NZIER's Shamubeel Eaqub on what to expect from an economic perspective in 2015

By Gareth Vaughan

Another year is coming to an end and 2015's just around the corner. 

From an economic perspective, both the global and domestic pictures remain interesting. So what can we expect in 2015?

I sat down with Shamubeel Eaqub, principal economist at the New Zealand Institute of Economic Research, to discuss this. In the Double Shot interview I ask him about the global economic picture going into 2015, where the risks and bright spots are, how New Zealand's key trade partners China and Australia may fare, what's going on with commodity prices, and we also discuss a range of key domestic factors such as the Auckland housing market, migration, inflation, interest rates and the New Zealand dollar.

In terms of the global picture Eaqub points out uneven growth continues to be a key characteristic of the long post Global Financial Crisis recovery.

"We've got some bright spots, particularly in places like the US. We're starting to see some pretty concerted evidence that there is a recovery taking place there," Eaqub said.

"But at the same time we're seeing a few risks. From a macro perspective the moderation in growth in China, the renewed recession in Japan, slowing growth in Australia, which is a very big trading partner for us, but more importantly for me the stagnation in Europe coupled with the geo-political risks around the Ukraine and Russia, that's starting to become more of a risk looking forward."

"Geo-political risks are very critical because these are low probability but high impact events. And when you throw in an economic decline with geopolitical risks and financial markets, it can have far reaching consequences," Eaqub said.

"And as we saw in the last Russian financial crisis, and (in) all of those kinds of things, New Zealand is vulnerable to aftershocks."

'Unusual and unfortunate event with commodity prices'

In terms of commodity prices we've seen significant falls over recent months highlighted by the falling price of oil and declining dairy prices in Fonterra's GlobalDairyTrade auctions. Although hard to predict, Eaqub suggests commodity prices are likely to stay low for the next couple of years.

"Right now we've got a few things happening. One is supply has increased and demand has suddenly been less strong than we thought. And at the same time the geo-political tensions in Russia have meant that supply that would've gone to a big consumer like Russia, is suddenly flooding the export market."

"All of those things together are creating this very unusual and unfortunate event with commodity prices coming off very rapidly. For New Zealand there's two consequences, first of course for our (dairy) farmers it means their returns are going to be quite a bit less than last year. That's roughly $5 or $6 billion that's not going to be earned as revenue, so that's pretty big," said Eaqub.

"But at the same time we have a little bit of offset from low inflation, particularly through oil prices, that gives us a bit of a buffer. And I think that's a bigger story about what's happening in the global economy, that there is just not a lot of inflation."

"There's not enough growth, not enough demand, and not enough increases in prices and commodities. " Eaqub added. "Right now the real risk in the global economy is really about growth and the risk of stagnation and slow inflation. That's a much bigger risk."

Impact on Australia from a slowing China something to watch

In terms of China, Eaqub expects the economy there to slow to grow at just under 7% in 2015.

"The important thing for New Zealand is because growth is shifting from investment led to consumption led, in many cases it's actually a good thing for New Zealand. The demand for soft commodities, particularly for food products, remains very strong."

Nonetheless he notes New Zealand's forestry sector may face a slow down in Chinese demand.

For New Zealand's other key trading partner, Australia, and its focus on mining, the Chinese slowdown is a big challenge. Eaqub points out the knock-on effect for New Zealand is important.

"Because the kinds of things we export to Australia are so different, they tend to be much more value added, much more manufactured, much more processed. And unless Australia's growing well, more high value manufacturing parts of the New Zealand economy really miss out on the consumer."

"What we're talking about is an Australian economy that's slowing and suffering from a lack of demand. And that's a very big risk for New Zealand because it is our second largest trading partner. It means that the demand for our goods and services won't be there and we may not get as many tourists as we're used to," said Eaqub.

With the Reserve Bank of Australia pragmatic, he expects interest rate cuts if the central bank believes this will inflate demand.

"But we have to wait until the beginning of February to see that happen and perhaps the economic consequences, the stimulus coming through middle of next year."

Auckland housing 'a very big source of vulnerability'

Domestically a, if not the, key focus in 2015 will be the Auckland housing market.

"Prices have risen to such a level that they're very disconnected from incomes and rents and that remains a very big source of vulnerability," said Eaqub.

If the second wind emerging in recent Auckland housing data, from the likes of Barfoot & Thompson and Quotable Value, continues the Reserve Bank will "clamp down," Eaqub said.

"And I'm really frightened if the Reserve Bank reacts on housing (about) the toll it will take on the rest of the economy, both in terms of other provinces but also sectors outside of housing. (It) will be quite negative, because we'll be in an environment of relatively speaking slow growth, very little inflation, and banks are probably going to become more resistant to lending to businesses."

In terms of housing across the rest of New Zealand, Eaqub suggests the picture is brightening in Christchurch with supply beginning to catch up to demand.

"We're starting to see that in the early parts of the market like rents. Rents are not growing as much. Labour cost inflation which used to be very, very, high is starting to moderate. All of these things tell us that the repair work in Canterbury is probably going to be done in the early part of next year. That'll release a lot of capacity and the Canterbury housing market, which has also been very special, will moderate," said Eaqub.

"In the rest of New Zealand, which has added almost no jobs in the last seven years, I can't see much happening. It's very much about prices have returned to levels that make sense relative to rents and incomes and we expect them to grow modesty in line with those things."

'Net migration very critical'

With immigration having hit a record 47,684 in the year to October, and tipped by some economists to reach 55,000 next year, migration will be a key factor to watch next year. The Australian economy remaining weak will mean fewer New Zealanders leave for Australia, with this impact felt right across New Zealand.

"The increase in arrivals has been quite interesting and a little bit different from what we have seen in the past. The biggest source has been students so they add a slightly different kind of demand to other people. The second lot has been returning kiwis from Australia," said Eaqub. "And the third one has been people coming on work visas, particularly from the Philippines and surprisingly from France."

In the latest immigration boom there wasn't yet evidence it was having a profound influence on housing supply and demand as a previous boom in the early 2000s did. However, Eaqub suggested this might be yet to come.

"Net migration remains something that's very critical to watch for New Zealand. Given our small population, changes in net migration can have a very big impact in terms of the underlying demographic demand drivers for the economy."

'Excess capacity'

The most recent official annualised inflation figures showed it up just 1%. And Eaqub expects inflation to remain low.

"Businesses remain very cautious about raising prices, in part because there's not a lot of those cost increases coming through. One of the biggest sticky bits of inflation tends to be the labour market, and labour cost inflation is really subdued," Eaqub said.

"There's so many people competing for a few jobs that we're not seeing that kind of sticky wage inflation coming through, and I think that's partly that unevenness story. Because the job losses were wide spread, but the job gains are concentrated in a few places and a few occupations."

"There are concentrations of inflation, but in large parts of the economy there is very little inflation because there's so much excess capacity."

Interest rates 'a hard call'

In terms of what happens with interest rates next year, he argues this is a hard call.

"If I looked at just the economy in terms of growth and inflation, we don't think there is any catalyst for interest rate increases well until the year after next, so 2016 at some stage. But the big kicker here's going to be what happens to Auckland housing."

"If the housing market picks up the Reserve Bank will react and they will snub it out. There's a real risk that the collateral damage is the rest of the economy," said Eaqub.

"So I'm hedging my bets here. If it was just the economic management side of things we would say absolutely no interest rate increases until 2016. But if the Auckland housing market starts picking up, which is a source of big risk for both the economy and the financial system, the Reserve Bank will be forced to react and they could hike by the middle of next year."

Kiwi dollar 'collateral damage'

As for the New Zealand dollar, Eaqub expects it to remain strong despite commodity prices weakening.

"Given what's happening in the global economy in terms of very, very slow growth and risks to it, it's very hard to see quantitative easing on a global scale coming back anytime soon."

"So this competitive devaluation of currencies continues and the New Zealand dollar is the collateral damage. I think our dollar will stay high because of that, and that means our exporters will still have to plan very carefully in terms of managing their revenues and cashflows," Eaqub said.

"Relatively speaking New Zealand will do better than a lot of other places, our interest rates will be higher, we are not printing money like others. All of those relative factors, despite falling commodity prices, means the New Zealand dollar will probably hang up at a fairly high level."

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