Westpac expects NZ economy to weaken until 2020, hit by low dairy prices, the Canterbury rebuild ending & with house price growth slowing

Westpac economists say the tide has turned on our economy and we’re headed down the same path Australia’s been on since the mining boom started unwinding.  

Westpac’s latest quarterly Economic Overview says it expects GDP growth to fall below 2%, unemployment to rise to 6.5%, and the OCR to fall to 2%.

Chief economist Dominick Stephens says, “After expanding at a robust pace over 2014, the economy showed signs of coming off the boil in early 2015.

“With the dairy sector taking a dramatic turn for the worse, we anticipate a further slowdown in GDP growth and a lift in unemployment.

“The falling exchange rate and lower interest rates will cushion the blow, but any recovery will soon run into headwinds from the waning Canterbury rebuild.”

Dairy price drop more severe than expected

Stephens admits Westpac got its forecasts wrong towards the start of the year, and the economy has worsened significantly more than expected.

Economic growth accelerated to 3.3% in 2014, on the back of a 40-year high in the terms of trade. The Canterbury rebuild and increasing population growth spurred the economy.  

However Stephens says cracks in the façade emerged early this year, as economic growth was only at 0.2% in the March quarter, with lacklustre personal consumption and weak business investment contributing.

Since then, dairy prices have plummeted. Westpac has lowered its forecast for this season’s Fonterra farmgate milk price to $3.70 from $5.70 where it was three months ago. Fonterra itself is forecasting $3.85.

“That implies that annual dairy export revenues will be more than $3.5 billion lower – about 1.5% of annual GDP – than we assumed in our last Economic Overview”, says Stephens.

He notes, “A milk price of $3.70 is well below break-even levels for many dairy farmers.

“A second consecutive season of very low returns will inevitably force much more wrenching on-farm spending adjustments than a one-year downturn might have. And downstream investment activity is also likely to slow.”

Stephens says agricultural borrowing is already up 9.3% in the last year, as dairy farmers borrow as they have little or no operating cash flow.

Furthermore, Westpac expects dairy farm sale prices to also take a dive, saying “it may only take a small number of distressed farm sales to establish a new, lower benchmark for farm prices.

“That in turn would constrain farmers’ ability to borrow against the equity in their properties.”

Canterbury rebuild slowing quicker than expected

Adding fuel to the fire, Westpac says the Canterbury rebuild – a key driver of national economic growth – is peaking about nine months sooner than expected.

Residential building consents in Canterbury are down about 25% since late last year. While consents for commercial buildings have continued to ramp up, the projects are complex so will proceed more gradually.

“We expected rebuild activity to plateau for the coming year”, says Stephens.

“By early 2017 the vast bulk of residential work will be done, and by our estimates commercial construction will be well-advanced. At that point the waning rebuild will become an outright drag on the economy.”

Weak data

Westpac says these developments are already affecting consumer confidence, business confidence, hiring and investment.

“Employment growth has slowed, imports of capital equipment have flattened out, and commercial vehicle registrations have come off sharply”, Stephens says.

“A shockingly weak business confidence survey in July suggests worse is yet to come.”

Westpac accordingly expects businesses to ease back on plant, machinery and transport investments over the coming December and March quarters. It expects we’ll see no employment growth over this time.

Stephens says, “We expect annual GDP growth will drop to 1.8%, while unemployment will rise to 6.5% and wage growth will slow even further”.

Economic bright spots

Amidst this doom and gloom, Westpac says there are still drivers of economic growth in sight.

Auckland needs new housing and infrastructure to accommodate the city’s rapidly growing population.

While issuance of residential building consents has doubled in recent years, Stephens says “it would be optimistic to expect a sudden further leg higher.

“However, with development rules slowly being relaxed and interest rates falling, we do expect building activity in the region to continue rising over time.”

Westpac also notes net immigration is showing little signs of slowing. It expects some moderation in population growth over the coming year, but says “it is unlikely to turn decisively until Australia becomes a more compelling alternative destination for New Zealand and international migrants”.

The international prices for kiwifruit, wool and beef exports are also faring better than dairy, and the lower exchange rate will provide a welcome windfall.

Stephens says the lower exchange rate is also good for tourism and the foreign education sector, “which were already enjoying a very strong year on the back of a recovering global economy, and have now become more price competitive”.

National house price inflation expected to drop

Westpac admits the future of the Auckland housing market is a “million dollar question”.

It is sceptical OCR cuts will further inflame house prices.

“The market has clearly been driven by expectations of capital gain, with prices running well ahead of existing rents or incomes”, Stephens says.

“Our preferred interpretation is that investors are betting on Auckland’s housing needs being met by denser development, which has driven up the perceived value of land.

“This leaves the market highly vulnerable to a shift in sentiment. We expect investor optimism to be increasingly challenged in the coming months as the economic climate continues to darken.”

Stephens also maintains the policy changes around investor lending and tax that are kicking in on October 1 will dampen investor confidence.

He concludes Westpac expects Auckland house price inflation to slow later this year.

Considering the fact house prices in dairy farming regions such as Southland, Taranaki and Canterbury are expected to decrease, while low interest rates and looser lending restrictions are expected to boost prices in other parts of the country, he’s forecasting national house price inflation dropping from 10% to 4.5% next year.

Forecasts modest until 2020

Westpac expects some economic recovery by mid next year, as it sees dairy prices recovering a bit by this time.

However it believes this will be short-lived, as the headwind of the waning Canterbury rebuild will be gathering force by late 2016 and into 2017.

“Our GDP forecasts are generally pretty modest until the end of the decade”, says Westpac.

It explains, “We estimate that New Zealand’s rate of potential GDP growth – the speed at which it can grow without adding to inflation – increased from less than 1% in 2011 to 3% last year. This meant that even when economic growth was at its peak, inflation was low.”

In this vain, below-potential GDP growth could cause non-tradable inflation to trend down further, from an already low starting point.

Stephens says, “We expect all of this will force the Reserve Bank to cut the OCR to 2.0%”.

Parallels with Australia

Stephens says we should brace ourselves to go down the same path Australia has since its mining boom slumped.

“Since late 2011 the RBA has reduced the cash rate from 4.75% to 2.0% and the Australian dollar has fallen about 30%.

“There have certainly been bright spots in the Australian economy – notably rising house prices in the biggest cities and robust urban construction activity.

“Still, Australia’s economic performance has not been strong enough to prevent stubbornly high unemployment, sagging wage growth, and persistently low business and consumer confidence.

“In our view, this provides a template for what New Zealand can expect over the next few years.”