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Sunday, October 16, 2005

Reserve Bank Governor: Look out Below!

Amidst increasing speculation about the form of the next government, Dr Alan Bollard, the Governor of the Reserve Bank, cautioned both the New Zealand consumer and the incoming Government about their big spending.

In a speech to the Credit and Finance institute Dr Bollard said that the upward trend in house prices would not be sustained and that an outright fall in prices was likely. He strongly hinted that interest rates would rise in the near term and that he expected the exchange rate for the New Zealand dollar to fall, occasioning more expensive imports.

He also cautioned that a more expansionary fiscal policy from the government would "increase the work of monetary policy", meaning that the more the government spends, the more likely interest rates are to rise.

The warnings come a few days out from the release of figures that are expected to show that the Consumer Price Index, the main measure of inflation, has exceeded the 3% upper threshold the Reserve Bank is mandated to maintain.

In response to the suggestion that a correction is likely in the housing market, Real Estate Institute president Howard Morley told home owners and buyers to "pay as little attention as possible" to the warnings. He went on to characterise those predicting a housing crash as constituting "a thriving but ultimatley pointless little industry."

Figures released recently show that the New Zealand consumer spends $1.12 for every dollar earned, the worst record in the OECD. This difference has seen the total value of mortgage debt expand by 67% in the last 4 years and consumer debt by 35%.

In addition to the increasing indebtedness of home owners, New Zealand is experiencing a slow down in the rate of migration, a key driver of the housing market.

Economists from the major banks have described the message as serious and the implications as clear, but have also wondered aloud whether a hike in the official cash rate may be too damaging to the economy.

Firms have almost universally indicated that they expect their trading conditions to worsen in the near term as costs rise and a shortage of skilled workers continues, but very few have indicated that they intend passing on the costs, opting instead for diminished profits.

It seems likely that the New Zealand economy is going to correct in the near term. However there are, I believe, two scenarios that will result in a painful rather than a measured correction. The first is a significant upward movement in the price of oil. Much of the increased cost being absorbed by business is the result of higher oil costs. An increase towards three figures in the price of a barrel of crude would force the hands of many businesses.

The second scenario that would spell doom for the economy is the outbreak of a global pandemic. This would cripple the economy for as long as borders remiained shut, and in the long term would affect migration and tourism.

Both scenarios are much more than remote possibilities at the moment and presage disaster for the average New Zealander.

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