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Opinion: Some questions to ponder over Christmas drinks

Opinion: Some questions to ponder over Christmas drinks

By Roger J Kerr As the year draws to a close and you are wondering what you may be contemplating over a Christmas drink or three, try putting together the interest rate/inflation/economic growth puzzle for 2010 by considering the following questions:- Q1:  How consistent is the RBNZ in its economic outlook from one statement to the next? A1:  Totally inconsistent, judging by December's Monetary Policy Statement. The clear signal from Governor Bollard just five weeks ago in the late October OCR review was the interest rates would be lower for longer in 2010, there were no inflation risks on the horizon and the market pricing at the time was wrong. The moneymarket pricing of interest rates came into line with the official RBNZ view over the subsequent weeks, only for the good Governor to concede last Thursday that the market pricing was right all along (i.e. he was wrong) and interest rates probably needed to go up in the first half of 2010. What changed in those five weeks to change the RBNZ views on the economy, inflation risks and the timing of monetary policy change away from the current stimulus settings? Blowed if I know! However one can guess that the RBNZ economist pre-occupation and fixation with the housing market got the better of them and some uplift in house prices since June has convinced them that this will fuel a consumer spending increase in 2010 and these demand pressures will cause a high inflation outcome. That cause and effect theory was proven to be wrong for the five years from 2003 to 2008, why would it be a correct now.? Q2:  How consistent is the RBNZ view within the Monetary Policy Statement? A2:  There are always plenty of "however's" "ifs" and "conditionals" in MPS commentaries, however it appeared to me that the hard-line, always-hawkish monetarist economists wrote the statement, Mr Bollard himself wrote the first six paragraphs of the "Introduction "“ Policy assessment" piece, but the always-hawkish economists forced the Governor to put in the last and seventh paragraph that changed the wording on timing from the previous "second half of 2010" to "around the middle of 2010". True, a very subtle change, but enough the lift swap rates 30 points and the NZD exchange rate two cents. A major inconsistency in the statement is the RBNZ's view that business investment will increase 10% in 2010 and 2011. Yet on the same page they state tax revenue coming into the Government has been weak "particularly taxation on corporate and entrepreneurial income". My assessment is that business profits have been decimated this year, there is no confidence by business to invest and capacity utlisation is lower. Hard to see 10% increases in this economic environment. Q3:  Should the RBNZ know in advance what their statements will do to market pricing? A3:  It is their job to understand the markets and the likely financial market reaction to the subtle changes in wording. The Governor losses much credibility when he has to come out the next day to say the markets have over-reacted to his statement and have misinterpreted what he said. It is not the first time the Governor has reacted in this way the next day. It does not give anyone any kind of confidence that the RBNZ are close to the markets or the economy. Q4:  Are the RBNZ GDP growth forecasts credible? A4:  As others have commented, the +3% annual growth for 2010 and +4% annual growth for 2011 are above official Australian GDP growth forecasts. Does it seem right that we are about to out-perform the Aussies does it? If you asked the RBNZ economists exactly what industry sectors in NZ are going to grow by 3% and 4% in the next two years, they would not have an answer for you. The wide range of forecasts for the September 2009 quarter's GDP from -0.2% to +1.00% suggests that the "dismal science" in NZ cannot even forecast history with accuracy, let alone the future! The RBNZ are basing their strong growth outlook on a re-building of inventories (stocks) that were run-down to low levels in the recession. What they fail to comprehend is that most companies in NZ have reduced their stock levels permanently and will not be re-building to previous levels. Tighter bank lending conditions/costs and being caught with too much stock on the downturn has forced a permanent reduction in inventory levels. The RBNZ expectation of strong housing and retail sectors in 2010 is also based on dubious grounds in my view. Household finances are squeezed a lot more than the uptick in consumer confidence would suggest. Consumer spending is being constrained today by the buy now/pay later "interest free" terms commitments households made two and three years ago and are now paying off. Latest housing and retail data supports a less optimistic "flat" outlook for next year, than what the RBNZ gurus are predicting. Q5:  What does all this mean for interest rates in 2010? A5:  As always, the timing of interest rate changes in the future will be dependent upon the economic data that comes out over coming months. My view is that the economic data will be weaker than RBNZ and market expectations.  There is a growing probability that the September quarter's GDP number could be closer to "0.0%" than the +0.4% concensus. When you have big industry sectors like construction, manufacturing, meat, dairy, wholesale trade and forestry all recording contraction in activity over the quarter it is hard to get excited about a positive number. Watch out for a surprise on historical GDP and that in turn reducing future expectation. At APRM we are sticking with our previous forecast that the OCR will not be increased until September 2010, even though the market is now pricing an April increase. "”"”"”"”"”- * 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

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