A plus and a minus

In recent weeks we have variously discussed the impact on the economy of plunging crude oil prices, the Reserve Bank’s shift away from a tightening bias, and the prospect of drought. The latest edition of our flagship Economic Overview, released earlier this week, draws all those threads together into a fresh set of forecasts.

As we noted last week, the dry summer will have a significant impact on agricultural production this year. Drought has now been officially declared for large parts of the South Island, and despite recent rains other parts of the country also remain drier than usual. This is a double blow for farming regions already braced for the lowest dairy payout in five years, and it is likely to take a big chunk out of quarterly GDP growth in the first half of this year, thanks to a sharp fall in milk production in coming months and lower meat production later this year (after an initial boost due to early culling).

However, in our judgement the positive development of cheaper petrol prices is likely to have a bigger knock-on effect on the wider economy. Accordingly, we have lifted our forecasts for New Zealand GDP growth over the next two years combined – albeit with more of the growth occurring in 2016, when the farm sector is expected to enjoy better growing conditions. Essentially, the impact of drought is sharp but concentrated, whereas the benefits of cheaper fuel are spread far more widely, affecting disposable incomes and profit margins across the economy – and as a result are more likely to spill over into consumption and investment decisions. What’s more, by demolishing any signs of inflation, falling petrol prices have indirectly contributed to the recent drop in fixed mortgage rates, which will fuel housing demand and further stimulate consumer spending in already buoyant urban parts of the country.

Last week’s economic data, which allowed us to test that hypothesis against a read of activity in the retail and housing markets in early 2015, offered mixed evidence in its favour. As expected, electronic card spending on non-fuel retail items surged in January, but house sales took an unexpected breather from their steep post-election ascent.