Opinion: Improvement in domestic economic data to turn moneymarket pricing

By Roger J Kerr

Media reports and bank commentaries on the outlook for monetary policy and interest rates are universal in the view that the RBNZ will not have to adjust the OCR upwards until March 2011 at the earliest and after that the 0.25% increases will be few and far between.

That’s how the scenario looks now after several month of weak domestic economic data and several economic forecasters giving a reasonable probability of the economy falling back into recession.

While GDP growth in the September and December quarters will be distorted by the Canterbury earthquake, the rebound in growth through the first half of 2011 may well surprise on the upside.

The problem is that we will not know officially how the economy performed in the first three months of 2011 until late June 2011.

The three-month lag in counting what has happened in the economy by Statistics NZ is quite unacceptable, and I am sure it is frustrating for the RBNZ as it is for everyone else. It pays not to mention the HLFS unemployment/employment statistics as the survey sampling is a complete mess and the numbers are not to be relied on.

My view is that the FX and interest rate markets will start to reflect GDP growth being higher in 2011 than generally forecast well before the official figures in June 2011.

The moneymarkets should start to price the potential of much more rapid increases in the OCR from March 2011 when it is realised that GDP growth in 2011 will be well above the RBNZ’s +2.6%.

By December this year I see the market sentiment and direction turning to such pricing due to the following developments:-

1. Domestic retail and housing market confidence and sentiment improving as the GST/income tax cut changes are now known and employment uncertainties reduce.

2. Business and consumer confidence improving as Jo and Josephine Public realise that the economy is expanding on good export performance and the prospect of a double-dip recession was just scaremongering.

3. The massive household de-leveraging and economic re-balancing running its course and wallets opening up somewhat.

4. High export commodity prices holding up and thus delivering higher profits and incomes in rural NZ.

5. Manufacturing improving markedly from current levels as the 0.7600 NZD/AUD cross-rate makes selling into Australia very profitable indeed. Output, investment and jobs can be expected to increase in this sector.

6. The 2011 Rugby World Cup providing a boost to tourism and the Christchurch re-build providing a real boost to the construction sector.

The major proviso to this more bullish economic outlook is that the NZD/USD exchange rate does not stay above 0.7500 for a prolonged period and ruin the advantage of the high commodity prices and hamper the export-led recovery.

The net result of improving domestic conditions is that the RBNZ will be forced to hastily revise their GDP growth forecast back up again in early 2011.

Their remit is to manage monetary policy today on their forecast of the economy and inflation risks in 12 to 18 months time. My take on matters is that they will be forced to remove the “emergency monetary stimulus” much earlier than the picture painted in their September Monetary Policy Statement.

--------------------

 * 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