New Zealand - RBNZ to cut rates more sharply than most expect - Capital Economics
Australia & New Zealand Economics

New Zealand – RBNZ to cut rates more sharply than most expect

Australia & New Zealand Economics Update
Written by Ben Udy
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We now expect growth in New Zealand to ease from 2.2% in 2019 to 1.5% in 2020. Along with a rising unemployment rate, weak economic activity will prompt the RBNZ to cut rates twice next year.

  • We now expect growth in New Zealand to ease from 2.2% in 2019 to 1.5% in 2020. Along with a rising unemployment rate, weak economic activity will prompt the RBNZ to cut rates twice next year.
  • Growth in New Zealand has gradually eased over 2019 as weak confidence and bleak global conditions weigh on investment and net exports. Forward indicators of economic activity point to an even sharper slowing in growth over the coming quarters. Our New Zealand Activity Proxy (NZAP) remained consistent with growth of around 1% in August. (See Chart 1.) That’s consistent with other indicators of near-term GDP growth such as the NZIER quarterly survey of business conditions. (See Chart 2.)
  • We suspect that weakness will persist into next year. For one thing, the global economy has not yet reached its trough. We expect trade-weighted growth in New Zealand’s largest export partners to slow from 3.0% in 2019 to 2.6% in 2020. That will hamper demand for New Zealand’s exports. We forecast export growth to slow from 2.7% this year to 0.7% in 2020. What’s more, slower global growth and concerns about the trade war seem to be weighing on business sentiment. (See Chart 3.) We think business investment growth will fall from 0.5% this year to -2.5% in 2020.
  • Taken together, we think GDP growth in New Zealand will slump to just 1.5% in 2020 from 2.2% this year. That’s the weakest pace of growth since the GFC and much weaker than the RBNZ expects. (See Chart 4.) And businesses surveys already point to falling employment before long. (See Chart 5.) We expect the combination of subdued business sentiment and falling GDP growth to cause the unemployment rate to surge from 3.9% in Q2 to 4.7% by mid-2020. (See Chart 6.)
  • What’s more, the largest percentage increases in the minimum wage are now behind us. The upshot is that wage growth has probably peaked, which should cause non-tradeable inflation to ease. That’s a key reason why we expect underlying inflation to fall from 1.7% in Q2 to 1.5% by the end of next year. (See Chart 7.)
  • The implications are clear: the New Zealand economy needs additional stimulus. Admittedly, the government may provide a bit of a boost. At the May Budget, the government significantly increased expenditure on social services. And it may now boost spending even further given the 2018/19 surplus was $7.5bn, more than double the forecast in May. But the RBNZ has expressed doubt on whether the government will actually be able to spend as quickly as it claims given mounting capacity constraints. Indeed, the government recently called off its KiwiBuild target to build 100,000 houses in 10 years as it was ‘overly ambitious’. To boost the economy the government needs to allocate some portion of its spending to achievable, growth-focused policies, such as tax cuts. We doubt that will happen until after next year’s election, which needs to take place by mid-November.
  • If the Reserve Bank wants to ensure the economy gets the supports it needs it will therefore have to do the heavy lifting by itself. We don’t think there will be enough negative news by the time of their next meeting in November to prompt the RBNZ to cut again. But by early next year, it will be clear that economic activity deteriorated further in the second half of 2019 and will continue to ease in 2020.
  • With economic activity and inflation both subdued and the unemployment rate rising fast we think the Bank will cut twice next year, more than markets and the analyst consensus currently expect. (See Chart 8.) We forecast the Bank to cut interest rates in February and May to a record low of 0.5%. And if the government doesn’t step up its game soon, the risks are clearly skewed towards the Bank cutting more, perhaps even into negative territory.

Chart 1: NZAP & GDP (% y/y)

Chart 2: NZIER Domestic Trading Activity & GDP

Chart 3: Business Investment & Investment Intentions

Chart 4: GDP (% y/y)

Chart 5: Employment Surveys & Employment

Chart 6: Unemployment rate (%)

Chart 7: Inflation (%)

Chart 8: Interest Rates (%)

Sources: Refinitiv, RBNZ, Bloomberg, ANZ, Stats NZ, Capital Economics


Ben Udy, Australia & New Zealand Economist, +65 6595 1517, ben.udy@capitaleconomics.com