NEW ZEALAND ECONOMY FACING RECESSION WHILE BATTLING

UNCLAS SECTION 01 OF 02 WELLINGTON 000225

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E.O. 12958: N/A
TAGS: ECON EFIN ETRD PGOV PREL NZ
SUBJECT: NEW ZEALAND ECONOMY FACING RECESSION WHILE BATTLING
INFLATION

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Reftel: WELLINGTON 168


1. Summary. The recent slowdown in New Zealand's economy is the
result of weaker private consumption growth, owing to higher fuel,
food, utilities and housing costs, which are cutting into Kiwis'
disposable income. Both business and consumer confidence remains
weak amid higher prices and rising unemployment. Fixed investment
is subdued as business confidence remains low. Despite this
weakening in the economy, the Reserve Bank of New Zealand (RBNZ) is
expected to leave interest rates on hold Thursday (July 24),but a
reduction of 25 basis points is possible within the next two months
as the pressure of a stalling economy outweighs rising inflation
concerns. A survey of New Zealand economists indicates that the
RBNZ Governor Alan Bollard will wait until the next full monetary
policy statement on September 11, by which time he will have a
better sense of market trends. Meanwhile, the Finance Minister has
limited fiscal stimulus options left to help stave off recession.
End summary.

Monetary Policy
--------------


2. Monetary policy has been on hold since July 2007, following a
significant tightening that left New Zealand's interest rates among
the highest in the developed world. However, the RBNZ, which targets
an inflation range of 1 to3%, remains concerned about the outlook
for price increases. The RBNZ raised the overnight cash rate (OCR)
by 25 basis points on four occasions in 2007, the most recent of
which, in late July 2007, saw the rate increased to 8.25%. RBNZ has
pointed to the substantial inflationary risks that exist, notably
rising oil and food prices, and medium term concerns about the tight
labor market and high capacity utilization. The RBNZ forecasts that
year-on-year inflation will peak at 4.7% in September 2008 before
slowing.


3. Local economists believe that the RBNZ will maintain current
interest rates when it meets Thursday (July 24). ASB Bank economist
Nick Tuffley predicted that a rate cut was unlikely. "We don't
think there has been sufficient easing on the non-tradable front to
counter concern over high headline inflation," said Tuffley.
Westpac chief economist Brendan O'Donovan has a gloomier prediction
of inflation rising to 5.5% by the end of September. "I think that
there will be the peak so long as oil prices don't scoot even
higher," he said. O'Donovan said the RBNZ was in a tricky situation
dealing with "stagflation," i.e., growth falling because higher
costs are hitting household budgets while inflation is rising.
Longer term, experts believe that monetary policy is likely to ease
slightly by the third quarter of 2008 (September).

Business Confidence
--------------


4. Businesses are the most pessimistic about their future than in
26 years, according to July 2008 Quarterly Survey of Business
Opinion (QSBO),which pointed to a recession lasting at least three
quarters of the year. A net 18 percent of firms reported a decline
in their activity, and the same proportion also expected activity to
fall in the next three months, as of the June quarter. Those
seasonally adjusted readings were the lowest since June 1998 and
December 1982, per the NZ Institute of Economic Research (NZIER).
NZIER economists predict two more quarters of economic decline are
likely to follow the 0.3 percent fall in Gross Domestic Product
(GDP) following the March 2008 quarter.

Inflation and Looming Recession
--------------


5. Statistics New Zealand reported in July that inflation in New
Zealand had jumped by its highest amount in 18 years during the June
2008 quarter, up 1.6% to top 4% for the year. It is the highest
inflation has been since June 1995. The consumer price index (CPI)
and the food price index were at their highest quarterly levels
since June 1990, led by increases in the price of petrol, groceries,
utilities and housing costs. The largest contributor to the
consumer price index (CPI) rise was petrol, up 12.8% in the June
quarter and by 25% over the past year. Food was up 2.2% in the
three months to June and by 8.2% over the past year. Electricity
was up 3.6% in the June quarter. The rise in grocery prices was
higher overall, up by 12% in the past year, led by significant price

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increases in dairy products. Fresh milk rose 22% in price over the
year, cheese 62% and butter 86.6%. A loaf of bread was up 15.2%,
fruit and vegetables 5.2% and fresh meat and poultry 4.8%.


6. Finance Minister Cullen reacted to the news by saying, "the CPI
only confirms what New Zealanders already know - that the global
commodity boom was putting considerable pressure on household
budgets." He went on to say, "it is important to remember that our
economic challenges are not of New Zealand's making - the global
increase in the prices of petrol and food are outside New Zealand's
control."


7. The NZ Treasury's June 2008 Report states, "New Zealand may
already be in recession experiencing a sharp slowing of growth in
early 2008 and pointing to further weakness in the June 2008
quarter." Drought and weaker domestic demand saw the economy
contract 0.3 percent in the first quarter, being the first quarterly
fall since 2005 and larger than the 0.1 percent fall forecast in the
government's May budget update. However, the NZ Treasury said the
economy could be expected to recover in the second half of the year
under the impact of high dairy prices boosting farmer incomes and
cuts to personal tax rates, which come into effect on October 1.

2008 Budget/Fiscal Policy
--------------


8. Finance Minister Michael Cullen announced a series of stimulus
and tax cutting measures in this year's annual budget (see Reftel),
which were calculated to regain voters' support. The first tranche
of tax cuts are programmed to take effect on October 1, 2008.
(Note: Some prognosticators maintain that PM Clark will wait until
November 8 to call elections allowing the benefits of the tax relief
package to be more acutely felt by voters. End note.) The tax cuts
will equate to between NZ$12 (US$8.80) and NZ$28 (US$21) per week,
depending on income level/tax bracket. Corporate taxes were cut
from 33% to 30% from April 1st 2008. Economists predict that the
rising costs of living will leave the average Kiwi worse off than a
year ago. Despite the tax relief scheduled for October, the average
New Zealand family will need NZ$57 more per week than last year to
buy the same amount of goods.

Comment
--------------


9. In the run-up to the general election, which is expected anytime
between September and November 2008, the governing Labour Party is
struggling to regain popular support against a contracting economy
with high interest rates and rising prices. These economic factors
are likely to weigh negatively on the Labour Party's chances of
re-election. Meanwhile, the National Party appears to be in no
hurry to reveal policy details on issues such as its proposed
alternative tax cuts. However, National will come under increasing
pressure to outline a comprehensive economic policy laying out
National's strategy for dealing with an economic environment that
New Zealand voters consider the most the most decisive factor in the
upcoming election.

MCCORMICK