NZ economy still moves like Jagger, says HSBC

CLOSE to 18 months ago, HSBC described New Zealand as the "rock star economy of 2014". Among other things, this fuelled debate in the media about whether this description was apt.

A number of articles even asked what kind of rock star it was? New Zealand was, after all, the fastest-growing among the OECD economies in that year.

Earlier this year, we reaffirmed our view, suggesting 2015 could see an "encore for the rock star". But with the Reserve Bank cutting its cash rate last week, we are being asked whether we have got it wrong for 2015.

Although growth has been strong, inflation has been exceptionally and surprisingly low. In typical cycles, a ramp-up in output and jobs growth puts upward pressure on demand, which then begins to run ahead of supply, and this leads to higher inflation and wages growth.

This time it is different. Although GDP is expected to have grown at an annual rate of more than 3 per cent in the first quarter and employment was up 3.3 per cent - both strong rates of growth - CPI inflation was only 0.1 per cent.

It seems strong demand has been met by even stronger supply, leaving few price pressures. Explaining this has not been easy. We see at least four supply factors at work.

First, the fall in oil prices led to a sharp fall in petrol prices, which pushed down inflation in the first quarter.

Second, the high level of the New Zealand dollar, combined with cheap global manufactured goods, has held down the prices of imported goods.

Third, the pick-up in labour demand has been matched by new record-high inward migration.

And, fourth, labour market participation has also reached historic highs.

As might be expected, given the strength of the economy, the Reserve Bank lifted interest rates in 2014, fearing the strong growth would lead to a sharp pick-up in inflation. After all, history showed this is what tends to happen.

Not this time.

Having been surprised that inflation is much lower than expected, the central bank has now begun to reverse course. The Reserve Bank cut its cash rate by 0.25 percentage points to 3.25 per cent last week and may cut again this year.

After all, at close to zero, inflation is well below the mandated target of 1-3 per cent.

Of course, it is also worth keeping in mind the reason inflation is low is not because demand is weak; nor is it because the economy is growing too slowly, or because the unemployment rate is too high.

It is because strong demand has been met by sufficient supply.

The weakness in the global economy, particularly in Australia, has meant there are ample goods, services and workers available at reasonable prices to meet New Zealand's demand. It does not get much better than this. New Zealand has had strong growth and low inflation. This is what central bankers dream about.

How long this will persist is hard to know. But we continue to expect New Zealand to outperform most of the developed economies in 2015 and thus continue to deserve its rock star label.

Of course, on the question of what kind of rock star New Zealand is, different commentators have come up with different views. Is it Justin Bieber or Mick Jagger?

For us, we think perhaps Nirvana. Certainly, central bankers around the world would agree that strong growth and low inflation are close to a heavenly combination.

• Paul Bloxham is chief economist Australia and New Zealand at HSBC.

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