No hike in Official Cash Rate until mid-2013 due to European debt crisis, NZIER says; 2014/15 govt surplus in doubt as growth forecasts tank

The fallout from the European sovereign debt crisis will dampen New Zealand growth and mean the Reserve Bank will not raise the Official Cash Rate from its current record low of 2.5% until mid 2013, the New Zealand Institute of Economic Research (NZIER) says.

Meanwhile, there was a 25% chance the Eurozone would split, restricting New Zealand's access to capital, pushing up borrowing costs and steering the economy into another recession, forcing the Reserve Bank to cut interest rates.

And if that wasn't enough, government spending programmes are likely to face renewed scrutiny as the government's 2014/15 surplus track becomes even more challenging due to economic growth rates well below what Treasury is forecasting.

NZIER Principal economist Shamubeel Eaqub delivered a dour outlook for the domestic and global economies when releasing NZIER's latest Quarterly Predictions.

Growth lower than Treasury assumes

“New Zealand’s fledgling recovery will be severely hampered by the rapidly worsening global economy,” Eaqub said.

"The fall-out from the European sovereign debt mess will depress export growth. It will weigh on exports and tourism, which had been a buffer. Investment will remain depressed because banks will find it harder to raise capital overseas. The uncertainty around the global outlook is also weighing heavy on business and consumer confidence and thus spending," he said.

NZIER's central scenario – where it assumes a political solution is found that prevents the Euro area from breaking up – has economic growth at just 1.5% in 2012, gradually rising to 2.5% by 2014.

In contrast, Treasury in its Pre-election update released on October 25 is forecasting 2.3% growth in the year to March 2012 to rise to 3.4% growth in the year to March 2013, followed by 3.3% in 2014 and 2.9% in 2015.

The OECD in its latest Economic Outlook released yesterday, is forecasting GDP growth for New Zealand of 2.5% in 2012 and 3% in 2013.

Domestic spending to remain soft

Eaqub said there was little domestic demand growth.

"Households are saving, the housing market is struggling, businesses are cautious about investing and the government is in a period of fiscal consolidation. The Canterbury rebuild will provide a much-needed injection of building activity from mid-2012, but the speed of the recovery programme is not yet clear," he said.

Interest rate rises off the table until mid-2013

"Faced with the darkening global outlook and weak domestic activity, the Reserve Bank will not raise the Official Cash Rate (OCR) until mid-2013. Inflation will be contained as excess labour market capacity keeps a lid on wage growth and firms hold prices low to remain competitive. If the global situation worsens, the RBNZ will have to cut the OCR," Eaqub said.

Return to fiscal surplus to be delayed

The slower recovery would dampen tax revenue.

"A 2014-15 return to budget surplus projected by the Treasury– estimated before the global outlook deteriorated so rapidly – will be challenging. Government spending programmes will face further scrutiny," he said.

Interest rate cuts if Euro splits

Finally, a more pessimistic scenario in Europe could not be ruled out.

“If the Euro area splits, New Zealand firms should prepare for another global crisis. This would restrict access to capital and push up global borrowing costs, in addition to an even weaker export outlook. New Zealand would likely experience another recession and the Reserve Bank would need to cut interest rates. We place the odds of such a scenario at about 25%,” Eaqub said.

(Updates with video interview)