manufacturing production in the region was not significantly affected.

The Canterbury rebuild is expected to be a positive driver of growth over the next several years through residential, commercial and infrastructure investment. Construction activity in the region has picked up since early 2012, and current indicators point to continued solid growth in 2015. Earthquake-related construction is expected to peak around the end of 2015 but the level of overall residential investment in the economy is expected to continue to expand, supported by housing construction in Auckland.

The global economy rebounded from the GFC in 2010 but then slowed significantly as public stimulus measures faded in China, the earthquake in Japan caused disruption in 2011 and European sovereign debt issues emerged. However, New Zealand's increasing exposure to the faster growing areas of the world, in particular Australia and emerging Asia including China, resulted in exports holding up better than otherwise expected. New Zealand's trading partner growth was 3.5% in 2013 and is expected to be 3.7% in 2014 and to increase to 3.9% 2015.

Monetary Policy

The focus of monetary policy is to maintain price stability. A Policy Targets Agreement (PTA) between the Governor of the RBNZ and the Minister of Finance sets out the specific targets for maintaining price stability, while seeking to avoid unnecessary instability in output, interest rates and the exchange rate. The current PTA requires the RBNZ to maintain inflation in the range of 1% to 3% on average over the medium term, but with an additional requirement to “focus on keeping future average inflation near the 2% target midpoint”.

The OCR was lowered from 8.25% in mid 2008 to 2.5% in April 2009 in response to the GFC but, as the economy began to recover, the Bank started to raise rates again. The OCR was increased to 3.0% in July 2010, before a 50 basis points cut back to 2.5% was made following the February 2011 Canterbury earthquake. A deteriorating global outlook meant that interest rates remained at 2.5% until March 2014 when the Bank began to tighten monetary policy. The OCR was increased by a cumulative 100 basis points to reach 3.5% in July 2014, as rising momentum in the Canterbury rebuild and domestic demand pressures were expected to lead to increasing inflationary pressures. However, the RBNZ has maintained the OCR at 3.5% since then as it assesses the impact of its recent monetary tightening before making further moves.

Macro-Prudential Policy

The RBNZ is also responsible for promoting the maintenance of a sound and efficient financial system. In May 2013, a Memorandum of Understanding was signed between the Minister of Finance and the Governor of the RBNZ defining macro-prudential policy and its operating guidelines. The objective of the Memorandum is to increase the resilience of the domestic financial system and counter instability arising from credit, asset price or liquidity shocks. Macro-prudential instruments include adjustments to the core funding ratio, countercyclical capital buffers, adjustments to sectoral capital requirements and quantitative restrictions on the share of high loan-to-value ratio (LVR) loans in the residential property sector. The latter was implemented on the 1 October 2013 with a requirement for commercial banks to restrict new residential mortgage lending at LVRs of 80% or higher to no more than 10% of the dollar value of new residential mortgage lending.

LVR restrictions have contributed to a moderation in the housing market. Demand for existing housing has fallen and annual house price inflation in November 2014 (6%) was lower than in November 2013 (10%). House sales recovered to some extent from their declines in early to mid-2014, to be up 6.5% on the previous year in November.

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