The New Zealand economic outlook
Recent global financial and economic developments have underlined the policy risks facing New Zealand, Reserve Bank Governor Alan Bollard told the Euromoney Australian Financial Markets Innovation Congress in Sydney today.
In a presentation entitled New Zealand and the World Economy, Dr Bollard said that the Bank was projecting a moderate slowdown in economic activity over the next few years, reflecting weaker household spending, business investment, the negative effects of dry weather conditions, and the impact of the exchange rate on exporters.
"As we noted in our recent Monetary Policy Statement, there is a risk that the slowdown in the US economy and international financial market turbulence results in a sharper downturn than we are projecting. Much rests on the extent to which the economies of the Asia-Pacific countries, which are important trading partners for New Zealand, can remain largely de-coupled from these developments."
On the global scene, Dr Bollard said fragile risk appetite has seen ongoing turbulence in global equity, foreign exchange, bond and money markets. From their origins in the US sub-prime mortgage market, credit market problems have now spread to a vast range of financing activities around the world.
"However, despite some negative headwinds, a number of factors are likely to help sustain activity in the New Zealand economy. A strong terms of trade is expected to support export revenues while higher government spending and the prospect of personal tax cuts may limit the extent to which the domestic economy cools.
"As we discussed in our last Financial Stability Report, released in November, New Zealand banks have virtually no direct exposure to the US sub-prime market, and have engaged in very little securitisation," he said. "However, as is the case in Australia, conditions in global markets have seen funding costs rise and credit conditions tighten.
"Over the past three weeks global financial markets have remained volatile, funding costs had risen and credit conditions tightened. New Zealand households and businesses are seeing the effects of this via higher interest rates," he said.
"Understandably much of the media commentary has been pessimistic, focussing on the prospects of a sharp world slowdown and financial market upheaval. Monetary policy must take these risks seriously but balance them against the inflation outlook.
"Inflation pressures in New Zealand remain relatively strong. Higher food and commodity prices are adding to inflation in New Zealand as they have in other countries, including Australia and China, which have continued tightening monetary policy in recent months. Over the next few years, the introduction of an Emissions Trading Scheme in New Zealand will also add to headline inflation.
"Monetary policy in New Zealand has been relatively tight for some time, and we think the current setting of 8.25 percent with a flat outlook remains appropriate. However, we will need to keep a close eye on global economic and financial developments for any indications that global activity is slowing by more than most forecasters are currently projecting."
Dr Bollard said the Bank will be closely watching a number of factors including: Northern Hemisphere financial market turbulence; conditions in the Australasian financial sector; the extent to which East Asia growth is coupled to US and European growth, and commodity price developments; and the way in which the adjustment in the housing market and domestic spending proceeds.
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