New Zealand economic outlook faces downside risks, downward pressure on inflation likely to remain

New Zealand economy’s growth rates recorded are quite encouraging, in principle. The Reserve Bank of New Zealand is seeking for the economy to expand 2.5 percent this year and 3.4 percent in 2017. Low level of interest rates, rise in residential construction, high population growth and increased incomes from the tourism sector is underpinning the economic growth of New Zealand. Commerzbank, in a research note, stated that it forecasts the New Zealand economy to grow 2.9 percent in 2016 and 2.7 percent in 2017.

However, risks on the downside continue to be high. The weak growth outlook for China, New Zealand’s key trading partner, and for other trading partners, is being a drag on the economic outlook. Also, further drop in commodity prices would lower GDP via a weaker contribution from foreign trade, according to Commerzbank.

Given this background, the central bank is quite worried about low milk prices in the country. Milk prices at present are trading more than 50 percent below their levels from early 2014. Subdued demand from China and Russia’s ban of dairy products from the EU has led to reduced demand. Meanwhile, milk production has increased in the EU, China and the US.

Even if demand for milk is growing in the emerging markets, the medium-term milk prices appear to be under pressure overall, stated Commerzbank. The RBNZ cut its medium-term projection for the milk powder price by nearly 10 percent in August. Thus, New Zealand’s terms of trade would continue to be impacted from low milk prices and therefore affect growth despite strong domestic demand.

Meanwhile, inflation continues to be the key concern of the central bank as it remains low despite decent growth. Low inflation environment globally is putting downward pressure on inflation rate of New Zealand. The RBNZ stated that that expansionary monetary policy put forth by several central banks has exerted upward pressure on the NZD exchange rate, which in turn is hurting the inflation rate through lower import prices.

As a result, inflation in the nation has remained lower than the central bank’s target range of 1 percent-3 percent since the end of 2015. There is no sign of improvement; however, the RBNZ cut its key rate by 50 basis points in 2016.

“The exchange rate is likely to keep tradable goods inflation in negative territory, with the downward pressure on the inflation rate thus likely to stay alive”, added Commerzbank.

The central bank projects inflation in the country to reach 0.4 percent in 2016 and 1.7 percent in 2017. Hence, reaching the mid value of the 1 percent -3 percent target range seems a long way off.