New Zealand economy continues to face significant downside risks; inflation causes concern for RBNZ

Significant risks on the downside are still being faced by the New Zealand economy. Heightened financial markets volatility and subdued outlook of the Chinese economy are posing as major headwinds on the global front. This is adversely impacting the outlook of export. Moreover, the RBNZ is also worried about the current demand related downward pressure on prices of commodity, said Commerzbank in a research note. The economy is particularly being hit by constant low milk prices that are exerting huge pressure on the nation’s terms of trade.

The domestic dairy sector is being challenged by low prices of milk. The dairy sector accounts for more than a quarter of exports. Nearly half of the firms are having a negative cash flow because of low milk prices and therefore face significant financing risks. However, the sentiment outside of the dairy sector is quite positive, despite the New Zealand’s economic outlook facing a major risk from a constant slower growth in China. Currently, the domestic demand is driven by higher immigration levels, constant strong activity in the building sector, low interest rates and tourism, according to Commerzbank.

But, inflation is not able to gain from that. In Q4 2015, inflation disappointed markedly. Since the end of 2014, inflation has been lower than the central bank’s target range of 1%-3%. Stronger New Zealand dollar and lower commodity prices are posing as downward risks for inflation. This is making the RBNZ quite vigilant. The central bank had cut interest rates last year by 100bp. The RBNZ also cut the key rates in March by additional 25bp to 2.25%.

A stronger NZD is expected to be the main reason for the central bank to cut rates again. The currency is trading above the levels that the central bank justified in the view of subdued export prices. The central bank has not excluded additional easing of the monetary policy if the return to inflation target be at risk.