ASB chief economist Nick Tuffley says 2011 will hold similar economic themes to last year but will hopefully serve to better heal the wounds inflicted by the recession in 2008 and 2009. He talks to Business editor Dene Mackenzie about the fading of last year's economic scars.
New Zealand's slow economic recovery is likely to make more progress this year than in 2010, ASB chief economist Nick Tuffley says.
"The strength of emerging economies will support the global economy, even as many developed countries struggle to make structural adjustments to promote growth."
However, an unknown is the impact of this week's earthquake, which will have financial ramifications for the whole economy.
ASB warned this week that while the personal and financial impact on Canterbury was obvious, it would be felt by the wider economy as private and public funds and resources are diverted to the city.
It is advocating the Reserve Bank cut the official cash rate by 50 basis points to provide an economic stimulation.
Mr Tuffley said New Zealand households would continue to spend within their means. New Zealand was starting along the path to a more balanced mix of growth, although the challenge would be improving the country's export performance on a more sustained and broader basis.
This year, New Zealand's trading partners would grow at a pace around the long-term average of 3.5%, he said.
Much of the economic momentum around the globe was Asia-centric as work continued to bolster economies in the United States, the United Kingdom and Europe.
"Back home, the hands controlling the purse strings will be prudent. Government spending will be on a tight leash, given slow growth in the tax base and the clear lessons being learnt from offshore economies."
New Zealand households were likely to remain cautious with their money for the fourth year running. Stronger housing construction and business capital expenditure over the year was likely to give the recovery more impetus, over and above the impacts of the Christchurch earthquakes, Mr Tuffley said.
Another buffer for the economy was the likelihood of commodity prices remaining firm this year as Asian demand for New Zealand exports continued to grow.
Interest rates were likely to stay low for much of the year, as the Reserve Bank takes a "very cautious approach" to removing monetary policy stimulus.
"A very important lesson from 2010 was that both businesses and households were reluctant to spend even at relatively low interest rates.
That may change in time, but until it does such self-restraint will keep the lid on inflation."
The export sector would remain a key factor underpinning the economic recovery. Mr Tuffley expected continued growth in China to provide support to New Zealand export commodity prices while exporting manufacturers should continue to perform well.
Any improvement in the labour market would underpin a recovery in consumer confidence, consumer spending and the housing market.
The reconstruction efforts would add to economic activity and tourist spending associated with the Rugby World Cup would add a temporary boost to economic activity in the second half of the year.
TOURISM: The outlook for tourism remained challenging, he said. While overall visitor numbers remained firm, average spend remained weak.
In particular, fewer high-spending American and European visitors had weighed on overall visitor spending in New Zealand. The world cup should provide a boost to tourism.
HOUSING: Housing market activity and new housing construction was very weak in the second half of last year and was likely to remain subdued this year. Turnover remained low and the stock of unsold housing elevated. The balance of supply and demand remained tipped in favour of buyers and, as a result, house prices had edged lower over the end of 2010.
Housing demand would improve gradually, underpinned by improving labour market conditions and increasing consumer confidence. That was likely to be offset by gradual increases in interest rates and slowing population growth. Soft net migration inflows and falling house prices would continue to weigh on underlying demand for new construction.
BUSINESS: Investment was one area to disappoint last year with business confidence stalling in the middle of the year and investment plans deferred, Mr Tuffley said. Many businesses experienced weaker than expected demand and slower than expected recovery in profitability in the year.
More recently, there had been encouraging signs, pointing to an increase in investment this year. Investment intentions remained at levels consistent with modest growth in plant and machinery investment. Recent import data showed a pick-up in imports of capital equipment. Firms remained cautious, opting to expand capabilities through hiring more labour rather than committing to new investment.
LABOUR MARKET: The labour market recovery proved to be patchy last year. Employment was up 1.8% on the same time last year and signs for further recovery were promising, he said.
Growth in hours worked had been robust, implying a strong recovery in labour demand with firms using up idle capacity within their own workforces. While the labour market had made a respectable recovery, a large degree of spare capacity remained.
Unemployment was sitting at 6.8%, considerably higher than pre-recession levels of below 4%. Reflecting that, firms continued to report few difficulties in finding labour, although skilled labour was starting to become slightly more difficult to find.
INFLATION: It appeared some retailers of imported consumer goods chose to absorb part of the GST increase into their margins. Beyond the boost from GST, the modest increase in non-tradeable inflation and recent inflation indicators suggested inflation pressures in the New Zealand economy were contained for now.
"Given the policy targets agreement allows the Reserve Bank to look through the direct effects of major Government policy changes such as GST increases, its key concern is how households and businesses will react to the spike in headline consumer price index."
The central bank assumed the flow-through effects on wage and price setting behaviour would be muted, Mr Tuffley said. He expected continued increases in petrol prices this year to underpin tradeable inflation. Rising commodity prices would also mean higher food prices.
"Overall, we expect annual inflation will only return within the Reserve Bank's target band [1% to 3%] in 2013. This is in contrast to the Reserve Bank's forecast that annual headline inflation will fall back to close to the middle of the target band by the end of this year with very weak inflation forecast over the second half of 2011."
INTEREST RATES: There was little urgency for the Reserve Bank to lift the official cash rate from 3%, he said.
Recent data continued to point to subdued demand. Inflation indicators pointed to inflation pressures being contained, for now. The Reserve Bank was expected to increase the OCR in September, with gradual increases also in December and March next year.
CURRENCY: The Kiwi was expected to fall in value this year as the improving US economy reduced the difference in interest rate expectations between the two countries, Mr Tuffley said.
There was speculation the improvement in US activity might prompt the Federal Reserve to exit its quantitative easing programme early.
The reduced yield advantage between New Zealand and Japan would see the Kiwi fall against the yen this year.
The New Zealand currency had depreciated substantially in the past year against the Australian dollar.
That largely reflected strong demand for the Australian dollar given the continued strength of the economy as demand from Asia supported the country's export growth.
Some depreciation in the Australian currency against the Kiwi this year should follow from the negative impact on the economy from the widespread Queensland floods.
