With global stock markets recovering lost ground, New Zealand house prices and house sales numbers turning up, the prospect of stable interest rates for another six months or so, rising net migration, and Australia, Germany and France recording positive GDP growth, many are suggesting the recession is past. From a technical sense, these suggestions are correct in that quarterly growth in New Zealand’s GDP will have returned to positive this quarter.

However, the evolving composition of this positive growth leaves us feeling very uneasy. Of course, much depends on how long one’s time horizon is. The outlook can be summarised as follows:

• short term – the next year will be better than the last year.
• medium term – the two years following the next year are unlikely to be better than the two years preceding last year.
• long term – the quest for a high-wage export-based economy with productivity advances will still remain elusive.

Without doubt, the immediate short-term outlook is more positive than it was earlier this year. With unemployment no longer set to reach double-digits (although, we point out, we were not amongst those suggesting such a blowout) and resurgent business confidence the climate of ‘fear’ has abated. Furthermore, the export contribution from forestry (logs to China), meat (receipts if not volumes), and kiwifruit and wine (ongoing industry growth) have added to the feeling that the worst may have passed.

Nevertheless, monthly indicators suggest that activity is still well below year-earlier levels across many sectors. While the rate of decline may have eased, new residential building consents are still more than 20 percent below those of a year ago. Similarly, the slight pick-up in retail sales turnover, with the latest three months being 2.6 percent up on year-earlier, suggests sales volumes remain flat.

Looking ahead, our projection for GDP growth in the March 2010 year is -1.0 percent. While this number looks worse than now, it is consistent with a quarterly profile of growth beginning from the June 2009 quarter. But the weakness of the recovery – barely 0.2 percent per quarter – ensures annual growth remains negative in the March 2010 year. Thereafter, we expect GDP growth to creep towards the 0.5 percent per quarter mark and so register close to 2 percent per annum for the March 2011 and 2012 years.

We are noticeably less optimistic than either of the Reserve Bank’s or Treasury’s latest forecasts of a quick rebound to a 3 percent growth trajectory. In this context, we remain unconvinced by the ‘green shoots’ argument in that the nascent recovery in Europe is fragile and the US economy continues to languish with serious imbalances to address. While we won’t see a repeat of the ‘shocks’ from abroad as we have had over the past year, the recurrence of additional isolated shocks cannot be discounted.

In addition, we have difficulty seeing a rapid recovery from the export sector. The forestry industry is making a contribution via increased log exports, but the prospects for any significant surge in processed products over the medium term is low. Further, export volumes from the meat industry remain static with cattle and sheep slaughtering totals for the year 7 percent down on the previous year.

Manufacturing has now shrunk for the three out of the last four March years. Consequently, the $18bn contribution to GDP (in 1996$s) from this sector in the year to March 2009 is equivalent to its contribution in the year to March 2003. That’s six years of standing still! And export volumes from machinery and transport equipment in the year to June 2009 were over 9 percent down on the previous June year.

Meanwhile, the tourism industry has been saved (for the day) courtesy of the Australian government’s largesse via the nation’s ski slopes.
In behind this sad and sorry export tale is the exchange rate that defies any relationship to fundamentals. It is a story that will not be rectified unless the relative price signals between the tradable and non-tradable sector are similarly rectified.

Much as BERL has been critical of many Reserve Bank actions over the past 20 years, we have to come to the RBNZ’s defence on these matters. Under the RBNZ Act 1989, the prevention of inflation is its single responsibility and variation of the OCR has been chosen as its only instrument. As we have argued throughout, inflation was always and still is more than just a monetary problem and influencing interest rates at the short end was never an adequate method of managing the monetary component. So it’s not the RBNZ’s fault, or at least its current management’s, that it has been given an impossible job to do and a useless instrument for the purpose.

In the meantime, the appreciation of the NZ$ has continued, although at a slower rate. We believe the TWI is now near its top. This is in contrast with the current market view that the US dollar has considerably further to fall. This could be true for the near term. But, taking a longer-term view, we note that financial authorities in general, and particularly in the US, are already considering the “claw-back” of government provided liquidity to major banks. We believe stimulus packages may soon begin to improve investment conditions in their respective real domestic economies. Thus we could have a concurrence of reduced liquidity and increased investment demand in major markets, both of which would tend to reduce capital outflow and therefore the demand for foreign currencies such as the Kiwi.

We doubt however that the TWI would fall to a level low enough to generate sustained export-led growth. As long as major currencies manage their currencies downward, it is inevitable that currencies not so managed will tend to be over-valued. If, as we believe, a TWI in the mid-50s is the natural rate required for such growth, it would follow that the actual TWI delivered by the market will fluctuate around a higher level, 60, say. This is our longer term forecast of the TWI, but we would hesitate to guess when the decline is likely to occur.

Our concern for the medium and, indeed, longer term is further heightened by the picture for private sector investment. The collapse in the March 2009 quarter (down 9.2 percent) means real investment spending by businesses in the year to March was 5 percent below that of the previous year. The prospects for a quick U-turn here is also unlikely, as businesses look to replenish cash flow and bank lending remains constrained.
And while short-term productivity numbers are set to look good, given reduced labour inputs, the prospects of longer-term sustainable productivity growth are not bright if business investment continues under pressure.

Therein lies our concerns as to the composition of economic activity. Consequently, our forecasts are tending towards yet another domestic spending base for the re-establishment of growth.

Despite the ‘technical’ end of the recession, a belated impact on employment numbers and numerous other labour market indicators is now being felt. While jobless numbers rose through last year, it wasn’t until the June quarter that employment growth turned negative coupled with an easing in rising participation rates.

We expect various labour market indicators to continue to lag behind those of overall economic activity. Businesses have not shed staff as quickly as in earlier recessions. Consequently, the return to positive growth as measured by GDP numbers this year will not be reflected in growth in employment numbers until later next year. But with such growth being muted, at best, unemployment numbers are set to remain high for some time.

Assisted by a slight reduction in participation rates, we are forecasting unemployment to peak at just over 7.3 percent in mid-2011. While well below some forecasts promulgated by others earlier this year, this is still a sobering number, representing over 170,000 officially unemployed. This represents a lengthy period of relatively high unemployment. So, while the recession may be technically over, the damage to economic performance and social conditions will continue well into the medium term