Latest Euro turmoil, commodity price and NZ$ falls right at the wrong time for Treasury and its Budget 2012 forecasts

By Alex Tarrant

Renewed turmoil in Europe over recent weeks appears to have come right at the wrong time for Treasury, which over the past couple of months has been cautiously readying its latest set of forecasts for next Thursday's Budget.

The economic forecasts contained in the Budget are generally finalised at least a month ahead of being released. Last year, tax revenue forecasts got an extra week on their economic counterparts (which were finalised 36 days before release), while the government's fiscal forecasts were finalised 17 days before Budget day. The Budget's text was finalised eight days before release.

So with this year's Budget to be released on May 24, Treasury is expected to have finalised its economic forecasts before the Greek elections on May 6, which failed to produce a government, and before French voters rejected European-wide austerity plans.  Greeks will now go back to the polls in June.

They would also have been finalised before the latest falls in New Zealand's commodity prices and an unexpected rise in unemployment. Prices at Fonterra's GlobalDairyTrade auctions are now at their lowest levels in three years, while ANZ's commodity price index, released on May 2, is at an 18-month low.

The New Zealand dollar has fallen from just above 82 US cents at the end of April to 76.6 US cents at time of writing.

'Look to their downside scenario'

While Treasury would have approached its forecasting with the caution forced by the global economic environment, Infometrics economist Gareth Kiernan doesn't think the government's forecasters would have expected such drops in commodity prices and the currency so soon.

In its own latest forecasts released in March, Infometrics had been expecting the Greek crisis to be resolved, which had appeared to be the case until a month ago, Kiernan said.

That means Budget 2012's downside scenario, where Treasury details an alternative track for the economy if headwinds are stronger than expected, may be of interest to Budget watchers.

“The risk for them is their economic growth looks overly optimistic. Maybe their assumptions on commodity prices as well – who knows. The tax take might not be as good as they expect, and the 2015 surplus target doesn’t look real," Kiernan told interest.co.nz.

“To be honest it was pretty dicey to begin with."

“Just what we’re seeing on dairy prices is pretty concerning for us, really. They’ve dropped off further than we would have thought," he said.

Infometrics' forecasts were based on two key elements in terms of getting the economy, and therefore the government's tax take, going again.

"One is the Christchurch rebuild, and I haven’t really seen anything there to change my view that it’s not until next year that you’ll start to see a bit more momentum," Kiernan said.

The second was getting farmers out spending a bit more freely again.

"Well, they’re not going to be doing that while commodity prices are falling. We’ve had anecdotal evidence at times over the last year that they were starting to feel a little more comfortable about spending, particularly around the middle of last year before Europe started to blow up," he said.

But at the moment farmers would again be looking to build up cash reserves and pay down debt.

“Not quite doing the bare minimum, because some of the farmers will be doing OK, but they’re definitely not rushing down to town and spending great deals of money,” Kiernan said.

Spain is the one to watch

BNZ's head of research, Stephen Toplis did not think the latest Greek news represented a step-change in what was happening in Europe. However, markets had not been expecting New Zealand's commodity prices and the currency to drop as fast as they had in recent weeks.

“It’s a reflection of the heightened uncertainty that something like Greece brings,” Toplis told interest.co.nz

“We are watching Greece. But fundamentally what has happened is not a deal breaker for anybody. And let’s face it, we’ve now got to wait for another set of Greek elections anyway," he said.

“In some ways Greece is a red herring in all this. The real issue is what happens to countries like Spain. A more alarming aspect of the last few weeks has been the blow-out in the Spanish bond spreads to German bond spreads to record highs.

“Greece will do what Greece does. It will be interesting and it will create lots of financial market volatility, but what Greece does is not the make or break of Europe. It’s what happens elsewhere,” Toplis said.

Having said that, markets would still focus on Greece because it was the news of the day.

On the fallout from a possible Greek debt default, Toplis noted creditors had already forgiven 75% of the government's debt.

“So three-quarters of the cost is already behind everyone – they’ve only got 25% left.”

“I think the more interesting thing for Greece, and the message it gives to others, is the possibility of civil unrest, and instability in the rest of Europe as a consequence of that. You’d have to say the probability of that continues to mount, not only in Greece, but places like Spain," he said.

“If you’ve got a 25% unemployment rate and a 50% youth unemployment rate, then the likelihood of some sort of civil unrest rises exponentially.”