Opinion: Why bank economists are getting their forecasts so wrong

By Roger J Kerr There were no surprises with the weak employment data last week, causing both interest rates and the NZD to decrease. Yet again the moneymarkets and bank economists have been forced by the economic facts to push their timing of OCR interest rate increases back to June/July form the previous March/April predictions. Go back a couple of months to early December a number of the bank economists were confidently predicting the first OCR increase in January 2010. Unfortunately you never see any explanation as to why those forecasts were so wrong. These interest rate forecasters are either just guessing with these very changeable predictions, or they are just so removed from what is actually happening in NZ businesses and industry sectors that their economic theory always dominates over the reality. According to the economic theoreticians that still seem to hog the media headlines here, the cause and affect chain goes as follows:- "Low mortgage interest rates + high immigration inflows = rising house prices = increased borrowing ability to fund household spending = higher retail sales = stronger demand pushes up retail/consumer prices = higher inflation = RBNZ tightens monetary policy Result: higher interest rates and higher NZD currency value" There are flaws with this theory in every one of the links in the above chain:- 1. Floating and one-year mortgage interest rates may be lower than historical averages, but the upward sloping yield curve has term mortgage rates at or above average. There is no certainty that immigration inflows will be so positive this year with more Kiwis expected to depart for Aussie than last year. 2. House prices have been rising due to a shortage of new listings, however upcoming tax changes are certainly now putting a damper on the rental investment property market. 3. The banks have fundamentally tightened credit and lending criteria on home mortgage borrowing as well as business lending. Property developers have very limited sources of debt financing. The credit environment today compared to three years ago is massively different. 4. Consumer confidence surveys may suggest growth in retail sales in 2010, but we have not seen any uplift yet. Expect this week's December retail sales data to be not much better than flat. Retail goods financiers are only talking about arrears, defaults and bankruptcies, thus their acceptance criteria have tightened dramatically. 5. We have not observed "demand-pull" inflation as a source of inflation for more than 10 years in New Zealand. Consumer goods prices continue to fall due to the NZD currency impact and extraordinary competition. 6. The inflation outlook is benign; the RBNZ are in no hurry to do anything. 7. The net result of the economic reality being diametrically opposed to the economic theory is ... interest rates lower for longer and a lower NZD value. However, there has to be a major qualification to the "interest rates lower for longer in 2010" view, and that is based on the NZD/USD exchange rate. A continuing weak Euro currency over coming months is expected to lower the NZD/USD rate (we follow the EUR against the USD) to 0.6500 and maybe lower. A lower NZD value, coupled with excellent commodity export prices will spark increased activity, confidence and investment in our big export industries. In turn that would cause us to lift our GDP forecasts for 2010, and that in turn would bring forward and increase associated inflation risks. A lower NZD value automatically eases monetary conditions, therefore the RBNZ would need to lean against that with higher interest rates earlier. "”"”"”"”"”- * Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com