Prospects for the economy are much better than predicted by the Reserve Bank and the bank economists who are focused too much on the negative impact of the fall in dairy farm incomes.
The Reserve Bank and most of the bank economists are fixated on the fall in dairy farm incomes. This is blinding them to the large stimulus in the pipeline from falling interest rates, stronger population growth and the fall in the exchange rate.
This is particularly the case for consumer spending, the largest component of economic activity. But it has implications for much more than firms supplying goods and services to consumers.
The consensus view of the nine economic forecasters surveyed by NZIER is that consumer spending growth will slow from 3.1% in the 2014/15 March year to 2.8% in 2015/16 and 2.4% in 2016/17.
The economic forecasters are assuming the fall in dairy farm incomes will have a sizeable negative impact on consumer spending. This is despite there being no clear link between the two other than when the financial crisis temporarily drove both (see the chart).
I see parallels between current prospects and the experience in 2003 when a large fall in dairy product prices was followed by a period of strong growth in consumer
spending. In 2003 a sizeable fall in interest rates coincided with high net migration, with these positives overpowering the fall in dairy farm incomes.
The two periods of strong growth in consumer spending in the 1990s were also largely the result of falling interest rates coinciding with high net migration.
Interest rates recently reached the lowest level in a lifetime and net migration is adding almost 70,000 to the population per annum. This is a recipe for strong growth in consumer spending even allowing for the fall in dairy farm incomes.
If consumer spending and economic growth turn out to be significantly stronger than predicted by the economic forecasters in 2016 it will probably trigger market-led increases in interest rates and eventually at least moderate OCR hikes.
The chart shows annual growth in consumer spending (black line, left scale)
and the annual percent change in the ANZ NZD Dairy Product Price Index
(blue line, right scale).
Written by Rodney Dickens. Visit www.sra.co.nz to learn about SRA Ltd’s services.