Superficially the Australian and New Zealand economies are in a similar position.
On the one hand, inflation hits a 13 year high of 4.5% in Australia in the year to June, and the Reserve Bank will hold rates steady, not increase them, as it waits for rate rises and the higher oil price to crunch the domestic economy to offset the pressures from the still booming resources sector.
Across the Tasman, the Reserve Bank of New Zealand cut rates unexpectedly yesterday by 0.25% (three months ahead of time) as inflation surges towards a forecast 5% annual rate by the end of the year, and the domestic economy continues to slide into recession.
And that’s despite the boom enjoyed by the country’s highly efficient dairy sector which is the world’s biggest exporter and has enjoyed record returns.
It was the first rate cut in five years in NZ and came three months ahead of expected: the cut had been widely tipped to happen in September. But the worsening state of the Kiwi economy obviously forced the central bank’s hand.
The Australian domestic economy has to be slowed to lessen the inflationary pressures building in the economy (as we have seen with Victorian-driven wage settlements for public servants and now building workers). In NZ, the central bank cut rates to a still very high 8%, to start the process of slowing the slide into recession and to revive the economy.
It’s our booming external economy that is giving us grief with the surge in the terms of trade expected to push national income higher as higher receipts from rising sales of coal, iron ore, oil and gas cascade through the economy over the rest of the year and out into 2009.
And that’s the difference. The Australian economy won’t plunge into recession, not unless China goes belly up and slumps sharply in the next year. The Kiwi economy will be battling to emerge from what looks like being a pretty long trough.
Despite the very real differences between the two economies, these comments from RBNZ Governor, Dr Alan Bollard, could have come from RBA Governor, Glenn Stevens in one of his recent speeches.
Dr Bollard said in yesterday’s statement: “More unpleasant international news has emerged since the June Monetary Policy Statement, and there is a risk that the domestic economy will slow further. Moreover, the cost of funds raised abroad by banks has been rising in recent months as the international financial situation has deteriorated.
"Today’s cut will help to mitigate the effect of these increases on the actual borrowing costs paid by firms and households.
“Recent oil and food price increases mean that annual CPI inflation should peak around 5 percent in the September quarter of this year.
"However, we expect that inflation will return inside the target band in the medium term. The weaker economy is expected to reduce pressure on resources, making it more difficult for firms to pass on costs and for higher wage claims to be agreed.
“Economic activity is likely to remain weak over the remainder of 2008. The ongoing correction in the housing market, together with the very high oil prices, will limit household spending and constrain the extent of recovery.
"However, high export prices and an expansionary fiscal policy are expected to contribute to a gradual pickup in activity through 2009."
“Consistent with the Policy Targets Agreement, the Bank’s focus will remain on medium-term inflation. In this regard, it is important to note that monetary policy has been reasonably tight for some time, and is now restraining activity and medium-term inflation pressures.
"Provided that the outlook for inflation continues to improve and there is no excessive exchange rate depreciation, we would expect to lower the OCR further.”
While the Kiwis are hoping for a slow rebound next year, the RBA expects the Australian economy to be still sluggish and perhaps not to start recovering until much later in the year; with inflation coming down to around 3% by mid 2010.
No one knows when the RBA will cut rates: after Wednesday’s Consumer Price Index figures for the June quarter and 2008 financial year, the best bet is sometime in the first half of 2009. The RBA won’t be publishing its new growth and inflation forecasts for about three weeks. The latest CPI numbers will be the basis for the new outlook.
But there won’t be any prediction that Australia will follow the New Zealand economy and contract, as it did in the March quarter, and as it almost certainly did in the June three months as housing, retail sales, exports and price rises crunched confidence and corporate profits.
Dr Bollard says inflation will return below the 3% limit of his target range within two years, which will allow him to cut borrowing costs further. But the betting is that rates will be cut much sooner.
It wouldn’t surprise to see a further trimming as a Christmas present in December, after the election.
NZ’s battle isn’t limited to that country: inflation is hurting economies the world over, as are higher interest rates caused by the credit crunch and slowing growth. Banks are in trouble in many countries.
NZ feels the backwash from the problems that have hit the Australian banks, but the collapse of confidence in the NZ housing sector is far more dramatic than the slowdown we are experiencing here.
House sales in NZ have fallen 30%-40% in recent months on a year ago.
At a predicted 5% rate for consumer inflation, NZ will match the current rate for the US and is exceeding the 4.5% rate for Australia and the 3.8% (and rising) rate for the UK and the 3.7% rate for the eurozone.
NZ consumer prices rose to 4% in the year to
